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Kyota Eguchi

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Financial compensation for dismissal: How much is paid in a trial?

Kyota Eguchi
Professor, Faculty of Commerce, Chuo University
Areas of Specialization: Labor Economics, applied microeconomics

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Employment protection legislation in Japan

Although Japan is said to have strict employment protection legislation (EPL), it is becoming clear through recent studies that the EPL is not necessarily strict compared to other developed countries.

Japan’s EPL has been codified in Article 16 of the Labor Contract Act, which stipulates that dismissal requires a reason with objectively reasonable grounds and that is considered as appropriate in general societal terms. Saying “you don’t have to come tomorrow” without any reason is not permitted at least by law, even if it may in reality. To put it the other way around, dismissal is possible if there is an adequate reason. It cannot be denied that in reference to Article 16 alone it is ambiguous as to in what situations and for what kind of reasons dismissal is recognized.

Because confusion is caused in real life if rules are ambiguous, rules need to be made as clear as possible. However, it turns out that this is somewhat difficult. As there are various jobs and industries and employment patterns are becoming increasingly varied, it is nearly impossible to specify detailed rules conditional on employment relations in advance. For this reason, Japan's EPL has been formed through the accumulation of precedents that reflect social justice in line with the state of the times, and it has eventually led to Article 16 serving as the end point of this process.

Financial compensation for dismissal

If we try to clarify the EPL, perhaps financial compensation for dismissal can be an effective option to obligate employers to provide an additional severance pay. While the amount tends to cause fierce debate, there is no doubt that ambiguity would be reduced if financial compensation for dismissal were introduced. Of course, because the monthly wages of workers vary greatly, rather than deciding on a fixed payment in all cases, for example, 1 million yen for every fired worker, it would be more desirable to make a payment equivalent to a worker’s monthly wage of several months or years, or a payment contingent on workers' tenures. Even in these cases, introduction of financial compensation for dismissal would make the EPL much clearer.

Introducing financial compensation for dismissal, however, would not be an easy task politically. There has been heavy resistance by the labor side such as the Japanese Trade Union Confederation to the idea of being able to fire people freely in return for some financial compensation. Additionally, the introduction of financial compensation would strengthen the EPL, thus employers would be reluctant to accept it.

Settlement money: fighting a year for wages of six months

While some economists and business persons have insisted that Japan’s EPL be ambiguous, the latest studies have revealed that on a practical level a going rate for settlement money in legal disputes on dismissal has been more or less established. A study by Ryo Kambayashi’s research group, which I got involved in, in Hitotsubashi University focused on lawsuits at the Tokyo District Court and has shown that the median value of settlement money is approximately equivalent to the half of the total monthly wages for the dispute period. In addition, the study by Yuichiro Mizumachi and Yoko Takahashi, the University of Tokyo, indicates that nearly the same levels are applied for the Labor Tribunal Decision introduced in 2006 (also referred to as the mini-trial system). Although some variation depending on the trial is inevitable due to the mixture of cases in which the claims of employers are clearly correct and cases in which the claims of employees are correct, the median value of amounts is almost identical between ordinal trails and the Labor Tribunal Decision.

At this going rate, if a person with a monthly wage of 500,000 yen is in dispute for one year, they are usually able to obtain 3 million yen. Not much is left over if attorney’s fees and the income that could have been gained through re-employment are considered. Note that this amount only applies if one goes through the judicial process. Additionally, Keiichiro Hamaguchi, a researcher in the Japan Institute for Labour Policy and Training, has demonstrated that the amount is much lower in cases such as mediation by the Labor Bureau. Actually, we should realize that many people choose to suffer in silence. At the very least, the reality in Japan is that settlement money is by no means large despite the supposed strictness of the EPL.

The effect of financial compensation

If a financial compensation rule were introduced, people who have been suffering in silence until now would be able to demand compensation. If the rule were adopted to provide several months of salary as compensation, this amount would be always guaranteed in trial. Firing costs would likely increase for companies that have not paid any compensation until now. This would particularly be the case for small businesses. The current situation, in which extremely unreasonable cases of dismissal are occurring, would likely be improved.

On the other hand, large companies have paid sufficiently additional severance pay for the compatibility with existing human resource management systems and negotiations with labor unions. If the going rate mentioned above was introduced as financial compensation for dismissal, this would have an affect on negotiations between employers and employees: Firing costs could get smaller for large companies.

Of course it is unclear whether large companies would often fire employees. Employment relations with high job security have enabled wages to be set low. In other words, from the perspective of workers, they have been enabled to collect wages over the long term. If the credibility of job security were significantly damaged, people would be less likely to contribute for their companies unless considerably high wages were paid from a younger age (although the wage payment may not be so much high as that paid in foreign-affiliated big investment banks).

The importance of building trust in industrial relationship

While the introduction of financial compensation for dismissal may have an impact on the human resource management system in Japan, we should realize that the essence of human resource management is to build trust in industrial relations. Upon firing workers, firm managers must pay much attention not only to the fired workers but also to the people who remain in companies. Since people left in companies are always watching what their managers do, managers should try to find a due process and show that the firing policy is fair, so that trust in industrial relationship is not much damaged. In fact, for many cases that make it to court, there has been no proper explanation on the dismissal or no trust between them from the beginning. While we tend to focus on how much compensation for dismissal should be paid, it is much more crucial for employers and employees to have a negotiation in the case in dismissal, and the EPL has just a significant role to give an opportunity for effective negotiations.

Kyota Eguchi
Professor, Faculty of Commerce, Chuo University
Areas of Specialization: Labor Economics, applied microeconomics
The author was born in Osaka in 1968. He graduated from the undergraduate school of Economics, the University of Tokyo in 1992, and received a Ph.D. in economics from the University of Tokyo in 2000. After serving as a research associate at the University of Tokyo, an associate professor at the Division of Policy and Planning Sciences, University of Tsukuba, and a visiting researcher at the University of Essex in UK, he has served at his current position since 2013. His books include Personnel Economics [Kyaria Risuku no Keizaigaku] (Seisansei Shuppan, 2010, sole author); Employment Protection Legislation in Japan [Kaiko Kisei no Ho to Keizai] (Nippon Hyoron Sha, 2008, joint author), Considering Employment Protection Legislation [Kaiko Hosei wo Kangaeru] (Keiso Shobo, 2002, joint author). His papers include “Trainers’ Dilemma of Choosing between Training and Promotion,” Labour Economics, vol. 11 (2004), 765-783; “Job Transfer and Influence Activities,” Journal of Economic Behavior and Organization, vol.56 (2005), 187-197; “Minimum Wages and Trainers’ Dilemma,” Labour, vol.24 (2010), 128-138.