Reforming Severance Pay

Severance pay is a valuable employee benefit that helps companies ease the transition of departing workers and reduce the cost of firing them. However, severance pay is only one component of the more comprehensive severance package, which often includes extended health benefits and outplacement services to help former employees find new employment. The amount of severance pay an employer offers can vary significantly depending on the company, industry and state regulations. It is important to consider all of the severance package components when determining a fair payout for departing workers.

The early, if misdirected, focus on firing cost distortions in the literature has obscured the broader role of severance programs as an essential instrument for job displacement insurance. This is a key policy instrument for increasing the productivity of firms by improving their ability to discharge inefficient or unproductive workers. This paper argues that severance packages are effective only if they are carefully designed to achieve this goal. It provides a 183-country review of existing severance programs and outlines three hypotheses regarding the economic rationale for these policies.

Section 3 considers the impact of severance pay mandates on aggregate labor market outcomes such as unemployment and employment. Although initial research suggested that mandatory severance pay might have negative effects on these outcomes, subsequent work has provided reassurance that such impacts are modest or trivial, and that the benefits of severance programs outweigh their costs.

Reforming Severance Pay – An International Perspective

In section 4, the author reviews the design of severance programs in different countries and industries. He finds that the optimal program design differs across industrial sectors, economies and worker job skills. Nevertheless, the general pattern is a combination of insurance-motivated and control-motivated elements. He argues that severance insurance-oriented schemes are effective in reducing the cost of firing a productive worker but that they also introduce avoidance incentives that reduce firm efficiency.

In today’s rapidly evolving work landscape, characterized by technological advancements, globalization, and shifting employment norms, organizations are compelled to adapt their severance practices to meet the evolving needs of employees and the demands of the modern workforce. As traditional employment models give way to gig work, remote arrangements, and agile organizational structures, the dynamics surrounding terminations and severance pay calculator are undergoing transformation, necessitating a reevaluation of established practices and policies.

The final chapter of the paper considers the implications of these findings for severance pay reform. It focuses on the use of severance packages to encourage worker retention, an issue that is particularly salient in Latin America where high severance payments may be associated with substantial disciplinary separations. This alternative use of severance pay is distinct from the insurance-motivated version but can have important productivity consequences when used to discourage the release of individually unproductive workers. The discussion is complemented by a brief comparison of this alternative use of severance packages with the more typical, insurance motivated design of severance plans.