IDEAS home Printed from https://ideas.repec.org/a/spr/izalpo/v6y2017i1d10.1186_s40173-017-0092-2.html
   My bibliography  Save this article

Optimal combination of wage cuts and layoffs—the unexpected side effect of a performance-based payment system

Author

Listed:
  • Izumi Yokoyama

    () (Hitotsubashi University)

  • Takuya Obara

    () (Hitotsubashi University)

Abstract

Abstract This study analyzes the trade-off relationship between layoffs and wage cuts. If the introduction of a performance-based payment system stimulates workers’ pecuniary-motivated minds, their morale can be damaged more severely by wage cuts than prior to the introduction thereof. Utilizing this idea, we demonstrate theoretically that the more heavily wages are based on performance, the more firms, fearing that workers’ morale will be damaged by wage cuts, try to avoid wage cuts and instead prefer layoffs. Next, we show empirically the trend whereby firms with performance-based payment systems are unlikely to implement wage cuts. Given this first-stage regression, the status of a performance-based payment system, based on the firm’s past decision and assured to be exogenous, is employed as an instrumental variable (IV) for wage cuts in a layoff regression model to overcome simultaneous bias. In the second-stage regression, the IV estimates for the impact of wage cuts on layoffs are significantly negative: if a firm implements wage cuts, it will reduce the probability of layoffs by 0.172. This supports the theoretical implication that implementing wage cuts can be a potential device for reducing layoffs. These results may imply an unexpected side effect of the increasing use of performance-based payment systems: as such systems become more widespread, layoffs will increase because firms will become less likely to impose wage cuts, thus potentially resulting in high unemployment.

Suggested Citation

  • Izumi Yokoyama & Takuya Obara, 2017. "Optimal combination of wage cuts and layoffs—the unexpected side effect of a performance-based payment system," IZA Journal of Labor Policy, Springer;Forschungsinstitut zur Zukunft der Arbeit GmbH (IZA), vol. 6(1), pages 1-15, December.
  • Handle: RePEc:spr:izalpo:v:6:y:2017:i:1:d:10.1186_s40173-017-0092-2
    DOI: 10.1186/s40173-017-0092-2
    as

    Download full text from publisher

    File URL: http://link.springer.com/10.1186/s40173-017-0092-2
    File Function: Abstract
    Download Restriction: no

    Other versions of this item:

