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1. Introduction
The issue of job security regulations has been a very important topic in labor economics. Many studies have used evidence from their respective countries to analyze the impacts of job security regulations on the labor market. In this context, one of the mostly analyzed regulations is the severance pay, which is often considered as the cost of firing an employee.
Severance pay is a payment required to be made by the employer when an employee is laid off, or when an employee leaves the firm voluntarily for some specific reasons. Precise regulations with regard to severance pay are different across countries. For example, severance pay can be very large in some undeveloped countries but relatively small in some developed countries. Generally, the difference in severance payment systems across countries is usually caused by different expected usage of the severance pay.
According to Wu (2005), the usage of severance pay can be summarized into five ways from a legal viewpoint. First, it can be taken as substitute for unemployment insurance, as well as compensation for retirement pension when the employee is laid off before retirement. Second, when the employee is laid off involuntarily, the employer can use severance pay to compensate the employee for letting him/her be unemployed. Third, it can help ease the financial burden of the employee during the period of job search. Fourth, severance pay can also be taken as postponed wages. But in reality, there are few countries which have legislated severance payment regulation from this viewpoint. Fifth, employer can appreciate the employee for contributions in the past years by paying severance pay. Besides, Kuo (2000) also indicates that severance pay can reduce the incentive for the employer to lay off the employee
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arbitrarily. In other words, severance pay regulations can prevent or discourage arbitrary layoffs to some extent.
As described above, severance pay can be used in many ways, and regulations are decided by the expected usage of the payment. Usually, severance pay is regarded as an appealing regulation in developing countries (Parsons 2011) and the reason might be that most of the labor security regulations in these countries are not complete and thus severance pay plays a relatively important role in their labor market. At present, developing counties such as Taiwan, South Korea, Hong Kong and Singapore have severance pay systems in place. Besides, undeveloped countries such as China, India, Malaysia and Thailand also have their own severance pay systems (Huang 2006).
Although there are relatively few developed countries which have specific severance pay systems, some kinds of regulations which are very similar to severance pay are legislated in these countries also. In Germany, a payment called “Abfindung”
is made when the layoff is illegal and the laid off employee tends to leave the firm instead of going back. The corresponding amount then depends on the position of the employee in the firm, and what the employer can afford. Since such kind of payment can be taken as compensation for unemployment, one can regard it as severance pay (Wu 2005).
Different from Germany, severance pay in Japan seems more like a part of the retirement pension system. To be specific, job displacement payment is made when an employee leaves the firm before the regulated job seniority, and the corresponding amount is just the accumulated retirement pension payment based on the job seniority (Lin 2000). Since the job displacement payment can be used as compensation for unemployment and financial support during the period of job search, it can be regarded as severance pay.
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In Taiwan, the severance payment system is directly regulated by provisions in the Labor Standards Act (LSA) and is isolated from the retirement pension payment.
According to LSA, severance pay is required to be paid when the employee is laid off involuntarily due to reasons such as business contraction, shutdown or personnel adjustment. Besides, severance pay can also be mandatory when the employee voluntarily quits the job for some specific reasons listed in LSA.
Before implementation of the Labor Pension Act (LPA) in 2005, severance pay under LSA used to be the substitution of unemployment, compensation for retirement pension payment and prevention of arbitrary layoffs. Therefore, despite the severance pay system of Taiwan being very similar with England and Australia, the amount of severance pay is much larger in Taiwan. However, after implementation of LPA, the usage of severance pay is mainly for prevention of arbitrary layoffs and the amount of payment has become very small. Therefore, whether the layoff decision of the employer is affected by the reduced severance pay is exactly what this study expects to analyze by using some appropriate econometric methods.
When it comes to severance pay, most studies refer to Lazear (1990), which has reported some important empirical results. Theoretically, severance pay can have no effect in a perfect market when a properly designed labor contract is there (Lazear 1987). However, using macro data from 22 OECD countries over 29 years, Lazear (1990) found that even the employer can choose to hire part-time or temporary employees in order to avoid severance pay, severance pay and advance notice requirements still reduces employment. Also, severance pay is supposed to discourage the willing of labor participation, thus reducing the labor force and increasing the unemployment.
Different from Lazear (1990), Kugler (1999) used the repeated-cross sectional data from Colombian National Household Survey (NHS) to analyze the impact of the
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Colombia labor market reform of 1990 on labor turnover where an important policy change is a substantial reduction of severance pay. To examine the corresponding impacts before and after the reform, difference in differences method is applied by taking the employees in the former sector as the treatment group. The empirical results show that increased firing cost reduces unemployment only when the effect of the exit hazard rate on unemployment is greater than the exit hazard rate when out of unemployment, and vice versa.
Instead of analyzing employment, unemployment or turnover, Marinescu (2009) focuses on the impact of layoff rate by analyzing the British policy change in 1999.
