Severance payments in equilibrium unemployment

Under the insider wage model of Mortensen and Pissarides [Mortensen, D.T., Pissarides, C.A., 1994. Job creation and job destruction in the theory of unemployment. Review of Economic Studies 61, 397-415], this paper shows that (1) severance pay negatively affects market tightness (vacancy to unemployment ratio) and (2) the amount of severance pay is limited thereby insuring the employer a rational bargaining outcome. (c) 2006 Elsevier B.V. All rights reserved.