    References listed on IDEAS

    as
    1. Sparks, Roger, 1986. "A Model of Involuntary Unemployment and Wage Rigidity: Worker Incentives and the Threat of Dismissal," Journal of Labor Economics, University of Chicago Press, vol. 4(4), pages 560-581, October.
    2. Grossman, Gene M, 1983. "Union Wages, Temporary Layoffs, and Seniority," American Economic Review, American Economic Association, vol. 73(3), pages 277-290, June.
    3. Jonas Agell & Per Lundborg, 2003. "Survey Evidence on Wage Rigidity and Unemployment: Sweden in the 1990s," Scandinavian Journal of Economics, Wiley Blackwell, vol. 105(1), pages 15-30, March.
    4. George A. Akerlof & Janet L. Yellen, 1990. "The Fair Wage-Effort Hypothesis and Unemployment," The Quarterly Journal of Economics, Oxford University Press, vol. 105(2), pages 255-283.
    5. Gibbons, Robert & Katz, Lawrence F, 1991. "Layoffs and Lemons," Journal of Labor Economics, University of Chicago Press, vol. 9(4), pages 351-380, October.
    6. Thomas Lemieux & W. Bentley MacLeod & Daniel Parent, 2009. "Performance Pay and Wage Inequality," The Quarterly Journal of Economics, Oxford University Press, vol. 124(1), pages 1-49.
    7. Heike Hennig-Schmidt & Bettina Rockenbach & Abdolkarim Sadrieh, 2010. "In Search Of Workers' Real Effort Reciprocity-A Field and a Laboratory Experiment," Journal of the European Economic Association, MIT Press, vol. 8(4), pages 817-837, June.
    8. Strand, Jon, 1991. "Unemployment and Wages under Worker Moral Hazard with Firm-Specific Cycles," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 32(3), pages 601-612, August.
    9. Sebastian Kube & Michel André Maréchal & Clemens Puppe, 2013. "Do Wage Cuts Damage Work Morale? Evidence From A Natural Field Experiment," Journal of the European Economic Association, European Economic Association, vol. 11(4), pages 853-870, August.
    10. Alan S. Blinder & Don H. Choi, 1990. "A Shred of Evidence on Theories of Wage Stickiness," The Quarterly Journal of Economics, Oxford University Press, vol. 105(4), pages 1003-1015.
    11. George A. Akerlof, 1982. "Labor Contracts as Partial Gift Exchange," The Quarterly Journal of Economics, Oxford University Press, vol. 97(4), pages 543-569.
    12. Akerlof, George A & Yellen, Janet L, 1988. "Fairness and Unemployment," American Economic Review, American Economic Association, vol. 78(2), pages 44-49, May.
    13. Yannis M. Ioannides & Christopher A. Pissarides, 1983. "Wages and Employment With Firm-Specific Seniority," Bell Journal of Economics, The RAND Corporation, vol. 14(2), pages 573-580, Autumn.
    14. Carl M. Campbell III & Kunal S. Kamlani, 1997. "The Reasons for Wage Rigidity: Evidence from a Survey of Firms," The Quarterly Journal of Economics, Oxford University Press, vol. 112(3), pages 759-789.
    15. Pedro S. Martins, 2009. "Dismissals for Cause: The Difference That Just Eight Paragraphs Can Make," Journal of Labor Economics, University of Chicago Press, vol. 27(2), pages 257-279, April.
    16. Lindbeck, Assar & Snower, Dennis J, 1988. "Cooperation, Harassment, and Involuntary Unemployment: An Insider-Outsider Approach," American Economic Review, American Economic Association, vol. 78(1), pages 167-188, March.
    17. Gordon, Donald F, 1974. "A Neo-Classical Theory of Keynesian Unemployment," Economic Inquiry, Western Economic Association International, vol. 12(4), pages 431-459, December.
    18. MacLeod, W Bentley & Malcomson, James M & Gomme, Paul, 1994. "Labor Turnover and the Natural Rate of Unemployment: Efficiency Wage versus Frictional Unemployment," Journal of Labor Economics, University of Chicago Press, vol. 12(2), pages 276-315, April.
    19. Derek Laing, 1994. "Involuntary Layoffs in a Model with Asymmetric Information Concerning Worker Ability," Review of Economic Studies, Oxford University Press, vol. 61(2), pages 375-392.
    20. Izumi Yokoyama, 2014. "Why do wages become more rigid during a recession than during a boom?," IZA Journal of Labor Economics, Springer;Forschungsinstitut zur Zukunft der Arbeit GmbH (IZA), vol. 3(1), pages 1-23, December.
    21. Kawaguchi, Daiji & Ueno, Yuko, 2013. "Declining long-term employment in Japan," Journal of the Japanese and International Economies, Elsevier, vol. 28(C), pages 19-36.
    22. Laing, D., 1990. "Involuntary Layoffs in a Model with Asymmetry Information Concerning Worker Ability," Papers 12-90-4, Pennsylvania State - Department of Economics.
    23. Uri Gneezy & John A List, 2006. "Putting Behavioral Economics to Work: Testing for Gift Exchange in Labor Markets Using Field Experiments," Econometrica, Econometric Society, vol. 74(5), pages 1365-1384, September.
    24. Baily, Martin Neil, 1977. "On the Theory of Layoffs and Unemployment," Econometrica, Econometric Society, vol. 45(5), pages 1043-1063, July.
    25. Frey, Bruno S & Jegen, Reto, 2001. " Motivation Crowding Theory," Journal of Economic Surveys, Wiley Blackwell, vol. 15(5), pages 589-611, December.
    26. Strand, Jon, 1992. "Business cycles with worker moral hazard," European Economic Review, Elsevier, vol. 36(6), pages 1291-1303, August.
    27. Martin Neil Baily, 1974. "Wages and Employment under Uncertain Demand," Review of Economic Studies, Oxford University Press, vol. 41(1), pages 37-50.
    28. Azariadis, Costas, 1975. "Implicit Contracts and Underemployment Equilibria," Journal of Political Economy, University of Chicago Press, vol. 83(6), pages 1183-1202, December.
    29. Noda, Tomohiko & Hirano, Daisuke, 2013. "Enterprise unions and downsizing in Japan before and after 1997," Journal of the Japanese and International Economies, Elsevier, vol. 28(C), pages 91-118.
    30. Shapiro, Carl & Stiglitz, Joseph E, 1984. "Equilibrium Unemployment as a Worker Discipline Device," American Economic Review, American Economic Association, vol. 74(3), pages 433-444, June.
    31. Agell, Jonas & Lundborg, Per, 1995. " Theories of Pay and Unemployment: Survey Evidence from Swedish Manufacturing Firms," Scandinavian Journal of Economics, Wiley Blackwell, vol. 97(2), pages 295-307, June.
    32. Nosal, Ed, 1990. "Incomplete Insurance Contracts and Seniority Layoff Rules," Economica, London School of Economics and Political Science, vol. 57(228), pages 423-438, November.
    Full references (including those not matched with items on IDEAS)

    More about this item

    Keywords

    Layoff; Wage cut; Morale; Performance-based payment system;

    JEL classification:

    • J30 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - General
    • J33 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Compensation Packages; Payment Methods
    • J63 - Labor and Demographic Economics - - Mobility, Unemployment, Vacancies, and Immigrant Workers - - - Turnover; Vacancies; Layoffs

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:spr:izalpo:v:6:y:2017:i:1:d:10.1186_s40173-017-0092-2. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Sonal Shukla) or (Mallaigh Nolan). General contact details of provider: http://www.springer.com .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.