Question

Under the situation where firms have to downsize by laying off large groups of employees, a profit-maximizing firm should target its most highly paid workers for the need of controlling compensation costs.

True
False

Answer 1

Laying off the highest-paid employees is not necessarily the best strategy for a profit-maximizing firm, as it could lead to losing the most productive workers and retaining less skilled ones, according to the adverse selection of wage cuts argument.

Step-by-step explanation:

The idea that a profit-maximizing firm should target its most highly paid workers for layoffs to control compensation costs is flawed. The adverse selection of wage cuts argument illustrates that if wages are cut across the board during tough business conditions, the most skilled workers with better employment prospects may leave the company, leaving behind less capable employees. This leads firms to strategically choose which workers to lay off rather than cutting wages for everyone.

Moreover, layoffs are generally chosen over wage cuts because convincing a workforce to accept reduced pay is quite rare. Also, in alignment with the first rule of labor markets, a firm aims to align compensation with the value of the employee's marginal productivity, making it counterproductive to simply target high earners without considering the value they bring to the firm.