During this financial crisis and economic downturn, is a wage freeze a good corporate decision?

As a result of the economic downturn caused by the financial crisis in the United States, many companies in Australia and some other countries with relatively strong economic performance, are implementing wage freezes as a hedge against further weakening of economic conditions. Asking some fundamental questions about the effect of a wage freeze (a reduction in real wages) on the economy, the short term and long term implications for companies and fairness to salaried employees suggests it is probably not the best decision. It is not necessarily good for the economy, it does not necessarily make a positive contribution to a company in the short term or long term, it is likely to be perceived to be unfair, and there are better examples of more effective decisions in the context of the current downturn.

Does a wage freeze make a positive contribution to the economy?

If every company froze wages, the current downturn could be even worse and last much longer. The combined actions of companies to freeze wages will at the extreme, reduce aggregate expenditure, counter expansionary monetary and fiscal policies, and set in motion a deflationary wage price spiral. An extended downturn is not in anyone's interest, as it will impact negatively on sales, revenues, profits, wages, bonuses and shareholder returns. Governments are doing their part to reduce the impact of the downturn, and there is no reason that companies with the capacity to do so cannot do the same with a reasonable and responsible wage policy. The combined effort by companies to hold the line on wage freezes and reductions where possible would help to turn the economy much quicker than government acting alone with fiscal stimulatory policies.

Does a wage freeze make a positive contribution to a company in the short term?

The idea that a wage freeze will contribute positively to short term profit could well be an illusion. A wage freeze may save some costs in the short term, but there is a high risk of lowering morale and motivation, which in turn could reduce productivity and revenue and negate any short term savings and profits.

Does a wage freeze make a positive contribution to a company in the long term?

A wage freeze creates a high risk of losing key staff, their skills, and business units over the long term. When the upturn comes, possibly sooner than expected, such losses will force the company to pay higher salaries for less qualified staff, resulting in skill shortages, lower revenue streams, lower profits and lower shareholder returns. A focus on how corporate decisions will play out during the forthcoming upturn not just the current downturn, suggests a wage freeze may be counterproductive.

Is a wage freeze fair or perceived to be fair by salaried employees?

There is a growing perception in the general community that companies that have instituted wage freezes or cutbacks are using the economic downturn as a self serving excuse to boost their returns in the short term at the expense of salaried employees. While money is never the most important motivating factor, there is no reason to believe that salaried employees who perceive the system to be unfair will be motivated, or will retain any sense of community and loyalty that a company may have built up over the years. There may be other options to prevent the system from being perceived to be unfair.

For example, an inflation linked across the board nominal wage rise (which is still a wage freeze) may be perceived to be more fair and reasonable than a real wage freeze, which is effectively a reduction in wages. It may be wiser to institute an incentive/profit sharing arrangement that has more upside for salaried employees, where everyone wins by fairly sharing gains during the upside and losses during the downside. Shareholders could for example offer salaried employees shares in exchange for a salary freeze. This would have the perception of fairness, it would virtually eliminate any risk of a wage freeze to current shareholders, and it would be much more likely to motivate employees, and improve productivity.

Is a wage freeze without compensation the right thing to do?

Not according to the "Eli Yones principle". Eli Yones is CEO of Mizrahi Tefahot Bank in Israel, which is actually quite profitable. As such Yones was entitled to and deserved a very large bonus. Yet he decided to decline it so that his employees would receive it for their hard work. According to Israel's online business report Globes: “Yones said, “Continuing the bank’s profit trend and the ongoing improvement in its image and positioning as a stable, successful, and leading bank are the result of hard and goal-oriented work demonstrated by the bank’s employees last year. There is no doubt that they deserve appreciation and financial compensation for this. Nonetheless, we must not ignore the difficult economic reality and expectations that the recession will worsen in 2009.”Yones advises that Mizrahi Bank’s 2008 bonus budget be smaller than the bonus for the bank’s 2007 profits. The 2008 bonus should reflect the employees’ achievements as well as the economic crisis and public mood. As for his own bonus for 2008, Yones said, “In such times, I believe that the bonus budget should go entirely to the employees and managers of the bank.” Yones, at his own initiative, forewent his annual bonus under his new contract for 2009-14, which comes into effect in April. His compensation will solely comprise his salary and stock options.

Mizrahi Tefahot Bank is no doubt generating more business than it has ever had from the positive publicity.

Now that is a brilliant decision.

The key is to come up with a win-win solution, and a salary freeze does not pass that basic test.