After this reform, the tenure required for entitlement to protection against unfair layoff dropped from 24 to 12 months. This means employees with 12 to 23 months of tenure cannot be unfairly laid off easily as before. Therefore, firing cost increased substantially as the policy change extended the coverage of employees to whom the severance pay system is applicable. Data drawn from the U.K. Labour Force Survey (longitudinal data) is used, and the difference in differences method is applied by using employees with 24 to 48 months of tenure as the reference group. The empirical results show that firing hazard for workers with 12 to 23 months of tenure decreases by 26 % relative to the reference group, which is consistent with the expectation.
Recently, there have been a lot of studies which have examined the impact of severance pay on the labor market. For example, Hofer, Schuh and Walch (2011) use the Austria Employment Protection Legislation (EPL) reform of 2002 to examine the impact of severance pay on voluntary separation. However, the results suggest that severance pay has only limited impacts. Bassanini and Garnero (2012) exploit a unique dataset to compare hiring and separation rates between different OECD countries and businesses or industry sectors over 13 years. By decomposing the effect of regulations on number of layoffs, their results show that severance pay appears to
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have no significant impacts on worker flows.
Actually, severance pay is often a small part of a policy reform, which makes estimation of the effect of severance pay in isolation very difficult (Parsons 2011).
Except for Bassanini and Garnero (2012), none of the studies mentioned above isolate the effects of severance pay from other broader interventions and, therefore, they may have attributed too much to severance plans. Moreover, Parsons (2011) reviews a lot of severance pay related empirical literatures and finds that “severance benefit mandates, unaccompanied by other labor regulations, have little apparent impact on labor market behaviors.”
While earlier studies have often neglected effects from other regulations, recent studies tend to suggest that severance pay has only modest or no impacts on the labor market. It is interesting to examine the effect of the reduced severance pay on the layoff rate in Taiwan.
Until now, papers which discuss the relationship between severance pay and the labor market of Taiwan are mainly based on the legal viewpoint. Only a small number of papers have examined the impact of severance pay on the labor market of Taiwan by using econometric methods. For example, Huang (2006) analyzed the impact of severance pay on the unemployment rate by using macro data which include undeveloped and developing countries of eastern Asia over the period 1980 to 2003.
The results show that for undeveloped countries, severance pay has negative effects on unemployment rate in the short as well as the long run. And for developing countries, severance pay has negative and positive effects on the unemployment rate, short run and long run.
In this study, based on micro data set, the implementation of the Labor Pension Act (LPA) in Taiwan is used as a quasi-experiment for examining the effect of severance pay on layoff rate. The policy change involves two important regulations.
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First, retirement pension system has changed from defined benefit plan (DB) into defined contribution plan (DC). Second, severance pay for involuntary separation is reduced significantly, while the eligibility conditions for severance pay have remained unchanged.
Since only severance pay is directly considered as the firing cost, identifying the effect of severance pay is not that difficult; one would naturally expect the effect on the layoff rate to be positive (i.e. it would rise). Nevertheless, it is worth noticing that in the new pension system, employers are forced to contribute to retirement pension for the employees. Therefore, employers might be more inclined to recruit employees who might not be laid off in the future. Besides, Blanchard and Katz (1997) indicate that firing cost may affect the efficiency of sorting workers into the jobs they are best suited to, thus affecting productivity. As a result, employees hired after the reform might meet the expectations of the employers and have higher productivity, resulting in a lower layoff rate.
Whether an employee had been laid off in the last year could be observed by using the quasi-longitudinal data and the information with regard to the last job was used as control variables. Besides, difference in differences method is used to capture the effect of policy change by controlling the common time trends. Definition of the treatment and reference group is based on what kind of protection an employee was entitled to. To be specific, employees to whom LSA was applicable are defined as the treatment group, and employees to whom LSA was not applicable are defined as the reference group.
This study uses many different windows of observations to analyze severance pay effects and most of the results suggest that severance pay has no significant effect on the layoff rate. After dropping observations difficult to identify, i.e. whether they are affected by the reduced severance pay or affected only by the reduced severance
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pay, there is still no significant correlation between severance pay and layoff rate.
However, despite these results not being so surprising, as recent studies have shown, some constraints of this study could still affect the accuracy of the estimation for the effect of severance pay.
The rest of this study is organized as follows. Section 2 describes details of the Labor Pension Act (LPA) and outlines how it is different from the Labor Standard Act (LSA). It also mentions the reasons why the government wants to implement this reform. Section 3 briefly describes the dataset used in this study and explains the process of classifying the treatment and reference groups as well. Section 4 explains the simple idea of the difference in differences method and the corresponding assumptions. Section 5 presents descriptive statistics and Section 6 shows the results.
Section 7 presents the conclusions and some constraints faced in this study.
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