Severance Payments and Unemployment Insurance: A Commitment Issue

Richard Martin (), Steeve Mongrain and Sean Parkinson

Journal of Public Economic Theory, 2004, vol. 6, issue 4, 593-606

Abstract: In the event of a job termination, many workers receive severance payments from their employer, in addition to publicly provided unemployment insurance (UI). In the absence of a third party enforcer, contracts featuring severance payments must be supported by an implicit self‐enforcing contract. Workers believe employers will make severance payments only if it is in their best interest ex post. If firms discount the future deeply, they will reduce the severance payment they offer, in order to relax their incentive constraint. Workers are forced to bear risk, and too many workers are laid off. We show that a well‐designed public UI system can correct these distortions.

Date: 2004
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