Guideline for employment problems / SHARING: 5.1 Comprehensive formula for calculating severance pay
First literature search: most plausible interventions
During the orientation process of the available literature, we identified the following interventions as most plausible for distributing financial resources in a fair way (sharing) in employment disputes related to dismissal:
Severance pay makes up for a large portion of the costs of dismissals borne by employers. Garibaldi and Violante (2005) find that severance pay accounts for about two thirds of total dismissal costs for employers in Italy. Fifty percent of the total cross-country variation in the OECD strictness of employment protection legislation that seeks to protect the interests of employees is also attributed to severance pay (Boeri, Garibaldi and Moen 2013). Clearly, severance pay has the potential to impact the well-being of the employer as well as the employee. Hence, in this recommendation we try to find a method to formulate the severance pay such that it is fair to both parties to a dispute related to dismissal: the employer and employee.
A severance pay is given to a dismissed employee to provide him or her an income until the time he or she is re-employed. The generosity or level of severance pay (also known as termination pay, redundancy pay) depends on the nature of the dismissal. Severance pay is not provided when an employee is being fired for disciplinary reasons, unless a court deems the dismissal to be unfair which is when the employee can claim a higher compensation. If the employee is being dismissed for reasons not related to his/her behaviour or for serious misconduct on part of the employee, then it constitutes a fair dismissal where the employee is entitled to receive a severance pay (Boeri, Garibaldi and Moen 2013). In such cases, the reasons for dismissal can be related to operational purposes, economic circumstances of the employer, lack of suitability for the job of the employee, definite term contracts, liquidation, bankruptcy of the form or other such economic reasons, breach of duties by the employee or long-term sickness of the employee.
It is important to note here that often employees are given a severance pay in lieu of a notice period. A notice period gives an employee enough time to secure another employment, before he or she loses the previous source of income or employment. When employees receive severance pay in lieu of notice period, they receive an amount that is equivalent to the period for which they would have worked in the notice period. At times, employees get both: a notice period and severance pay. It is not clear in literature if the calculation of severance pay differs in presence of notice period. So we also keep this recommendation broad, such that we recommend one single formula of severance pay irrespective of whether it is accompanied by a notice period.
This recommendation pertains to dismissal where the employer dismisses the employee without notice and violates terms and conditions outlined in the contract of the employee when the worker is not guilty of serious misconduct (ILO 1995). Here, the employment relationship is being terminated for reasons such as operational purposes, economic circumstances of the employer, lack of suitability for the job of the employee, definite term contracts, liquidation, bankruptcy of the form or other such economic reasons, or long-term sickness of the employee. The terminology for such dismissals vary across countries, so instead of using particular names, we are specifying the core reason for the dismissal so that the reader can judge despite inconsistency in the terminology.
The recommendation is applicable for employees who are employed in the formal economy. Rules and regulations governing short-term contracts, zero-hour contracts or relationships of people in the informal economy and so on may be distinct from the rules governing employees with permanent contracts. As a result, this recommendation may not be applicable there. However, that does not preclude this recommendation from being taken into consideration when formulating rules on severance pay for such employment relationships in the future.
In the below paragraph, we will compare two methods used to calculate severance pay:
Current formula of severance pay (Laws, collective agreements and specific contractual obligations)
Comprehensive and systematic way of developing severance pay formula
There is multiplicity in the laws and institutions that govern the calculation of severance pay. As mentioned before, employment law, collective agreements, common law as well as the actual contract drafted between the parties, can all be used to determine the severance pay. In such cases, employers and employees can contest the incidence of severance or the generosity of severance in courts. As a result, courts have also been involved in the determination of severance pay. Courts involved in the adjudication of such cases have taken into account various factors that were otherwise not included in laws, collective agreements and contracts that determined severance pay.
A Canadian court in the case Bardal vs The Globe and Mail Ltd., for example, identified that the below factors need to be taken into consideration when determining the severance pay of an employee:
So far, Canadian courts have applied the Bardal factors in 1,010 other judicial decisions as of June 2015, according to the database maintained by the Canadian Legal Information Institute (Thornicraft 2015, p.782).
