Why companies fire employees

Vivek Kaul

In the aftermath of the financial crisis that started in September 2008, after the investment bank Lehman Brothers went bust, the news regarding companies firing employees in order to cut costs, is regularly published in the media. The global information technology firms have fired a lot of people over the last few years in order to stay competitive.
In an economic environment where business is dull, the companies try to maintain profit levels by cutting costs. There are various ways in which this is done. An organisation I worked for in the past tried to cut costs by getting rid of toilet paper in the restrooms. This move was met with immediate protests and sometime later the status quo was restored.
Jokes apart, a major way in which companies cut costs is by firing employees. This is a painful process which typically leads to people working at the middle and lower levels suddenly finding themselves without a job. Normally, those at the top levels of management as well as those who work in the HR department, carry on with their jobs.
What makes the situation worse is the fact that people who are fired are in no way prepared for it and are told one fine day that they would no longer be needed. In this day and age when almost everybody has EMIs to pay and the joint family system has completely broken down in cities (in the Indian context), it is a very difficult situation to be in.
What I have always wondered is why do companies fire employees? Why don’t they reduce salaries across the board and ensure that everyone has a job. In fact, those at the upper levels should forego more, given that they are more responsible for the good or bad performance of the company. Those at the middle and junior levels typically do what they are told to. Further, cutting salaries across the board can’t be very difficult to implement, I guess.
I have put this question to a few HR people I happen to know. The answer I typically get from them is that when the economy is not doing very well, it is a good time to get rid of the “deadwood” (essentially employees who are not very productive) and make the company leaner. This I guess is a part of the answer but not a complete answer to my question.
To get a complete answer we need to know a little about a famous American economist Irving Fisher. In the latter part of his career, Fisher had turned into an entrepreneur and hence, ended up employing people.
One of the interesting things that he did was to index the salaries of his employees to the rate of inflation. So if inflation went up salaries went up as well and vice versa. As Sylvia Nasar writes in Grand Pursuit—The Story of Economic Genius: “He [i.e. Fisher] was probably the first employer to ever grant an explicit, annual, automatic “cost of living” adjustment.”
Nevertheless, Fisher’s experience with this experiment wasn’t very smooth. As long as the salaries were going up his employees were fine with the situation. But the moment salaries started to fall the employees resented it.
As Fisher would later recount in Stable Money—A History of the Movement: “As long as cost of living was getting higher…employees welcomed the swelling contents of their…pay envelopes…But as soon as cost of living fell they resented the “reduction” in their wages.”
The point being that employees do not like salaries being cut and it typically leads to a lot of resentment. Hence, it is just easier for organisations to fire people, rather than cut salaries across the board.
As Richard Thaler writes in Misbehaving—The Making of Behavioural Economics: “Cutting wage makes workers so angry that firms find it better to keep pay levels fixed and just lay off surplus employees(who are not around to complain).”
This behavioural problem essentially leads to people being fired.
(Vivek Kaul is the author of the Easy Money trilogy. He can be reached at [email protected])

The column originally appeared in the Bangalore Mirror on July 22, 2015