Just how bad will the economy get? For employers facing tough decisions about layoffs, the question is far from rhetorical. If the current economic turmoil is contained sooner than expected, premature layoffs could be a disaster. If not enough employees are laid off and the recession continues, the company’s bottom line could suffer. And in any scenario involving layoffs, morale among those employees remaining at the company is sure to plummet.

Some companies consider alternatives to layoffs, such as voluntary retirements or salary cuts, hiring freezes, reductions in hours, or the cancellation of business trips and/or costly perquisites. Even standard benefit packages and matching contributions to 401(k) plans might come under the microscope.

According to Wharton management professor Peter Cappelli, director of the Wharton Center for Human Resources, the use of creative layoff alternatives peaked in the 1980s but then fell into decline. Executives came to a general consensus that if salaries were cut by 10%, or hours were shaved from the workweek, the company’s best people would disappear. The thinking was that the “most mobile” employees would be hired by competitors, Cappelli says.

But that prediction, he adds, doesn’t hold up. “It is driven by the executives’ view of the way things work, and the executives, frankly, think that everyone thinks like them. They see themselves as the kind of talent that is mobile.” They also don’t believe that employees would buy into the idea of doing something good on behalf of their colleagues [by accepting reduced wages or hours] because “they themselves wouldn’t buy it.” Once again, Cappelli adds, that perception “is probably wrong.” The act of making sacrifices for fellow employees “might actually build some morale and knit the company together.”

Besides, Cappelli says, if the economy stays the way it is or worsens, the concern that a company’s top employees will leave is irrelevant, since no one else is hiring either. “If you have a choice between a 10% wage cut and laying off 10% of the work force, why on earth would you choose the latter?” he asks.

Cappelli suggests that it’s worth thinking about what kind of problem a company is trying to solve. If there is a concern about what happens when business activity picks back up, for example, companies that hold on to their workers would be in much better shape than companies that have undergone large-scale layoffs.

Spreading the Pain

The costs of layoffs go beyond the morale problems they cause — both for those laid off and those who keep their jobs. Unemployment insurance premiums spike. Depending on the company, there are severance packages to consider and outplacement services (costly in these days of bigger demand for them). Litigation is a not insignificant risk. Cappelli suggests that if a company can cut back without instituting layoffs, it should do so. “Then you don’t have those start-up costs” once things are back on track.

On the other hand, there’s nothing like a good economic downturn to get rid of dead wood. A sagging economy can be an opportune time for management to deal with performance problems by using the bluntest instrument possible, Cappelli says. Firing people is often difficult to execute, but an over-arching justification tends to lessen complications.

The subject of alternatives to layoffs is almost always seen from the point of view of the employer, he adds. It would be a rare employee who suggests his or her hours be cut. But executives can share the decision by asking for voluntary pay cuts in exchange for some sort of deferred compensation, such as shares of stock or extra vacation. Some U.S. cities coping with recession-driven budget crises have already opted to reduce salaries and hours. Atlanta Mayor Shirley Franklin recently said 4,600 city employees would see their hours cut by 10% because of a $60 million budget gap.

In the private sector, the conventional wisdom is that the smaller the company, the more apt owners are to work things out personally with workers. “We recently reduced hours in our department,” says Ben Atkinson, director of risk management for Edison, N.J.-based Peoplelink Staffing, a provider of staffing, software training, consulting, development and support. “My team proposed the idea, and each [of us] volunteered to reduce [his or her] number of work days. I have asked other managers across our enterprise to consider this approach.”

Atkinson says the move has prevented major disruptions to projects, and retains the investment the company has made in training its employees. “This is not to say we won’t consider layoffs,” he adds. “But it depends on your economic prognosis. If we anticipate a recovery sooner, we are more likely to consider reduced hours. If we expect a long slog, layoffs may seem more appropriate.”

“The really small companies are probably more willing to find alternatives,” Cappelli suggests. “Relationships are much more personal. It’s one thing for the CEO to call the HR person and say, ‘Lay off 10% of the staff.’ It’s another thing for the person at the top to look the [laid-off employee] in the eye” and say he or she no longer has a job.

Small, privately held companies also do not have as much pressure to cut costs if the owner believes it is possible to ride out the storm. Conversely, in a publicly held company, even if a CEO is inclined to seek alternatives to layoffs, pressure from shareholders and Wall Street analysts to cut staff might be too great. “With bigger companies, there is a certain skill to laying people off,” notes Cappelli. “It will be interesting to see in this recession how companies do it, because a lot of them have lost that skill.”

In the past 20 years, staff cutbacks have more frequently included attractive incentives, according to Daniel O’Meara, a senior fellow at Wharton’s Human Resources Center and an employment law attorney with Montgomery, McCracken, Walker & Rhoads in Philadelphia. In the 1990s, O’Meara saw more opportunities for voluntary retirement incentives. “It was more feasible with a defined benefit plan, and very feasible with over-funded pension plans. If [employers] could afford it now, it might be that anyone with 20 years of service and at least 55 [years old] would be treated as [if they have] 30 years [of service] and … are 65.”

