Employment Protection and Incentives: Severance Pay vs. Procedural Inconvenience

I consider the effects of employment protection (EP) on workers’ incentives and thelabor market with search friction. EP is categorized into severance pay and proceduralinconvenience. Severance pay is merely a transfer of money from firms to dismissedemployees, while procedural inconvenience yields a wasteful cost. This difference iscrucial to workers’ incentives because severance pay is a benefit for shirking employees.Although it appears to negatively affect workers’ incentives, EP, particularly proceduralinconvenience, has a positive effect on incentives if EP is not severe. An optimalbalance exists between severance pay and procedural inconvenience