The Impact of Firing Restrictions on Labour Market Equilibrium in the Presence of On-the-job Search


  • A previous version of this article was circulated under the title ‘Severance Packages’. We thank the editor and three anonymous referees for particularly helpful and constructive comments.


Job-to-job turnover provides a way for employers to escape statutory firing costs, as unprofitable workers may willfully quit their job on receiving an outside offer, or may be induced to accept one that they would otherwise reject with a negotiated severance package. We formalise those mechanisms within an extension of the Diamond–Mortensen–Pissarides model that allows for employed job search. We find that our model explains why higher firing costs intensify job-to-job turnover at the expense of transitions out of unemployment and that ignoring on-the-job Search leads one to overstate the adverse impact of firing costs on employment.