As mentioned before, at times severance pay is given in lieu of the notice period. In such cases, employers have to arrive at a notice period that is acceptable and fair to both parties keeping in mind that the notice period can be switched with a monetary compensation. To help employers provide employees with the right amount of severance pay, McShane and McPhillips (1987) identified the factors that significantly affected the length of notice awarded in more than 100 British Columbia cases between 1980-86. They find that seven predictors account for 69 percent of the variance in reasonable notice awards. They are:
In West Germany, a survey of labour courts show that 75% labour courts calculate the severance pay based on tenure (in years) and the last monthly gross wage of the employee. This severance pay acts as the baseline pay. It is then modified by taking into consideration the characteristics of each case such as
In Bohemier v. Storwal International Inc., Justice Saunders of Canada ruled that the notice period or severance pay has to be reasonable for both parties, the employer and employee. If the employer is functioning in an unfavourable economic environment, it should be possible for him or her to reduce the staff without having to bear large dismissal costs.
Following from what we discussed above, this intervention suggests the following factors should be used to determine the severance pay: 1) age, 2) tenure, 3)
character of employment, 4) firm size, 5) economic condition, 6) availability of new employment, 7) gender, 8) salary 10) cost of employment `11) alimony. These factors have been identified by courts while adjudicating disputes between employees and employers over severance pay whereas factors outlined in the first intervention have been determined by laws, collective agreements, macro-economy and political economy and a few miscellaneous factors.
Holzman et al. (2011) establish the economic rationale for severance pay. They reason that ‘’severance payment is a primitive form of social benefits which predate or complement existing benefits for unemployment and retirement and that it also functions as a job protection instrument. Based on that hypothesis, they identify the following factors as determinants of severance pay: 1) per capita income of the country 2) unemployment benefits 3) pension and 4) union density ( political economy factor). The authors perform correlation analysis using empirical data which indicates that these factors are taken into consideration by policymakers while making decisions on labour rights and social protection programmes.
A model developed by Goerka and Panenburg (2015) predicts that the generosity of severance payments increases if firms expect court-awarded payments to be high. As a consequence, the incidence and expected level of severance pay increases with the determinants of such payments (implicitly) laid down by employment protection legislation. The model also predicts that employers are less likely to provide a generous severance pay or provide a severance pay at all, if the employee cannot bear the financial costs associated with a court dispute. Thus, two additional factors of severance pay emerge from this model: 1) expected court-awarded payment and 2) the ability of an employee to afford a court dispute.
To sum up, this intervention uses the following 18 factors to determine an employee’s severance pay: 1) age, 2) tenure, 3) character of employment 4) firm size, 5) economic condition 6) availability of new employment 7) gender, 8) salary 10) cost of employment `11) alimony 12) per capita income of the country 13) unemployment benefits 14) pension and 15) union density 16) expected court awarded payments and 17) ability of employee to afford a court dispute 18) pension entitlements forfeited due to job loss.
For parties to an employment dispute related to dismissal looking to distribute (share) financial resources in a fair way, is the current four factor method of calculating severance pay or a comprehensive formula that takes into account additional factors more effective for well-being?
To assess the status quo of the formula of severance pay and identify severance pay, Google Search and Google Scholar were used.
Keywords used in the search strategy are: Severance pay formula, determinants of severance pay, recession, labour courts, factors that compose severance pay, economic downturns, gender
Quality of evidence and research gap
Note: In the below section, we will compare the advantages and disadvantages of each intervention (current formula for calculating severance pay and severance pay as calculated by courts). Both interventions have overlapping factors that determine severance pay, namely tenure/length of service, age of employee, salary, and age. Despite being present in both interventions, these factors have not been included uniformly across countries, so it becomes important to list their disadvantages and advantages so as to come to a common understanding on the calculation of severance pay.
