Do companies cut wages or lay off workers during an economic crisis?

Many companies see crises as an opportune time to lay off or reorganise, but what are the considerations at play?

"Crisis" typed with a typewriter questions how organisations handle economic crises: through wage cuts or layoffs

Photo by Markus Winkler on Unsplash

Once a month, researchers from CBS write a column in Børsen, where they give readers a current and research-based perspective on the challenges that leaders face.

This month, Birthe Larsen, Associate Professor at the CBS Department of Economics and Business Economics, has helped investigate whether companies cut wages or lay off employees when the economic crisis hits. Many companies indeed see crises as an opportune time to lay off or reorganise, but what are the considerations at play?

Economic crises often lead to high levels of redundancies and rising unemployment. We saw this most recently during the corona crisis. Layoffs are costly for both employees and companies.

It is costly for dismissed employees, as they are placed in an uncertain and financially challenging situation. And it is costly for companies, because when the economy turns around and things pick up, they have to rehire. This process is resource-intensive for two reasons. Firstly, because it takes time to find the right employee and secondly, because it takes time to train a new hire.

So why don't companies cut wages to a greater extent to avoid layoffs? And what are their general considerations when making layoff decisions during an economic crisis?

That is what I have been investigating in a research project with researchers at the University of Copenhagen, Bergen School of Economics and the San Francisco Fed.

How do you adapt?

In the summer of 2021, we asked all Danish companies about their layoff and wage policies in the first pandemic year of 2020. We were interested in how they adapted their workforce during the corona crisis in 2020, whether it was through an adjustment to the number of employees or a salary reduction.

We also asked them about the reasons for the adaptation strategy they chose to follow. We used quantitative, open-ended, hypothetical and qualitative questions to understand how and why employers undertook the adjustment process. We then linked our survey to register data for all companies and employees to gain insight into which companies did what. The final dataset has responses from 2400 companies and is a representative sample of the population of Danish companies.

Around 70% of companies agree that pay cuts hurt morale

First, as expected, we found that layoffs are more common than pay cuts, but that pay cuts are far from rare.

Among companies that experienced a reduction in revenue in 2020, 29% took some form of pay cut. We also found that 68% of companies changed the number of employees or hours worked.

Perhaps surprisingly, we found that salary reductions are not at all uncommon in a normal year, even in years when there is no economic crisis. We see that even in a normal year, such as 2019, many employees experience a pay cut.

Big pay cuts to save jobs

Secondly, we found that most companies don't consider a pay cut as a possible alternative to layoffs. More than half of companies disagree that they could have reduced pay instead of laying off employees. When asked directly about a hypothetical necessary pay cut to save an employee from being laid off, they respond that the pay cut would have to be over 20%.

Another important observation is that many companies see crises as an opportune time for companies to lay off some workers. In fact, most of the companies surveyed stated that during recessions it is easier to lay off less productive employees, change employee tasks or reorganise. And almost a quarter of companies say that all the layoffs that took place in 2020 would have happened in 2020 or the following two years anyway, even without the scary embrace of the pandemic.

Damaging to morale?

Thirdly, we looked at the main reasons for not lowering base salaries. Around 70% of companies agree that pay cuts hurt morale, more than 60% agree that pay cuts would cause employees to quit, and 60% see base pay as a commitment to employees. Therefore, our research suggests that while morale matters, the role of base salary as a commitment to employees and the fear of employees quitting also play a role in not cutting pay.

And finally, we show that worker skills and the time it takes for a company and employee to find each other are the most important considerations in layoff decisions. For those companies that experienced a reduction in revenue in 2020, a full 90% agree or strongly agree that they want to retain current employees to avoid loss of skills and knowledge, 70% agree or strongly agree that they have difficulty finding and hiring a new employee quickly as the economy recovers from the crisis.

This confirms that company-specific work experience and finding a good match between company and worker are extremely important considerations in a company's layoff decision.

You’ve just gained new insight thanks to CBS Leadership Centre.

CBS Leadership centre is connecting researchers and leaders around a shared ambition: to enable professionals to successfully assume their leadership and create value and resilience in businesses and organisations –and bring on necessary transformation fueled by significant societal agendas such as green transition, diversity, digitalisation, innovation and ethics.

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