Severance Pay Mandates: Firing Costs,Hiring Costs, and Firm Avoidance Behaviors

The potentially adverse labor market effects of severance pay mandates are a continuingsource of policy concern. In a seminal study, Lazear (1990) found that contract avoidance ofseverance pay firing costs was theoretically simple – a bonding scheme would do – but thatempirically the labor market distortions were large. Subsequent empirical work resolved theapparent paradox – firing cost effects are modest even without firm avoidance activities. Toexplore why that should be so, formal measures of severance-induced firing costs and hiringcosts are derived. Firing costs are, it turns out, systematically less than benefit generosityalone would imply. Moreover their interrelationship with hiring costs, often employed inempirical studies as a substitute measure, is complex, with co-movements varying in signand magnitude across policy parameters and the economic environment. Although theanalysis assumes a fixed benefit mandate, the cost measures are easily extended to assessthe impact of service-linked severance benefits on age-specific employment levels. Themodel permits design of a cohort-neutral severance mandate – which is not a flat ratestructure....