According to our research method, we grade the quality of evidence as low. Many of the articles are based on court cases and are not backed up by robust statistical analysis, empirical research, meta-analyses or systematic reviews. This can be explained by the fact that in the absence of proper guidelines that define severance pay, courts have set a precedent by factoring in every employee’s personal circumstances as well as the macroeconomic context that employee lives in. These one-off decisions then became baseline decisions for other courts. Additionally, due to the lack of data and scholarship, it was challenging to identify undesirable outcomes for most of the factors.
Keeping in line with this methodology of developing recommendations, in the section of desirable and undesirable outcomes, we are mentioning factors associated with each intervention that have outcomes identified in literature. Unfortunately, research on many of the factors is lacking despite the wide usage of the factor across court decisions or laws. Yet, we would like to present these factors as evidence because a) we want to provide practitioners an overview of the different factors that go in severance pay calculation across different countries and b) we could not access some of the research that could have justified the inclusion of the factor because it was available in a language other than English c) it makes intuitive sense. To explain the third point, intuitively, we know that men may be required to pay alimony which is an amount previously agreed upon between the couple. In the event that the man loses his job, he might still be required to pay the alimony regardless of him being employed or not. To protect the financial well-being of the employee, it is necessary that the alimony sum is taken into account while calculating his severance pay.
Following are the factors that literature does not offer desirable and undesirable outcomes for but are relevant to the recommendation.
Level of expected court-awarded payments: ‘’Empirical data from Socio-
Economic Panel (SOEP) for 1991–2006 in West Germany shows that severance payments offered by firms in order to avoid a verdict rise with the level of expected court-awarded payments’’(Goerka and Pannenberg 2009, pg.82).
Severance pay as determined by courts
Alimony, pension entitlements forfeited due to job loss, age, tenure, salary, firm size, probability of being re-employed: More than 75% of labour courts in Germany, use factors such as age, probability of being re-employed, firm size and alimony payments to determine severance pay along with classic factors of age, tenure and last monthly gross wage (Goerka and Pannenberg 2009, p.3).
Current formula to calculate severance pay (tenure, age, firm size and salary of the employee)
Comprehensive and systematic formula (Severance pay as calculated by courts, macroeconomic factors, miscellaneous factors)
Tenure: Associating tenure with severance pay ensures that workers invest time in the job before they reap employment related benefits and that employers don’t fire workers with little reason. There are fiscal benefits associated with adjusting severance pay with tenure and it also protects older employees from being fired. Severance is needed as moral hazard of employers prevent them from committing not to fire workers investing in the productivity of the job. At the same time, the nature of dismissal costs and the distinction between economic and disciplinary dismissals increases the moral hazard problem of workers as they can get away with it even when they shirk. The model developed by Boeri, Garibaldi and Moen (2013, p.2) shows that ‘’tenure-related severance pay increases productivity, reduces inefficient firing and induces an efficient allocation of labor’’. There are also ‘’social efficiency considerations for having employment protection increasing with tenure, e.g. related to the fiscal externalities associated to layoffs in presence of tenure-related unemployment benefit systems and/or job finding rates declining with age. There can also be equity considerations for offering stronger protection against layoffs to older workers…(p.7)’’
Age : Canadian courts posit that older workers are likely to take a long time to find a new job, earn less money in the new job, will not be able to sustain that new job for a long time. So by factoring in the age of the employee, while calculating severance pay is important for his/her well-being. Following dismissal, “older workers, relative to their younger counterparts, return to work at lower rates, are less successful at returning to the earnings levels achieved before they lost their jobs, and are less likely to have sustained employment after returning to work.” (Thornicraft 2015, p.796). A recent Statistics Canada study, based on the Longitudinal Worker File (a database comprising a 10 percent random sample of all individuals with positive employment or self-employment income in any year from 1983 to 2010), concluded that while 17 percent of men who lost long-term employment (defined as 12 years’ or more tenure) between ages 50 to 54 years never re-entered the workforce, 53 percent of men aged 60 to 64 when they lost their jobs never returned to paid employment. Further, even when these men found paid employment, it was typically at much lower wage levels compared to their former jobs; similar patterns prevailed for women in the same age cohorts but women were even less likely to return to paid employment following long-term job loss. When they do find new work, it is more likely to be non-standard work such as part-time work, casual employment and self-employment. (Thornicraft 2015, p.797). The long notice periods for older workers will discourage employers from hiring older employees’’ (Thornicraft 2015, p.784).
