Severance Pay: Corporate Obligation to Long-Term Workers

Photograph by Nathaniel St. Clair

In recent months there have been a number of large retail companies that went into bankruptcy, most notably Sears and Toys “R” Us. In these and other cases, the public is naturally concerned about the plight of long-term workers who have often spent decades working for the same company.

We know from much research that many of these workers will never be able to find employment again at comparable wages, especially older workers in their 50s and 60s. In situations where workers are fortunate enough to have unions, they are generally entitled to some amount of severance pay, based on their years of employment. However, with the share of the private sector workforce in unions now under 7.0 percent, most workers can expect nothing if their employer shuts the doors.

U.S. workers are the exception in this area. Every other wealthy country in the world guarantees long-term employees some amount of severance pay if they lose their job. Only Montana guarantees any compensation to workers who are dismissed without cause.

There has been some recent movement to have the United States catch up to the rest of the world in this area. Senator Tammy Baldwin has proposed legislation which would require private equity funds to pay severance to workers they lay off.

This is a good start, but there is no obvious reason to treat workers employed by private equity differently from other workers. It would be reasonable to guarantee all workers severance pay if they are dismissed without cause.

A reasonable scale would be two weeks of pay for each year of service up to a maximum of 40 weeks. This would ensure that long-term workers at least get something when their company makes large-scale layoffs.

But more important than the money being paid to workers is the altered incentive structure for employers. If an employer can lay off a worker after 25 years, and not give them a dime, they won’t think twice about dumping a worker that they don’t think they need.

That story changes substantially if employers have to provide a long-term employee with 40 weeks of pay. In that situation, employers have a strong incentive to find ways to keep the worker employed. If the reason for the layoff is that they are changing their line of business so that the worker’s position is no longer needed, then the severance pay requirement gives the employer an incentive to retrain the worker to fit into the new line of business.

On the job worker training is an area where the United States seriously lags other countries, most notably Germany. While we will not be able to catch up to the best practices in other countries with a single measure, making it more difficult for companies to lay off workers will be a big step in the right direction.

A way to think about the severance pay requirement is that it requires the company to bear a burden that would otherwise fall on the worker and the government. Longer-term employees are likely to experience long periods of unemployment and then see substantial reductions in pay if and when they find a new job. This is a huge burden to them and their family.

In addition, they will likely to be drawing unemployment insurance and other benefits from the government, quite possibly for an extended period of time. Severance pay forces companies to internalize some of these costs.

Just to be clear, a severance pay requirement does not prevent employers from firing workers who are not doing their job, violate workplace rules, or provide other grounds for dismissal. Severance pay only applies to workers who are losing their job only for business reasons, not for cause. There will always be some borderline cases, but that is a small price to pay for giving long-term workers some measure of job security.

There is a new push, at both the state and federal levels, to provide U.S. workers with many of the benefits that workers in other countries have long taken for granted. The list includes paid family leave, paid sick days, and paid vacation. Severance pay should also be on this list. It should not be as easy to discard a worker who put in a quarter-century with the company as it is to take out the garbage.

This column originally appeared in the Austin American-Statesman.

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Dean Baker is the senior economist at the Center for Economic and Policy Research in Washington, DC. 

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