Why do firms losing money almost always reduce labor costs via layoffs instead of pay cuts? At least in the United States, firms seem to almost always reduce labor costs via layoffs rather than pay cuts. Pay cuts are so rare that they're literally headline news. From an economic standpoint, if workers are being paid more than their marginal product, then either solution fixes the problem - layoffs boost marginal product to match the old wage, while pay cuts lower the wage to match the new marginal product.

But it seems to me that a pay cut is better for both the employer and the employee. From the employer's side, when times get better they don't need to bring in a bunch of inexperienced new employees to replace the ones they laid off. From the employee's side, they still make some money rather than no money, and they are free  to leave the company if they can find sufficiently higher pay at another firm to compensate for the inconvenience of switching jobs. Personally, I would always prefer to be offered a pay cut than laid off, and apparently over 90% of workers feel the same way. So why are layoffs so ubiquitous?
Here are four possible reasons:

Reason #1. Fixed costs per employee.

Due to taxes, insurance, 401k plans, etc., the cost of an employee (to the employer) is significantly greater than the employee's take-home pay.

For simplicity, assume an employer must bear an additional lump sum cost per employee that is equal to 20% of each employee's current take-home pay. Assume also that all employees are identical. Then to cut payroll costs by 30%, the employer can either:

A. Fire 30% of the employees; OR

B. Cut each employee's take-home pay by 36%.

Many firms will prefer A to B.



Reason #2. Parkinson's Law

Parkinson's Law is the humorous adage that "work expands so as to fill the time available for its completion".

This may apply also to workers in a firm. Laying off say 5% of employees may make no difference to total production -- especially if a firm was already bloated and overstaffed to begin with.



Reason #3. Keeping employees on their toes.

By occasionally laying off a significant fraction of employees during downturns, one credibly demonstrates that employees should work hard and well or risk being fired.

[There are here two separate questions: (a) Does this tactic really work (in motivating employees)?; and (b) Do there exist employers who believe in this tactic? An affirmative answer to (b) suffices to serve as an explanation to your question.]



Reason #4. Worker morale.

Suppose we ignore Reason #1 and happily, we can save 30% in payroll costs by either:

C. Firing 30% of the employees; OR

D. Cutting each employee's take-home pay by 30%.

Under C, the 30% who are fired will indeed be very heavily demoralized, but they are no longer your problem. As for the remaining 70%, they might be slightly demoralized about losing some of their work buddies. But they might even be reinvigorated after discovering they survive the cut.

In contrast, under D, every employee is rather demoralized about the 30% pay cut.

Many firms will prefer C to D.