Offering Pay Cuts to Stave Off Layoffs is Easier Said Than Done for Employers

Offering employees pay cuts in lieu of layoffs seems like a win-win situation for organizations and their workers. Or at least it looks good on the surface.

A recent working paper published in the National Bureau of Economic Research found that out of more than 2,500 workers collecting unemployment benefits in Illinois, 60% would have accepted a pay cut of 5% instead of being laid off, and a third would have accepted a pay cut of 25% to keep their job. Yet few employers offer pay cuts instead of layoffs. Just 3% of the surveyed workers reported being offered a salary reduction to avoid being laid off.

Ultimately, offering pay cuts to stave off layoffs is easier said than done, according to both the paper’s coauthors and an employee compensation expert. Organizations have to assess how much of a pay cut will be needed to avoid layoffs. And don’t forget that salary is just one part of labor costs, in addition to benefits and payroll taxes. Even if an organization does try cutting salaries to avoid layoffs, they probably won’t want to do so by more than 5% says Lori Wisper, a managing director at Willis Towers Watson’s rewards consulting business.

“When you take all this complexity into account, you can see why companies maybe say, ‘Ah, I'm just gonna do the layoffs,’” says Wisper. “There might be individuals who would [accept a pay cut], but when you do en masse, where it's holistic, it's just this total downer.”

She adds that if employers pursued pay cuts on a case-by-case approach instead, they could face accusations of unfairness and discrimination.

Plus, as some industries like manufacturing face continued labor shortages, implementing employee pay cuts could damage an organization’s competitive standing in the talent market. “You don't want to be the one employer that is not paying competitively in a labor market that still is low on employment,” says Wisper.

As previously reported by Fortune’s Geoff Colvin, welding equipment manufacturer Lincoln Electric has managed to avoid layoffs for over 70 years partly because of a policy that cuts worker hours when customer demand is low. But Lincoln CEO Christopher Mapes says other companies are unlikely to adopt the practice because its no layoffs policy is just one part of an overarching, resiliency-focused management philosophy. 

If a company does consider offering pay cuts instead of layoffs, Wisper urges leaders to think about how many jobs salary reductions could actually save, and the size of the reduction.

“A CHRO is going to be very careful about what they present to leadership, they're not just going to do it because employees say they would prefer that. There needs to be a business case for it,” says Wisper.

Steven Davis, co-author of the NBER, says there are five things that HR leaders should consider before raising the pay cut vs. layoffs tradeoff with top management: 

1. Don’t assume workers are willing to take a cut.
2. Be realistic about how big the cut will be.
3. Think about what the company can offer in lieu of salary: working remotely, for instance. 
4. How will you handle disgruntled workers who don’t want to take a cut?
5. Think hard about how much trust there is between management and workers. Without that, cuts probably won’t work.

“The HR team and senior management need a coherent, persuasive explanation for why pay cuts are needed to save jobs," says Davis. “And to persuade employees that it’s the right business decision and the fair thing to do.”

This article was written by Joseph Abrams and Paige McGlauflin for Fortune and was legally licensed through the Industry Dive Content Marketplace. Please direct all licensing questions to legal@industrydive.com.