Do Businesses Have the Right to Lower Employee Salaries?

Lowering salaries as an alternative to layoffs: It's legal, but there are catches, such as how likely employees are to agree to a pay cut and why you should cut executive pay first.

The risks of layoffs  

Layoffs are a proven way to cut costs, but they can adversely impact companies, and the impact is sometimes difficult to overlook. One example is so-called turnover contagion, where a business consistently laying off employees sees a mass exodus. In this context, even the best employees leave. This has led some companies to consider lowering employee salaries in lieu of more drastic measures. 

Employee pay cuts are legal – with some catches. 

Yes, businesses have the right to lower employee salaries, but there are certain rules and guidelines to follow. For one, you can't lower them retroactively. The company must pay the amounts previously agreed on for work that has been completed. 

Most states require companies to give the employee notice and inform them of the planned decrease. In some states, you must give written notice. The employee decides whether to accept or refuse the reduction. 

Exemptions 

Salary reductions are limited or prohibited altogether in some cases. For example, they may not apply to workers who are members of a union because they frequently have contracts that protect their salaries. Unions and employers then need to renegotiate contracts regarding salary adjustments. Online payroll services professionals can help your company navigate these and other more complex aspects. 

The law prohibits reducing an exempt worker's predetermined salary due to variations in the quantity or quality of their work. With some exceptions, the worker must receive his full salary for any week in which he has worked, no matter how many days or hours he has worked.

Due to a business's financial constraints, it can reduce an exempt salary but not so much that the employee loses their status as exempt. 

The Civil Rights Act of 1964 prohibits salary reductions for retaliatory or discriminatory reasons. Businesses can't reduce wages to below the statutory minimum, either. 

When should you lower salaries?

According to labor market analysts HCMI, employee expenses can account for 70% of a company's total expenses. Reducing salaries will help the company make it through hard times. It also depends on whether you're reducing the salaries of a group vs. just one specific employee. If an employee is moving to a new position at the company, they might get a lower salary to match their smaller role. While "demotion" often sparks negative associations, some people might agree to take up a position with fewer responsibilities for various reasons, such as personal problems. They might agree to a lower salary as part of the transition.

Will they, though? 

Fewer than a third of respondents in a 2022 Gartner survey of more than 10,000 employees said they would be willing to accept lower payment to avoid layoffs. Most respondents pointed out they would tolerate this reduction for a maximum of three months. 41% of Gen Z employees and 38% of Millennials said they were willing to take a pay cut. Of those, over 50% would accept a cut of 10% or less. 

A possible solution: cutting executive pay first to build trust

Considering that CEOs make around 300 times more than ordinary employees, it might make sense to cut executive pay first. Shareholders and employees want the leaders of a company to carry their weight when making sacrifices. According to the Gartner survey, 77% of employees believe top executives should agree to a significant salary reduction before they make any changes to worker compensation. This helps create trust in the organization, which is the most critical factor impacting employee perception of pay. 

Inflation is another important factor. Employees hired in 2022 earned 17% more on average than counterparts in the same position with tenure. Fewer than a third feel their salaries are fair, and just 34% believe their pay is reasonable. 

Finally, Gartner research shows that almost 43% of employees talk about their salaries with coworkers holding the same position, and 45% check third-party payment websites once a year or more often. 

Summary 

• Employee pay cuts are legal – with some catches 
• When should you lower salaries
• Will employees agree to a pay cut
• Advantages of cutting executive pay