Recent headlines may have you believing every company, whether it’s a massive tech titan or a mom-and-pop shop on Main Street, is drastically reducing the size of its workforce. With talks of an impending recession and increased business expenses due to inflation (and who knows what’s going on with the banks these days), many businesses are using layoffs as a way to reduce costs. This much is true.
However, while layoffs may be a tried-and-true cost-cutting measure, they can also negatively impact your business — for example, have you heard of turnover contagion? To avoid a mass employee exodus and hang on to your all-star staff while still corralling operating expenses, you might want to consider reducing employee wages instead. But before you go slashing zeros from your business payroll, it’s essential to learn the ins and outs of salary reductions and how to implement them the right way.
>> Read next: This Salary Mistake Could Cost Your Business $250K
What are salary reductions?
A salary reduction, also known as a wage reduction or pay cut, is an agreement between an employer and employee to reduce the employee’s pay, either permanently or temporarily. An employee pay reduction can also be accompanied by a reduction in job responsibilities, but that’s not always the case. Although you may fear team members will start jumping ship as soon as you slash salaries, wage reductions are sometimes a necessary evil that workers understand and accept, depending on the circumstances.
Whether you’re reducing or raising salaries, every organization should have a carefully thought-out compensation management strategy and use the best payroll services for a seamless experience.
Are pay cuts legal?
Yes, employee pay cuts are legal, but employers must follow certain rules and guidelines. For example, a company can’t retroactively reduce an employee’s salary; you must pay workers the previously agreed-upon wages for work they have already performed.
Additionally, most states require employers to provide advance notice to the employee and alert them about the intended decrease in pay. Some states even require that notice to be in writing. The employee can choose to accept or decline the pay cut; however, if they decline, that often means they will be handing in their resignation as well.
In certain cases salary reductions are restricted or prohibited altogether. For instance, pay cuts may not be applicable to unionized employees, since union workers often have contracts in place that protect their pay. Instead, the employer and union staffers would need to enter a contract renegotiation regarding pay adjustments.
Limitations apply to exempt employees as well. By law, the predetermined salary of an exempt employee “cannot be reduced because of variations in the quality or quantity of the employee’s work. Subject to [some] exceptions… an exempt employee must receive the full salary for any week in which the employee performs any work, regardless of the number of days or hours worked.”
In some instances, you can reduce exempt salaries due to company budgetary constraints, but be wary of reducing wages so low that the employee loses their exempt status.
Worker misclassification is a common HR compliance challenge that many employers face. If you’re unsure whether your workers are exempt, check out our guide on the differences between exempt and nonexempt employees.
Other laws around pay cuts mandate that employees can’t have their pay reduced based on discriminatory or retaliatory reasons, as protected by the Title VII of the Civil Rights Act of 1964. You also can’t reduce wages so low that they drop an employee’s overall hourly rate to less than minimum wage.
When should you cut employee salaries?
Salary reductions might not be your first choice, but in some instances it’s an option worth weighing or even necessary. Here are some common reasons you might opt to reduce employee compensation.
- To protect your business: If your company is facing economic hardships or other financial struggles, you may need to reduce operating expenses and protect your cash flow to stay afloat. Since labor costs can account for up to 70 percent of an organization’s total business costs, according to workforce analytics company HCMI, it only makes sense that reducing payroll would decrease your overall expenses while you make it through hard times.
- To protect your employees: OK, we know what you’re thinking: Reducing pay seems like more of a “con” for employees than a “pro,” but that depends on how you look at it. If you must drastically reduce operating expenses, you have the option of furloughing or laying off workers. Employees may agree that taking a small pay cut is better than losing their jobs altogether. So if you want to protect staff members’ jobs, reducing their salaries is one solution.
- To reflect an employee job change: This scenario is a little different because it typically involves reducing pay for one specific employee as opposed to a group of employees. If a team member is changing their position at your company, such as taking a demotion, you might consider reducing their pay to match their smaller role. The term “demotion” often has a negative connotation, but some people intentionally choose to switch to a lower role so they can change their scope of work responsibilities for personal or professional reasons. As that’s their choice, they may be willing to accept a pay cut as part of the transition.
If salary reductions seem too drastic for your organization, another cost-cutting alternative is to eliminate certain employee benefits.
How do you reduce employee salaries?
Just because salary cuts may be legal and sometimes necessary doesn’t mean they’re without consequences. For example, pay cuts can fuel employee stress that negatively impacts productivity and morale and even cause some employees to quit. If you are in the unlucky position of having to reduce staff wages, follow these steps to minimize the backlash that may ensue.
1. Consider the current labor market and unemployment rate.
Before you officially cut salaries, evaluate the current labor market and unemployment rate. If there is a booming market with low unemployment, chances are good that employees or executives will seek employment elsewhere if you reduce their salaries. This is vital to consider at all levels of your company if you want to implement pay cuts with minimal fallout.
2. Cut executive pay first.
Many employees subscribe to the notion that salary reductions should start at the top. In fact, a recent Gartner survey found that 77 percent of employees believe senior executives should take a significant pay cut before other employee pay cuts or layoffs. Companies like Apple and Google have recently implemented significant pay cuts for their CEOs, and we expect other companies to follow suit. Not only does this make financial sense — since senior executives tend to have much higher salaries to begin with — but it can also be seen as altruistic and improve your brand reputation. Reduce executive pay and study the impacts before implementing such measures with lower-level employees.
3. Establish a fair and equitable way to reduce employee salaries.
If you’ve gotten to the point where it’s necessary to reduce nonexecutive employee wages to keep your business afloat, it’s crucial that you use a fair and unbiased system to make the pay cuts. The last thing you want is to run into discrimination claims because you targeted individuals unfairly. If there are legal reasons why you can reduce some employees’ pay and not others (e.g., minimum wage laws), document that. [Read related article: Employee Rights You’re Violating Right Now]
4. Communicate your reason for reducing pay.
Typically and understandably, people don’t like being told they’ll be making less money for the same amount of work. However, you can limit the blowback by explaining the “why” to your employees. Are you reducing wages in order to save jobs? Make that known. Are pay cuts only temporary during an economic downturn? Explain that. Having an open and honest dialogue is essential if you want to keep up business productivity and worker morale.
5. Provide a written notice for employees to sign.
Whether or not you are legally required to provide employees with written notice of pay reductions, do so anyway. Create a formal written notice for staffers to sign and store it in their employee personnel file. This is a great way to protect your business if an employee becomes disgruntled in the future and tries to retroactively raise a stink about their salary change.