Does It Pay to Reduce Pay?

Via Business Week

By Jena McGregor

Once considered off limits for salaried managers and professionals, base pay reductions are becoming increasingly common in today’s brutal recession. Many human resources experts believe the recent moves by major companies—household names such as FedEx (FDX), Hewlett-Packard (HPQ) and Saks Fifth Avenue are all trimming salaries—could present perils when the economy turns back up again. They argue that star performers could bolt to other companies and that morale and productivity could suffer.

But others see an upside to reducing pay rather than making more layoffs. One of them is Dan Ariely, the author of the popular behavioral economics book Predictably Irrational, and a professor at Duke University. He believes that in the right environment, pay cuts can even boost morale and loyalty. He spoke recently with Management Editor Jena McGregor. Below is an edited excerpt of their conversation:

You’re a behavioral economist. How do you think people will respond to pay cuts when the economy turns back around?

People hate pay reductions as a procedure. We don’t want to think that as we get older, we get paid less and less and less. Then our productivity will go down and down and down. But [the current salary cuts] are supposed to be a one-time thing, and that’s more acceptable.

It also helps that salary is very much what we call a positional good. At some level you care more about how much money you make compared with other people than the absolute level. For people who struggle, of course, the absolute level of how much they make is important. But for people at high positions, it’s basically a chase to the top. We see other people making more, we feel bad—not so much because we need the money, but just because it tells us something about who we are. So if you reduce pay at the whole company, you in a sense keep the relative position the same.

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