Pay Cuts vs. Lay-Offs

Recessions and downturns are part of a normal business cycle. When business is booming, corporations tend to hire more people than they need. This is the reason why these same corporations are later forced to lay off some of their employees during periods of recession.

However, layoffs are seen as being inherently negative. Companies that indulge in routine layoffs are often portrayed as being inhuman and materialistic. This is the reason why several companies have started replacing layoffs with pay-cuts for all employees. The financial effect is about the same in both the cases. However, whilst layoffs are viewed as being a PR disaster, pay-cuts are not. In this article, we will compare both pay cuts as well as layoffs to find the pros and cons of both.

Pay Cuts

  • More Humane: Pay-cuts are considered to be the more humane option when it comes to cost savings. In a way, pay-cuts follow the risk management principle. They distribute the risks and the extent of the damage. Hence, when pay-cuts occur, employees all over the company are forced to take a financial hit. As a result, everybody loses a small part of their salary instead of a few people losing 100% of their salary. Corporations can save the same sum of money via pay-cuts that they would have done by laying off people. Only the human cost is less. There are no devastated families, no suicides, and no foreclosures and so on.

    In fact, companies may end up saving money by using pay-cuts instead of layoffs. Companies have to spend a lot of money on public relations after they lay off people. Also, some companies are contractually bound to pay severance money. All this can be simply avoided by forcing employees across the board to take pay cuts. However, for the process to be fair, the employees at higher levels must sacrifice a greater portion of their income. For instance, when pay cuts were used in Las Vegas-based Wynn Corporation, employees with a salary greater than $150,000 took a 15% pay cut whereas employees whose salaries were lower only took a 10% pay cut.

  • Favored By the Government: Governments tend to favor pay cuts more than layoffs. This is the case for obvious reasons. In the case of layoffs, people are left unemployed, and also they do not have insurance. In most developed countries of the world, people only have insurance covers that their employers provide. Hence, when they are out of a job, they are also out of insurance coverage. Given the fact that job losses can be stressful, this is also the time when a lot of people end up incurring medical expenses. The government has to pick up the medical bill and also make welfare payments to the unemployed people. In the case of pay cuts, since nobody is out of a job and they all still have insurance, the government has to spend a lot less money.

Lay-Offs:

  • Adverse Selection: The problem with pay-cuts is that it tends to retain the worst kind of employees. Imagine being in a company which reduces your salary by 10%. If you are a productive employee, you will find other job offers in other companies who will be willing to pay you better. On the other hand, if you are a non-productive employee, there will be no offers for you from other companies. Hence, over the long term, most productive employees will leave the company. Only the non-productive ones will be left over. This is the reason why companies tend to prefer layoffs over pay cuts even though the former turns out to attract more negative attention. An ailing company needs to get rid of non-productive employees. When they choose pay cuts over layoffs, they do the exact opposite of what needs to be done. Hence, instead of solving a crisis situation, they end up creating a newer, bigger crisis.
  • Low Morale: Pay-cuts and layoffs have very different psychological effects on the average worker. Pay-cuts tend to demotivate workers. Studies conducted in this field have concluded that workers tend to slack off work once their wages are cut. They become less productive and less responsible. On the other hand, when layoffs occur, there is an atmosphere of fear. This makes workers more productive in the short run. Of course, in the long run, such type of relentless stress is sure to burn out employees. However, layoffs do seem to be better of the two evils.

To sum it up, pay cuts may be better if the entire economy or the entire industry is facing economic challenges. This will ensure that high performing workers do not get better opportunities outside. Hence, the company will be able to retain its talent, save money and also not attract any negative attention. However, if the other companies in the industry are doing well, and a pay-cut is announced, it is like an open invitation for them to poach your best talent. Just like other corporate decisions pay-cuts vs. layoffs cannot really be decided in a vacuum. The external situation does have a huge bearing on the decision.


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The article is Written By “Prachi Juneja” and Reviewed By Management Study Guide Content Team. MSG Content Team comprises experienced Faculty Member, Professionals and Subject Matter Experts. We are a ISO 2001:2015 Certified Education Provider. To Know more, click on About Us. The use of this material is free for learning and education purpose. Please reference authorship of content used, including link(s) to ManagementStudyGuide.com and the content page url.


Human Resource Management