Wage rigidity and employment adjustment at the firm level: Evidence from survey data

•We investigate how firms adjust labour costs in the presence of wage rigidities.•Portuguese firms adjust labour costs by adjusting the quantity and cost of labour.•Firms with more flexible base wages are 20 pp. less likely to reduce employment.•By cutting labour costs, firms are 35 pp. less likely to reduce employment.

This paper uses firm level survey data from Portugal to investigate how firms adjust their labour costs in the presence of wage rigidities. We document that Portuguese firms, besides reducing employment or freezing nominal base wages, also make frequent use of other cost-cutting strategies, like freezing or cutting bonuses and other monetary or non-monetary benefits, slowing down or freezing the rate at which promotions are filled, or recruiting new employees at wages lower than those received by the employees that have left the firm. We show that the utilisation of these different adjustment strategies is affected by workers' and firms' attributes, as well as by some indicators of the economic environment in which firms operate. More importantly, we provide evidence that firms with more flexible base wages are less likely to reduce employment, and that such effect may be significantly strengthened by the availability of alternative labour-cost adjustment margins that firms can use in bad times.