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Optimal Combination of Wage Cuts and Layoffs : The Unexpected Side Effect of a Performance-based Payment System

Listed author(s):
  • YOKOYAMA, Izumi
  • OBARA, Takuya
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    We analyze the optimal combination of wage cuts and layoffs from the viewpoint of behavioral economics. First, we theoretically show that with the increase in the parameter representing a firm's estimate of the degree to which nominal wage cuts damage worker morale, the firm becomes less likely to impose wage cuts and instead implements layoffs. We show empirically that there is a trend whereby a firm under a performance-based payment system is unlikely to implement wage cuts because the system acts as a device for strengthening the relationship between wages and worker morale. Given this first-order regression, the status of a performance-based payment system is employed as an instrumental variable (IV) for wage cuts in a layoff regression model, and the IV estimate for the impact of wage cuts on layoffs becomes significantly negative. This supports the theoretical implication that implementing wage cuts can be a potential device to reduce layoffs. These results may imply an unexpected side effect of the increasing use of a performance-based reward system in Japan: as the system becomes more widespread, layoffs will increase because companies will become less likely to impose wage cuts. This in turn may lead to a high unemployment rate in Japan, where the fluidity of the labor market is not as advanced as that in the United States.

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    File URL: http://hermes-ir.lib.hit-u.ac.jp/rs/bitstream/10086/27715/1/070econDP15-07.pdf
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    Paper provided by Graduate School of Economics, Hitotsubashi University in its series Discussion Papers with number 2015-07.

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    Length: 22 p.
    Date of creation: Oct 2015
    Handle: RePEc:hit:econdp:2015-07
    Contact details of provider: Phone: +81-42-580-8000
    Web page: http://www.econ.hit-u.ac.jp/

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    15. Baily, Martin Neil, 1977. "On the Theory of Layoffs and Unemployment," Econometrica, Econometric Society, vol. 45(5), pages 1043-1063, July.
    16. Strand, Jon, 1992. "Business cycles with worker moral hazard," European Economic Review, Elsevier, vol. 36(6), pages 1291-1303, August.
    17. 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.
    18. 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.
    19. 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.
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