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Severance Payments as a Commitment Device

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  • Florian Baumann

Abstract

The present paper analyzes the role of severance payments in optimal labor contracts, employing an efficiency-wage model with two-sided moral hazard. We show how employers commit to job security for their workers by using severance payments, but that in general, employees are not fully compensated for the loss in income in the event of a layoff. By extending the analysis we establish a positive relation between investment in firm-specific training and the probability that a worker dismissed for behavioral reasons receives severance payments, and suggest that a mandatory increase in severance payments may yield a Pareto improvement.

Suggested Citation

  • Florian Baumann, 2010. "Severance Payments as a Commitment Device," Journal of Institutional and Theoretical Economics (JITE), Mohr Siebeck, Tübingen, vol. 166(4), pages 715-734, December.
  • Handle: RePEc:mhr:jinste:urn:sici:0932-4569(201012)166:4_715:spaacd_2.0.tx_2-h
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    References listed on IDEAS

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    1. Giorgio Brunello, 2006. "Workplace Training and Labour Market Institutions in Europe," ifo DICE Report, ifo Institute - Leibniz Institute for Economic Research at the University of Munich, vol. 4(4), pages 33-41, 02.
    2. Edward P. Lazear, 1990. "Job Security Provisions and Employment," The Quarterly Journal of Economics, Oxford University Press, vol. 105(3), pages 699-726.
    3. Burguet, Roberto & Caminal, Ramon, 2008. "Does the market provide sufficient employment protection?," Labour Economics, Elsevier, vol. 15(3), pages 406-422, June.
    4. Margarita Katsimi, 2008. "Training, Job Security And Incentive Wages," Scottish Journal of Political Economy, Scottish Economic Society, vol. 55(1), pages 67-78, February.
    5. repec:ebl:ecbull:v:10:y:2006:i:1:p:1-7 is not listed on IDEAS
    6. Ichino, Andrea & Polo, Michele & Rettore, Enrico, 2003. "Are judges biased by labor market conditions?," European Economic Review, Elsevier, vol. 47(5), pages 913-944, October.
    7. Kaplow, Louis & Shavell, Steven, 1994. "Accuracy in the Determination of Liability," Journal of Law and Economics, University of Chicago Press, vol. 37(1), pages 1-15, April.
    8. Brander, James A & Spencer, Barbara J, 1989. "Moral Hazard and Limited Liability: Implications for the Theory of the Firm," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 30(4), pages 833-849, November.
    9. Richard Martin & Steeve Mongrain & Sean Parkinson, 2004. "Severance Payments and Unemployment Insurance: A Commitment Issue," Journal of Public Economic Theory, Association for Public Economic Theory, vol. 6(4), pages 593-606, October.
    10. Fella, Giulio, 2000. "Efficiency wage and efficient redundancy pay," European Economic Review, Elsevier, vol. 44(8), pages 1473-1490, August.
    11. Booth, Alison & Chatterji, Monojit, 1989. "Redundancy Payments and Firm-Specific Training," Economica, London School of Economics and Political Science, vol. 56(224), pages 505-521, November.
    12. Kenji Azetsu & Taro Kumagai, 2006. "Severance pay and the accuracy of judgment," Economics Bulletin, AccessEcon, vol. 10(1), pages 1-7.
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    Cited by:

    1. Boeri, Tito & Garibaldi, Pietro & Moen, Espen R., 2017. "Inside severance pay," Journal of Public Economics, Elsevier, vol. 145(C), pages 211-225.
    2. Ashok Thomas & Luca Spataro, 2013. "Pension funds and Market Efficiency: A review," Discussion Papers 2013/164, Dipartimento di Economia e Management (DEM), University of Pisa, Pisa, Italy.

    More about this item

    JEL classification:

    • J41 - Labor and Demographic Economics - - Particular Labor Markets - - - Labor Contracts
    • J65 - Labor and Demographic Economics - - Mobility, Unemployment, Vacancies, and Immigrant Workers - - - Unemployment Insurance; Severance Pay; Plant Closings

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