Economic compensation is the statutory severance payable under China's Labor Contract Law when an employment relationship ends in most employer-initiated scenarios — and in several scenarios foreign employers do not expect, such as the expiry of a fixed-term contract the employer chooses not to renew. The formula is one month's average salary per full year of service (half a month for periods under six months), with the monthly figure capped at three times the local average wage for high earners.
Why it matters
China has no at-will employment. An employer may only terminate on grounds enumerated in the statute, with proof. Lawful termination costs the standard compensation; termination a labor arbitration panel finds unlawful costs double (the "2N" penalty) or reinstatement at the employee's election. Because arbitrators interpret employer grounds narrowly and demand documentation, most contested dismissals of underperformers end in negotiated exits priced around N plus one month or more. Budgeting severance, documenting performance, and drafting employee handbooks that define "serious violation of rules" are what separate a controlled exit from a year of arbitration. Note that mutual-agreement terminations still trigger compensation when initiated by the employer, and severance interacts with any non-compete obligations you want to keep alive after exit.
Example
A US software company's Shanghai WFOE dismisses a sales manager with seven years of service for missing targets, paying nothing. The manager files labor arbitration; the company cannot produce signed performance standards or warning records. The panel finds the dismissal unlawful and awards double compensation — fourteen months of salary — plus the cost of a year of management distraction.
Common mistakes
- Assuming probation allows free termination — even that requires proof of failing recruitment conditions
- Skipping severance when a fixed-term contract simply expires without renewal
- Terminating for "poor performance" without prior documented warnings and training or transfer
- Forgetting the double-compensation penalty when grounds are shaky
- Ignoring the social insurance and unused-leave items that ride along with severance claims