Do firms obey the law when they fire workers? Social criteria and severance payments in Germany

Purpose – Employment protection legislation defines social criteria according to which firms can dismiss workers. If firms evade the law, then negotiation about compensation begins. To reduce the legal and financial uncertainty often associated with ex post bargaining, the German government stipulate severance payments in the case of mutual agreements in law in 2004. This paper aims to examine whether social criteria affect the dismissal probability of workers. Design/methodology/approach – The probability of receiving compensation and the factors determining the amount of severance payment are estimated when it comes to private negotiations about the termination of an employment contract. In addition, the effect of the reform of the employment protection legislation on the probability of receiving compensation and the amount of redundancy pay is analysed. A stepwise estimation strategy is developed to account for sample selection bias when examining which workers receive severance payments and the determinants of severance pay variation. Empirical evidence is provided using German panel data for the period 2000‐2006. Findings – The paper shows that workers protected by law have the lowest probability of being dismissed. The expected severance payment and firm size increase the probability of receiving compensation while the amount of severance payment depends significantly on the way the employment relationship is dissolved. Contrary to the intention of the legislator, the reform increases the level of compensation. Originality/value – The paper fills a gap in the literature by taking into account selectivity bias when estimating the probability of receiving redundancy pay and the size of compensation. The evidence also provides insights which may be useful for the ongoing discussion to reform employment protection legislation in Germany.