Layoffs or Reduced Hours? Effects of the Performance Measurement System

Firms facing financial distress must decide how to reduce costs, which often involves choosing between laying off some employees or reducing hours for a larger number. We investigate two questions related to this choice. First, how does the precision of a firm's performance measurement system influence managers’ decision to institute layoffs or reduced hours? Second, how do employees react to this choice? An interactive experiment indicates that the effect of performance measurement precision on managers’ cost reduction decision is moderated by overall workforce performance. Specifically, under a precise system, managers are more likely to choose layoffs when overall workforce performance has been poor, but they are more likely to reduce hours when performance has been strong. However, under an imprecise system, managers rely less on the observed performance information when deciding their cost reduction strategy, and instead appear to resort to their personal preferences. When managers choose layoffs, retained workers reward managers with higher reciprocal effort and performance under an imprecise system compared to a precise system, consistent with theory on reference-dependent reciprocity, but inconsistent with workers’ perceptions of the decision’s fairness. When managers reduce hours, workers respond with similar performance under the two systems. Overall, our study documents important environmental and behavioral factors that influence managers’ choice of labor cost reduction measures and the consequences for employee performance