Employers' Unilateral Settlement of Dismissal Disputes

A legally binding unilateral settlement option for dismissal disputes could streamline the dismissal process, but concerns persist about the potential overuse of dismissals. To assess this claim, we develop a model of employment adjustment followed by negotiation under litigation threat, and show that, contrary to conventional wisdom, unilateral settlement can enhance total surplus and benefit workers with relatively high productivity when employment adjustment does not significantly hurt productivity. These results stem from a fundamental trade-off: employers must forgo potential worker output to avoid litigation costs, which alters the threat points of wage negotiations and dismissal decisions in favor of workers. Our findings suggest that properly designed unilateral settlement institutions can contribute to both stable employment, efficiency and distributional equity in labor markets beyond merely reducing litigation costs, particularly in contexts with high productivity retention rates.