Lump-sum severance pay from which shirkers can be excluded raises employment in an efficiency
wage economy. However, severance payments are usually related to wages. It is shown that
earnings-related, mandated severance pay will have ambiguous employment effects if effort can be
varied continuously. A substitution of the earnings-related for the lump-sum component reduces
employment. Thus, the predominating form of severance payments in OECD countries might have
less advantageous employment effects than previously conjectured.