Availability of alternate employment – When alternative jobs are not easily available, a high severance pay gives employees enough time to find a job. French and Treleaven (2014, p.29) recommend that where availability of alternative employment is small, even low-skilled employees should be given a relatively long notice period so that it gives them enough time to look for an alternative job.
Character of employment: Persons occupying senior positions will have greater difficulty in finding alternative employment. So its beneficial for the employee if his or her job status is is factored in while calculating severance pay. Some industries or sectors are dominated by a few companies. Employees working here will face difficulty in finding a job elsewhere. So the character of employment should also be factored in while calculating severance pay. Character of employer refers to the skillsets, level of responsibility of the employee as well as the peculiarities of the industry in which the employee works. Historically, courts have drawn a distinction between management and non-management employees in determining notice, and have assumed that the former may require more time to find similar employment than the latter (Ha-Redeye 2015). ‘The often-cited British case of Morrison v. Abernethy School Board, that persons in senior positions have more difficulty than those in lower-status positions securing a comparable position with another employer. Though some writers have questioned this assumption (England 1978; Harrison 1972), the labor market principle remains a popular justification for considering job status in the calculation of reasonable notice’ (McShane and McPhillips 1987, p.110). With regards to peculiarities of industry, courts have taken note of features of a particular industry. For example, in Bardal v. The Globe & Mail Ltd. the court recognised that there are few large metropolitan papers so the employee can work so he must receive a long notice period (Ha-Redeye 2015).
Size of employer/company : Small companies cannot afford a large severance pay especially in economically distressing times. So factoring in the size of the company will be in the interest of employers. A Canadian court in the case Gristey vs Emke Schaab Climatecare Inc. declared that employee’s notice period should be reduced by one-third. This decision was in support of small companies who faced financial setbacks in difficult economic situations (French and Treleaven 2014, p.29).
Economic conditions: It is in the interest of firms to take into consideration the economic or market conditions because analysis performed by Gamberoni, Uexkull and Weber (2010, p.3) shows that it’s more profitable for firms to reduce severance pay and then lay off workers while facing economic shocks.
Cost of employment: If an employee has incurred a significant cost while taking up the job, such a moving residence at a considerable distance or the spouse giving up a job opportunity, then its beneficial for the employee if this cost is taken into consideration while calculating the severance pay: ‘’Regression analysis of court cases in British Columbia between 1980-1986 shows that ‘individual’s cost of accepting employment with the defendant organization affects the length of notice awarded by courts. Specifically, the courts represented in our sample apparently were sympathetic to individuals employed less than three years with the defendant for whom that employment had entailed moving a considerable distance, leaving a secure job with another employer, or sacrificing a spouse’s job’’ (McShane and McPhillips 1987, p.115).
Per capita income: This factor affects the level of severance pay and has an impact on the well being of the employee. Simply put, according to this hypothesis, in high income countries, employees can fall back on other social security benefits such as pension and unemployment benefits, so the severance pay is reduced. In low income countries where employees cannot fall back on a safety net, the severance pay should be high.
Pension benefits and unemployment benefits perform a role similar to that severance pay. They are a form of job protection and income security for the employee. Therefore, while calculating the severance pay, an employer should take into consideration if the employee has a safety net to fall back on. In the absence of such benefits, employees should receive a high severance pay.
Trade unions: Unions can influence the severance pay of employees positively, which is advantageous for the employee. (Holzmann et al. 2011).
Level of expected court-awarded payments: Empirical data from Socio-Economic Panel (SOEP) for 1991–2006 in West Germany shows ‘’severance payments offered by firms in order to avoid a verdict rise with the level of expected court-awarded payments. Therefore, to arrive at an optimal severance pay, firms should factor in the level of expected court-awarded payment’’ (Goerka and Pannenberg 2009, p.82).
