When Can an Employer Make a Pay Cut?

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Increased compensation, upskilling, mentoring, and morale-boosting perks. There’s no shortage of advice encouraging employers to invest in ways to improve employee performance and engagement. But what do you do when your company faces a financial challenge? Can you make a pay cut?

The short answer for most employers is yes. The longer answer is that there are some circumstances when it makes sense to reduce employee compensation to avert even harsher cost-cutting measures, but only temporarily and only after you’ve considered all the possible unintended consequences that come with cutting pay.

When It’s Okay for an Employer to Cut Pay?

Pay cuts should not be an answer to a short-term drop in profits. Nor do they make sense in the face of an unavoidable long-term downturn in your business. Your organizational strategy should account for short-term cashflow challenges. Longer term sales challenges are better addressed through staff reductions or a shift in strategy.

However, cutting wages temporarily may be the appropriate answer to prevent severe losses from adversely affecting your company’s viability — but only if the alternative is layoffs or going out of business.

How do you know when to consider cutting employee pay? First, calculate your current staffing costs and then, based on revenue forecasts, determine whether you can withstand expected losses and still maintain your current payroll. If honoring your current compensation levels means you might need to let staff go, then it may make sense to see if you can maintain your current staff levels at slightly decreased wages.

If you think a temporary decrease in compensation costs might help you keep your doors open, then it’s time to create a plan for how to communicate and implement pay cuts.

Legal Considerations

If your workers are part of a collective bargaining agreement or working under the provisions of a contract, you may be prohibited from cutting pay, hours, or benefits. Doing so could incur penalties or make you vulnerable to a lawsuit or other legal action.

However, most employees are at-will, which means that the employer, or the employee, can end or alter the relationship at any point for almost any reason. So, technically, if you do not have an existing contract with a unionized workforce, you can reduce your employees’ compensation — wages, benefits, and performance-based incentives — if you adhere to the following conditions:

  • You announce the pay cut before you implement it. Keep in mind that the amount of notification required differs by state.
  • You do not make the reduction retroactively.
  • You do not reduce earnings of hourly employees below the national minimum wage or your state’s minimum wage.
  • You do not exempt workers’ salaries below the federal or state threshold below which they would need to be redefined as hourly wage workers.
  • You do not reduce salaries in a discriminatory manner based on a worker’s protected status, such as race, gender, or disability, or implement wage reductions in a way that exacerbates existing diversity, equity, and inclusion (DEI) issues.
  • You are not cutting pay as a punishment for taking time off to perform protected activities, such as jury duty, taking family leave, or military service.
  • You are not retaliating against an employee for whistleblowing, organizing a collective bargaining unit, or acting as an employee representative for union.
  • You give each employee the opportunity to agree to the reduction or resign.

Why Employee Pay Cuts Are Not Usually the Answer

In most cases, pay reductions are not a long-term solution to profit loss or poor performance, as they tend to:

  • Negatively affect morale, decrease productivity, and further depress profits.
  • Erode trust between workers and management.
  • Prompt your best performers to look elsewhere for opportunities, possibly to your competition.
  • Damage your employer brand and company culture.

The Problem With Across-the-Board Pay Cuts

Your business plan should be flexible enough to withstand a short-term dip in profits without necessitating layoffs or pay cuts. If your instinct is to cut compensation whenever times are tough, the message your frontline workers will take away is that they — rather than owners and top-level management — are the only ones making sacrifices for the benefit of the business’s overall health.

The Problem With Targeted Pay Cuts

You want your workplace to be a place where hard workers can thrive. Reducing pay communicates that your financial situation is unstable or that struggling employees will be penalized rather than supported. Either way, pay cuts are likely to cost you your highest achieving employees.

Offering support, upskilling, mentoring, and changing team and individual assignments are much better ways to improve the performance of an employee who is failing to reach their potential. If you have a problem employee who has very little chance of thriving in your company culture or your industry sector, or one who behaves in an unethical manner, termination is a better way to address the situation than a punitive pay cut.

If you decide to go forward with a targeted pay reduction it should be accompanied by a reduction in responsibilities or demotion. Asking an employee to do the same work for less pay is not likely to incentivize increased effort or performance.

How to Implement a Salary Reduction

As with a targeted pay cut to an individual employee, companywide pay cuts should be temporary and accompanied by a reduction in responsibilities. You should discuss the reductions with staff ahead of time and distribute a written announcement that outlines the terms of the compensation adjustment.

For example, you might keep base salaries at their current level but suspend bonuses. You may also want to specify that the reinstatement of previous compensation practices will be contingent upon a return to previous profitability levels or a change in economic conditions.

Cost-cutting Alternatives

Rather than implement wage reductions, consider offering your employees the following options that can help to temporarily — or even permanently — reduce payroll:

  • Offer furloughs in the form of voluntary or mandatory time off during times that are less busy or that work well for each employee. Some employees may even welcome unpaid time off to focus on family obligations, educational opportunities, or extended vacations.
  • Allow sabbaticals of various intervals, from a few months to a year, to pursue educational, volunteer, or other opportunities.
  • Institute job sharing for employees who want to work part-time for the short term to fulfill caregiving obligations or pursue educational opportunities.
  • Create a remote work policy to reduce overhead costs.

You may also want to consider filling critical openings with part-time or contract workers, at least for the duration of your current financial challenges.

How to Soften the Blow

If you are asking your workforce to sacrifice wages you should be prepared to offer something in return. You might focus on other aspects of your and more affordable incentives, such as making an extra effort to highlight workers’ performance, throwing an office party to thank people for their efforts, or working with community partners to provide gift certificates in lieu of cash bonuses for the near term.

You might also look to other non-monetary forms of compensation, such as increased paid time off (PTO) or offering top performers an equity stake in the company.

Learn More Ways to Reduce Costs Without Making a Pay Cut

Now that you know when an employer can cut employee pay, and how to temper the blow, learn about more ways to grow your bottom line, from crisis management to the latest hiring news and expert how-tos.

Legal disclaimer: None of the information provided herein constitutes legal advice on behalf of Monster.