These days, such options are less generous, he says, citing a particular hospital where buyout offers are more typical: one or two weeks of pay for each year of service. “No one who is happy in their job and doesn’t have something lined up would leave for four or eight weeks of pay. But you might have people who were going to leave anyway, and see it as a great opportunity.”

The other side of that coin is that some companies make such offers “only to show employees that they are basically good people, just before the involuntary layoffs come. Since the Depression, all these alternatives have been discussed — to lay people off or share the pain,” O’Meara says, recalling personal experiences as a young man growing up in western Pennsylvania, where he worked summers in a steel mill. “There, when things got slow, we all worked four days a week. That’s [a case] where the union had the effect of making sure people held on to their jobs. A lot of this stuff has been around for a long time. These decisions have huge impacts on people and there are no easy solutions.”

O’Meara has mixed emotions about unions in general, mentioning “pay compression,” where an unskilled broom-sweeper makes perhaps 60% of what a skilled steelworker makes. But that “socialist preference” clearly had a positive impact when the situation went beyond cuts in hours and moved into layoffs. “I have seen people retire and [accept] these fairly modest offers. [They figure] that they are older and their kids are out of college, and they think, ‘When I was younger and needed the job, I would have appreciated someone doing that for me,'” O’Meara recalls. “It doesn’t happen often, but I saw it in the steel mill.”

A new factor on the playing field of labor negotiations is pending legislation called the Employee Free Choice Act, pushed by the AFL-CIO and backed by many Democrats in Congress, including the President-elect. Passed by the U.S. House of Representatives in 2007 and eventually filibustered in the Senate, the act would require a union’s certification by the National Labor Relations Board (NLRB) when a majority of employees has signed a card designating a union as its bargaining representative.

“The bill would make it much easier to organize employees,” O’Meara says, which might make the case for alternatives to layoffs more pressing. At the same time it could possibly restrict options for employers. “You don’t want to lower morale when [Congress] is about to pass a law making it easier to organize. [But] it would make anything innovative a little more difficult.”

Avoiding Layoffs ‘At All Costs’

“The economy has got us all watching very closely. Like anyone, we are trying to figure out where the bottom is,” says Tim Roth, president of Megavolt, an agricultural machine re-manufacturer based in Springfield, Mo. “Agriculture has been relatively strong compared to other industries, but in June, we saw that in future months we would have some problems. We tried to figure out how to keep people and avoid layoffs at all costs.”

Megavolt has two advantages over many other private companies. First, it is a joint venture with two other firms descended from International Harvester after a buyout 25 years ago. In some cases, this allows employees who get additional training and certification to temporarily move to other work places, as needed.

Second, the company moved in October to a “shared work program” of three 10-hour days a week as a way to cope with the downturn. While workers keep their jobs, the lost 10 hours each week is nonetheless enough for them to be eligible for state unemployment benefits in Missouri, where Megavolt is located. The Missouri program also does not restrict unemployment benefits for people who take on part-time jobs, Roth says. And within the shared work program, companies can soften the blow to people who are laid off. In that situation, the state stipulates that the employer give the volunteers a specific recall date — generally, anywhere from one to six months out, according to Roth. The company also maintains health benefits for employees and defers their contribution to the premiums.

“It’s one thing to have lost a job completely, but it’s quite another to be able to look for work and know you have got something else behind you,” Roth says. “It’s a good program.”

Cappelli says Missouri’s program sounds promising as a model for other states. But it might be a moot point in the short term. Indiana officials just announced that they are running out of unemployment dollars and might have to increase the state tax that generates those funds. Currently, the first $7,000 of earned income is taxed for unemployment insurance, something Indiana may need to increase to offset its own residents’ needs.

Other states, such as New York, have shared work programs similar to Missouri’s, but the gap in flexibility from one state to another can be wide. At the moment, most state unemployment offices are passing on the news to out-of-work residents who have exhausted their benefits that recently passed legislation provides up to seven additional weeks of compensation, funded by the federal government.

In the end, companies need to balance what’s best for their employees while making sure the company remains viable in tough times. Small companies might be able to maneuver more nimbly, Cappelli says, but innovation will suit the times and circumstances no matter what the size of the firm, public or private.

He cites Cisco Systems in 2001, after the tech bubble and before 9/11, as an example. Cisco allowed employees to take sabbaticals while they were paid one-third their salary. “The reason was that at one-third pay, you couldn’t survive forever, but it was enough money that you wouldn’t necessarily be looking for another job” in the meantime. Cisco saved both money and talent.

Roth maintains that solutions like the ones his company have come up with work well only if state and federal agencies leave the innovation to the companies. “We can have the greatest idea to do something, and if the state doesn’t support us, we can’t do it,” Roth says. “We have to save jobs. We cannot let this country lose more jobs.”