Abstract

How do the employer and the worker interact during a dismissal? This paper tests whether they cooperate to minimize costs or instead engage in conflict—i.e., deliberately amplify costs. We leverage a unique feature of the French labor market: an employer and a worker can jointly opt to replace a costly dismissal by a cheaper and more flexible “separation by mutual agreement” (SMA). Introduced in 2008, SMAs eliminate red tape costs, enable severance pay bargaining, and preclude litigation. However, we find that only 12% of dismissals are resolved through SMAs—far below the efficient level predicted by standard bargaining models. Surveying HR directors, we identify three drivers of conflict that hinder cost minimization: (i) hostility between the employer and the employee, (ii) employers using dismissals as a “discipline device” to maintain incentives, and (iii) asymmetric beliefs about subsequent labor court outcomes. Using counterfactual scenarios in the survey, we find that removing these three drivers of conflict would increase SMA adoption from 12% to 67% of dismissals. We confirm that less conflictual dismissals—due to either better employer-employee relationships or workers benefiting from early retirement—end more often as SMAs.