Encouraging Flexibility

Historically labor markets have demonstrated downward wage rigidity and that creates bigger-than-optimal swings in both corporate profitability and employment. That is, when there is a downturn in customer demand, wages stay constant and profits tumble, causing corporations to fire employees to match capacity to lower demand. That can spur a downward spiral as out-of-work former employees stop consuming and go on welfare/unemployment insurance, hurting government finances and so on.

If instead corporations could balance capacity and demand by lowering wages temporarily - either by lowering hourly wage or reducing the number of hours worked - the adjustment process would be smoother and less devastating to individual workers.

However, workers don't trust senior management to eschew taking advantage of workers in this fashion, so it generally doesn't work. But it does for some companies like Four Seasons Hotels and Resorts, which has historically adjusted in ways that don't require lay-offs.

If leaders want to encourage workers to believe that introducing downward wage flexibility into the whole system can be good for everyone, the best place to start is with themselves. Only if leaders take the first step will rank and file workers consider following suit. So if a leader wants to generate greater flexibility to deal with the current significant economic downturn, he or she should volunteer to take a pay cut of the approximate magnitude that he or she would like to see from followers.

By Roger Martin

 |  March 15, 2009; 10:09 PM ET
Category:  Compensation
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