Firing cost and firm size : a study of Sri Lanka's severance pay system

Consistent with its focus on social policies, Sri Lanka has devoted significant attention to worker protection. One of the main pillars of its worker protection policy is the Termination of Employment of Workman Act (TEWA) introduced in 1971. The act aims to limit unemployment by raising the cost of layoffs. The act requires that each layoff of a covered worker, whether individual or as a part of a mass layoff, must be approved by the government. Until recently, the government also decided on a case-by-case basis the level of severance pay the firm had to pay to the laid off workers. Since its introduction, critics have argued that the TEWA's non-transparent, discretionary, and costly regulations discourage employment growth, hinder reallocation of labor from inefficient firms to more profitable sectors, slow the introduction of new technologies, and increase unemployment. Defenders including trade unions and the government argue that on the contrary, severance pay promotes longer-lasting employment relationships that improve incentives for training and enhance cooperation and trust between employers and workers. The paper is organized as follows: section two provides an institutional background, highlighting the intensions of the TEWA at its introduction, and it's the provisions and procedures. Section three presents the theoretical framework and formulates hypotheses to be empirically tested. Section four describes the data and the identification strategy devised to identify the employment effects of TEWA. Section five presents the empirical results based on the estimation of the multinomial model of employment growth of firms. Section six concludes witha summary and policy recommendations.