This post is a response to Bryan Caplan’s request that I share my experiences cutting wages. It was not fun.
While I was CEO of MetaMed, we were continuously short of revenue. We started the company thinking we would be able to sustain ourselves through sales, but those sales did not materialize. In order to survive long enough to give the sales force a chance, we needed to cut pay.
To do this, the business of the company had to be put on hold while we worked out what would be done. I had to take my core employees aside, one by one, and get them on board with the idea. They were all willing to pitch in, provided the others were as well; if any of them had balked, it is likely all of them would have refused. The conversations went about as well as one could hope, but even then, the amount of stress and tension involved was huge.
From that point on, the cut was a constant drain on the company’s morale, but an even bigger one on its time. The question of when full salaries would be restored came up constantly, as people had committed to expenses on the basis of those salaries. It forced finances to be an open book; every week I was pleading poverty to a different person. Every person who didn’t get a pay cut had to be continuously explained and justified, as discussions of who we would lose, who needed the money, and which contacts were not negotiable took the time and energy we needed elsewhere.
Everyone was constantly comparing their pay to everyone else’s pay, their cuts to other people’s cuts. When we agreed to salaries and an equity division, everyone put their personal incentives aside to play for the same team, but once pay was fluid, that became impossible. Even if they weren’t consciously doing it, almost everyone was signaling how valuable they were to the company, what they were worth in the market, and/or how much they needed the money or how much pay would be fair.
If we couldn’t pay full salaries, that meant we were in deep trouble (which we were, of course) so that was yet another reason to jump ship. Lots of time was spent holding the team together and preventing or postponing key people quitting.
A quality employee is worth far more than you pay them. A bad employee is often actively harmful. Figuring out who is who is expensive. Once you have both invested in finding a good match, there’s a lot of surplus, without which few companies can survive, and a huge zone of possible agreement.
Cutting pay is considered harmful for good reason. Bryan did an interview that went into some of the reasons why. I will affirm all the answers he gets, but would tie it together differently. When you decide what everyone is paid, your primary goal is to finish the discussion with everyone content so you can get on with business. By closing the door on the question of money, you can focus on the job at hand. By credibly committing to a deal, you can take actions that would cause problems in a future negotiation: Making someone indispensable, or investing in their skills and relationships, or giving up on other connections and opportunities to help the business.
Giving small nominal nominal raises, and mostly basing pay on your job title, makes that possible. This frees up time, gives better incentives, and lowers stress. People do not have to worry about being able to pay their bills, and they do not have to worry they are being cheated by someone who negotiated harder or gained leverage. Breaking the deal is high stress, destroys morale, and pits people against each other.
If I had to do it over again, even though it went well, I would not ask my employees to take pay cuts. If that had killed the company, the company was likely doomed in any case, and it would have let us all move on faster. Losing a job is a major disruption, but staying in one with little pay and no future is a trap; even if it did maximize our chances of success, keeping MetaMed alive for so long though such methods was in hindsight clearly a mistake.