The employment effects of severance payments with wage rigidities

Firing costs have two separate dimensions: a transfer from the firm to the laid-off worker and a tax paid outside the firm-worker pair. To avoid the 'bonding critique' most of the existing literature implicitly assumes that, in the presence of wage rigidity, transfers have the same real effects as taxes. This paper shows that this presumption is in general misplaced, especially so when the degree of wage rigidity is endogenous. The predictions of our theory find empirical support in a panel data-set of OECD countries.