Layoffs and Litigation

Abstract

This paper studies a possible link between two trends that have affected the labor market over the last decade: increases in wrongful termination litigation and increasing frequency of mass layoffs. We model the displacement strategy of a firm faced with concave displacement costs and employees who vary in productivity. The firm has some periods of layoffs, where it displaces a relatively large group, and other periods where it engages in selective of only the least productive employees. We show that layoffs and firings are substitutes and that the set of steady-state policies shifts in the direction of smaller firings and larger layoffs as the cost of firings increases. We explore the relationship between displacement costs and layoff size by considering potential effects of the Civil Rights Act (CRA) of 1991. By increasing most firms' exposure to wrongful termination lawsuits, this legislation made displacements of smaller groups of workers more costly without proportionately affecting the costs of large layoffs. Using data from the Survey of Income and Program Participation (SIPP), we explore the effects of CRA91 using variation in protected status (specifically, race), state Fair Employment Laws, age, and employer size. We find evidence suggesting that CRA91 affected firms' choices about how to displace workers and had especially strong effects on the firing rates of black men.