Faculty of Economics and Business Administration Publications Database

The Effect of Dismissal Protection Legislation on the Stability of Newly Started Employment Relationships

Boockmann, Bernhard
Steffes, Susanne
Volume: 41
Number: 2/3
Pages: 347 - 364
Year: 2008

In this paper we examine the effect of German dismissal protection legislation on theindividual employment stability of newly started employment relationships. To identifycausal effects, we exploit changes in the threshold value for the applicability of dis-missal protection as a natural experiment. This allows us to identify the effect of dis-missal protection on the job exit probability in companies with six to ten employees.We address two key questions. First, does the waiting period of six months beforedismissal protection comes into effect increase the job exit probability as firms wish toend less productive job matches before legal employment protection applies? Second,does dismissal protection decrease the job exit probability after the waiting period?Unlike previous studies, we use individual job stability, not firm-level mobility rates,as the outcome. This approach has several methodological advantages. First, it is possi-ble to focus specifically on short-term spells. Due to transition periods granted to exist-ing employment relationships, the legislative change on which the natural experimentis based affected only newly begun employment spells. Second, we are able to accountfor employment changes that carry firms above or below the threshold value, thuschanging the application of dismissal protection. By contrast, previous studies had toclassify each firm into a treatment status for the whole period of analysis. Finally, weare able to account for substitution effects whereby firms increasingly use fixed-termcontracts for hiring once the law comes into effect.Our results show that there is a positive effect of dismissal protection on the individualemployment stability of newly begun jobs. The effect does not, however, apply in-stantly, but only unfolds after about 200 days of employment duration. Since this coin-cides with the length of the waiting period, we interpret this finding as support for acausal effect. By contrast, we do not observe a negative effect of dismissal protectionon job stability during the waiting period. Thus, there is no evidence of increasedsorting before dismissal protection applies.We perform several robustness checks. One of them concerns the use of fixed-termcontracts instead of regular employment relationships. We do not find that the resultsare altered substantially after excluding firms using fixed-term work. Thus, the poten-tial bias due to the use of fixed-term contracts appears to be small. A second robustnesscheck concerns changing the control group from firms with 11 to 14 employees to firmswith one to five employees. While the estimated effect of dismissal protection is similarin magnitude, it ceases to be statistically significant. This is most likely due to a smallernumber of observations, giving rise to larger standard errors.The estimated effects apply to newly started employment relationships. As the strin-gency of German dismissal protection increases with employment duration, they maybe interpreted as minimum effects. Previous studies have not found effects of dismissalprotection on job exit rates estimated for all employees. In contrast, our finding of asignificant effect even for newly started jobs suggests that the overall effects of employ-ment protection are substantial.