Optimal severance pay in a matching model
This paper extends Mortensen and Pissarides (1994) by introducing workers' risk aversion. In doing so, it provides a framework within which to study jointly the optimal supply of job security and the allocational and welfare consequences of government intervention in excess of private arrangements. Firms offer insurance in the form of simple explicit employment contracts featuring productivity-independent wages and severance pay. Contracts can be renegotiated ex post by mutual consent. Laissez-faire contracts are never renegotiated and fully insure workers. Positive severance payments are part of an optimal contract whenever employed workers enjoy positive rents over their unemployed counterparts. The optimal severance payment size is increasing in the expected income loss associated with job mobility. Hence it is positively related to unemployment duration. We present empirical evidence that legislated job security is positively correlated with the optimal severance pay according to the model. Such evidence cannot be explained in terms of reverse causation from high state-mandated job security to high job duration. Legislated firing costs well in excess of privately optimal ones have negligible welfare effects and a small negative impact on unemployment and its duration as wages fall to minimize the distortion.
|Date of creation:||2004|
|Date of revision:|
|Contact details of provider:|| Postal: Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA|
Web page: http://www.EconomicDynamics.org/
More information through EDIRC
References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Edward P. Lazear, 1990. "Job Security Provisions and Employment," The Quarterly Journal of Economics, Oxford University Press, vol. 105(3), pages 699-726.
- Henry Farber, 2003. "Job Loss in the United States, 1981-2001," NBER Working Papers 9707, National Bureau of Economic Research, Inc.
- Leena Rudanko, 2006.
"Labor Market Dynamics under Long Term Wage Contracting,"
2006 Meeting Papers
314, Society for Economic Dynamics.
- Rudanko, Leena, 2009. "Labor market dynamics under long-term wage contracting," Journal of Monetary Economics, Elsevier, vol. 56(2), pages 170-183, March.
- Leena Rudanko, 2005. "Labor Market Dynamics under Long Term Wage Contracting," 2005 Meeting Papers 876, Society for Economic Dynamics.
- Leena Rudanko, 2008. "Labor Market Dynamics under Long Term Wage Contracting," Boston University - Department of Economics - Working Papers Series wp2008-003, Boston University - Department of Economics.
- Martin Neil Baily, 1974. "Wages and Employment under Uncertain Demand," Review of Economic Studies, Oxford University Press, vol. 41(1), pages 37-50.
- Christopher A. Pissarides, 2002.
"Consumption and Savings with Unemployment Risk: Implications for Optimal Employment Contracts,"
CEP Discussion Papers
dp0542, Centre for Economic Performance, LSE.
- Pissarides, Christopher A., 2004. "Consumption and Savings with Unemployment Risk: Implications for Optimal Employment Contracts," IZA Discussion Papers 1183, Institute for the Study of Labor (IZA).
- Christopher Pissarides, 2002. "Consumption and savings with unemployment risk: implications for optimal employment contracts," LSE Research Online Documents on Economics 2211, London School of Economics and Political Science, LSE Library.
- S. Rao Aiyagari, 1994.
"Uninsured Idiosyncratic Risk and Aggregate Saving,"
The Quarterly Journal of Economics,
Oxford University Press, vol. 109(3), pages 659-684.
- Macleod, W.B. & Malcomson, J.M., 1991.
"Investments, Hold Up And The Reform Of Market Contracts,"
Cahiers de recherche
9114, Centre interuniversitaire de recherche en économie quantitative, CIREQ.
- Macleod, W.B. & Malcomson, J.M., 1991. "Investments, Hold Up and the Reform of Market Contracts," Cahiers de recherche 9114, Universite de Montreal, Departement de sciences economiques.
- Melvyn Coles & Adrian Masters, 2006.
"Optimal Unemployment Insurance in a Matching Equilibrium,"
Journal of Labor Economics,
University of Chicago Press, vol. 24(1), pages 109-138, January.
- Adrian Masters & Melvyn Coles, 2004. "Optimal Unemployment Insurance in a Matching Equilibrium," Discussion Papers 04-12, University at Albany, SUNY, Department of Economics.
- Pedro Portugal & Olivier Blanchard, 2001. "What Hides Behind an Unemployment Rate: Comparing Portuguese and U.S. Labor Markets," American Economic Review, American Economic Association, vol. 91(1), pages 187-207, March.
- Dale T. Mortensen & Christopher A. Pissarides, 1994.
"Job Creation and Job Destruction in the Theory of Unemployment,"
Review of Economic Studies,
Oxford University Press, vol. 61(3), pages 397-415.
- Mortensen, Dale & Pissarides, Christopher, 2011. "Job Creation and Job Destruction in the Theory of Unemployment," Economic Policy, Russian Presidential Academy of National Economy and Public Administration, vol. 1, pages 19 pages.
- Dale T. Mortensen & Christopher A. Pissarides, 1993. "Job Creation and Job Destruction in the Theory of Unemployment," CEP Discussion Papers dp0110, Centre for Economic Performance, LSE.
- Alfonso Rosolia & Gilles Saint Paul, 1998. "The effect of unemployment spells on subsequent wages in Spain," Economics Working Papers 295, Department of Economics and Business, Universitat Pompeu Fabra.
- Fredriksson, P. & Holmlund, B., 1998.
"Optimal Unemployment Insurance in Search Equilibrium,"
1998-2, Uppsala - Working Paper Series.
- Fredriksson, Peter & Holmlund, Bertil, 2001. "Optimal Unemployment Insurance in Search Equilibrium," Journal of Labor Economics, University of Chicago Press, vol. 19(2), pages 370-99, April.
- Fredriksson, Peter & Holmlund, Bertil, 1998. "Optimal Unemployment Insurance in Search Equilibrium," Working Paper Series 1998:2, Uppsala University, Department of Economics.
- Cahuc, Pierre & Lehmann, Etienne, 2000. "Should unemployment benefits decrease with the unemployment spell?," Journal of Public Economics, Elsevier, vol. 77(1), pages 135-153, July.
- Fella, Giulio, 2005. "Termination restrictions and investment in general training," European Economic Review, Elsevier, vol. 49(6), pages 1479-1499, August.
- Daniel Cohen & Arnaud Lefranc & Gilles Saint-Paul, 1997. "French unemployment: a transatlantic perspective," Economic Policy, CEPR;CES;MSH, vol. 12(25), pages 265-292, October.
When requesting a correction, please mention this item's handle: RePEc:red:sed004:794. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Christian Zimmermann)
If references are entirely missing, you can add them using this form.