Reforming Severance Pay

Severance pay (or redundancy pay) is the world’s most widely used but perhaps least understood income protection program after employment termination. It is often blamed for creating significant economic inefficiencies ranging from reducing employment to restricting access to jobs for disadvantaged groups. Reforming Severance Pay: An International Perspective fills a gap in the literature by presenting a collection of worldwide overviews and labor market impact assessments, theoretical analyses, and country case studies.

Severence payments vary enormously across countries and industries, and their size is often driven by local law or collective bargaining agreements. As such, they can have significant ramifications on hiring and firing decisions, and therefore may affect overall employment levels. In addition, severance pay can influence workers’ incentives to find other employment, especially in a recession when unemployment is high.

A number of studies have focused on the potential distortions caused by employer-financed severance packages and their impact on layoffs. However, it is important to note that such concerns arise out of financing considerations rather than from the design of severance benefits. In fact, most OECD countries mandate that firms finance severance benefits for dismissed workers with the funding falling entirely on the firm (parsons, 2012d).

This financing arrangement is a fundamental difference from the way in which worker pensions are financed, with deposit insurance provided by the government (e.g., ERISA in the United States). A similar system might work for severance benefits, although this would be more costly than the prevailing arrangements and could potentially lead to less generous programs.

In many OECD countries, severance benefits are paid out based on the length of the employee’s tenure. A standardized formula, such as one week of pay for each year of service is usually used to calculate these benefits. As such, severance payouts can vary considerably from country to country because of the different laws and employment traditions that govern dismissal practices.

Reforming Severance Pay: An International Perspective

Finally, severance benefits may also differ from those mandated by the state due to differences in local employment and pension law. This can create challenges for global teams that have to develop severance packages that are compliant with all applicable laws.

In the end, severance benefits are a valuable tool for job displacement risk management. They are an alternative to actual loss-based unemployment or wage insurance, which can have disincentives for active job search and imposes substantial administrative costs. However, severance compensation should be designed to avoid imposing excessive financial burdens on hiring and firing decisions.

It should also be structured to provide workers with scheduled supplemental income that can help them weather a temporary decline in employment. In this context, how to get severance pay should be more generous if they are accompanied by additional employment security provisions that are more generous than those found in mandatory severance benefit laws.

Despite the lack of federal requirements, some states and local jurisdictions have laws mandating severance pay under certain circumstances. For example, in the state of California, employers with 75 or more employees are required to provide written notice 60 days in advance of a mass layoff, relocation, or termination affecting 50 or more employees within a 30-day period. Failure to provide this notice can result in the employer being liable for severance pay equivalent to the employees’ wages for the notice period.