Employee’s cost of court procedure: ‘’Empirical data from Socio-Economic Panel (SOEP) for 1991–2006 in West Germany shows that the incidence and level of severance pay declines with the employee’s cost of a court procedure’’. So it is in the interest of firms to examine the employee’s ability to afford a court procedure (Goerka and Pannenberg 2009, p.82).
Existing formula to determine severance pay
Comprehensive and systematic formula for calculating severance pay
Age: ‘Canadian courts do take into consideration the age of the employee such that an older employee’s age is noted as a factor justifying increased notice, the court do not specify the exact amount of the increase awarded on account of the employee’s older age’ (Thornicraft 2015, p.783).
Gender: ‘Gender does not covary with the length of the notice awarded by the court’(McShane and McPhillips 1987, p.114).
Character of employment: These cases contest the assumption that senior employees have more difficulty finding comparable employment, and this proposition has been empirically challenged. Judicial notice of this assumption was rejected, absent explicit evidence demonstrating a link between the character of lost employment to any substitute employment (Ha-Redeye 2015).
Literature suggests that each country, court, and agreement has developed its own unique formula of calculating the severance pay. There is no uniformity in this formula. Often, its calculation left up to the discretion of the employer, who in turn depends on laws. At times, the employer makes necessary modifications according to the nature of employment.
As demonstrated above, laws, collective agreements and specific contractual obligations have a simplistic way of calculating the severance pay as opposed to courts that seem to have taken a more comprehensive approach, as they take into account several factors that have positive outcomes associated with them (McShane and McPhillips 1987; Goerka and Pannenberg 2010; Thornicraft 2015). Scholars have also established the importance of taking macro-economic and political economy factors into consideration while calculating the severance pay (Holzmann et al. 2011) along with a few miscellaneous factors (Goerka and Pannenberg 2009). Literature suggests undesirable outcomes of the two interventions are very few and not sufficiently strong enough to negative the positive outcomes. However, the lack of negative outcomes on the two interventions can also be indicative of the lack of research on the issue.
Comparing the two interventions, we conclude that a more comprehensive formula is more effective for the well-being of both the employer and employee as it takes into account various aspects that influence the well-being of the two, as compared to the current formula of calculating severance pay. By that, we mean the 1) age, 2) tenure, 3) character of employment 4) firm size, 5) economic condition 6) availability of new employment 7) gender, 8) salary 10) cost of employment `11) alimony 12) per capita income of the country 13) unemployment benefits 14) pension and 15) union density 16) expected court awarded payments and 17) ability of employee to afford a court dispute 18) pension entitlements forfeited due to job loss.
In practice, that would mean that each of these factors need to be assigned weights. The assigned weight may depend on the strength of the relationship between the factor and its ability to affect the well-being of the employer and employee. Moreover, not every factor will be relevant to every type of employment relationship or at a given time. All of which leads us to conclude that the calculation of severance pay is a complex and nuanced process. It needs the attention of an interdisciplinary and multi-level team of scholars, policy-makers and experts. Therefore, international development organisations need to play a role in developing a standard formula that can be taken as a baseline by a country or industry and then modified according to their requirements. Similarly, this standardised formula can also serve as a baseline formula for employers who can then adapt it to suit their own needs.
Meanwhile, from a practitioner’s perspective, this recommendation can serve a starting point when making decisions about the severance pay to be provided to employees.
The discussion in the balance of outcomes suggests that a more comprehensive and systematic way of calculating the severance pay is more effective for the well-being of the employer and employee as they try to resolve disputes related to dismissal and sharing of financial resources in a fair way.
This recommendation is based on the current way of defining severance pay, court rulings on the same and macro-economic factors identified by scholars with the help of regression analysis. Empirical evidence that shows benefits of including these factors in calculation of severance pay is lacking. So this recommendation is primarily based on theoretical justifications that establish the importance of these factors in calculation of the severance pay.
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