Individual Dismissals in Europe and the United States: A Model on the Influence of the Legal Framework on Firing Costs

In this article, we present a model of individual dismissals based on the workers' right to file a suit against their employer arguing that the dismissal is unjustified or unfair. The model is a standard pre-trial bargaining game between a firm and a worker. We study two cases: when the law states the severance pay for unfair dismissal (the European case), and when judges can decide freely on the compensation to be paid to the worker (the American case). The model provides some guidelines for Labour Law reforms. In the European case, a decrease in the severance pay for unfair dismissals fixed by law will decrease the severance pay offered by the firm, and only under some assumptions will decrease the expected firing cost and will increase the settlement probability. In addition, the transition from the European to the American case is likely to increase the probability of settlement (and to decrease it in the opposite case) with ambiguous effects on agreed severance pay and expected firing costs.