Why Firms Lay Off Workers instead of Cutting Wages: Evidence from Matched Survey-Administrative Data

We study how firms adjust labor in response to adverse shocks—via layoffs or pay cuts—and the reasons behind each adjustment margin. To do so, we design and implement a novel large-scale survey of firms in Denmark and link it to administrative data. We find, first, that layoffs are much more prevalent than pay cuts, but pay cuts are not rare. Second, employers do not consider pay cuts to be a viable substitute for layoffs during crises. The size of a hypothetical pay cut needed to save a layoff is large. Furthermore, some layoffs during a crisis are not caused by the crisis. Rather, a crisis is an opportune time for firms to lay off some workers. Third, employers who did not cut base pay think that it would damage morale, or lead employees to quit, or they perceive base pay as a commitment to employees. Fourth, losing specific workers’ skills is the most important consideration in layoff decisions.