Introduction

Business decisions to hire, to train and to lay off employees are affected by the employer's expectations about how much the employee will contribute to generation of cash flow for the company, similarly to the decision to invest in a real asset. On the other hand, hiring an employee also implies in a cost. Like other common investment decisions, hiring an employee is a decision under high uncertainty, both on the employee's performance and the level of use of its services. These two aspects can be considered uncertainties on labor offer and on labor demand respectively. Do employers correctly evaluate the volatility of the company's demand amd its impact on the demand for labor? And even more important than that: are hiring and layoffs decisions taken considering the value of managerial flexibility of hiring and dismissal of employees?

In times of economic crisis, it is very frequent to many workers being fired because the cost of labor becomes much higher than the value of its economic output. On the other hand, as the social cost of unemployment is very high, especially with regard to maintaining the living conditions of the unemployed and their families, it is common that labor laws of many countries impose high costs on termination of employment without cause, in order to discourage employers to take this decision.

A Case Study

According to Heckman and Pagés, it is a common occurrence reforms that increase workers’ rights in periods after a country’s return to democracy. Brazil, which returned to democracy in 1985 and promulgated a new constitution in 1988, has experienced considerable increase in the level of penalties to the layoffs in the new magna carta. As you read this post, the Brazilian senate is considering some changes in the labor laws in the country. In Brazil, the main costs on termination of employment without cause are the prior notice of dismissal and the fine of Government Severance Indemnity Fund (in that country, known for acronym “FGTS”). The latter, to be paid by the company that decides to dismiss employees without cause, equivalent to about 4% of the sum of the wages received by the employee during the entire period he or she worked at that company. The former, when the employee is indemnified, has a value that refers to the sum of wages and other labor rights in proportion to the period of 30 days plus 3 days per year of service to the company.

However, even if such costs are effective in reducing the number of layoffs, they tend to negatively impact, too, the decision to hire,. Thus, in a situation of economic normalcy, both the level of employment as wages are lower when the flexibility to lay off workers is not full. Moreover, the incentive to labor outsourcing increases in the presence of severance costs of the employment relationship.

Understanding the effects of managerial inflexibility to dismiss employees is relevant to the correct decision making of hiring by employers. Moreover, it is essential to analyze the cost-benefit of public policies that interfere with the flexibility to dismiss without cause. The costs imposed by labor legislation to companies upon termination employment contract without cause are important to protect workers against dismissal not motivated by the employee. By the way, receipt of 40% of total deposits made in the employee's FGTS account during the employment contract is a breath to the newly unemployed people and their family. However, there is a decreased appetite of companies for hiring employees because these costs, what is not so easily observable or measurable. It is important to have a more comprehensive analysis of the social cost-benefit of the barriers to layoff of employees, to the extent that it turns out to be possible to measure the undesired effect of the value decrease of employee to the company, which may cause adverse effect on hiring new employees or in salary level.

This image is merely illustrative of real option analysis application.

Conclusion

It is essential that human resources managers include real options analysis (ROA) in their human resources strategic decisions. They need to understand how important for them is understanding all the flexibility involved in hiring, dismissing, training, temporarily laying off and postponing such decisions. Each country has full autonomy to regulate the employment relationship existing on its territory. Some countries are more liberal, while others impose costs to the employer upon termination of employment without cause. In countries such as Brazil, where labor laws impose high costs on some decisions, human resources managers should have an even higher attention on real options analysis when considering all possible option regarding human resources in the company.