The government abandoned a central plank of its work experience scheme on Wednesday when it was forced to bow to pressure from businesses to drop benefit sanctions against young people on the programme.

Amid threats from some of Britain's largest employers that they would withdraw from the scheme, which has been criticised for exploiting young people, the Department for Work and Pensions announced that participants would now keep their benefits even if they left a placement.

The announcement by Chris Grayling, the employment minister, came after business leaders raised concerns that involvement in the voluntary work experience scheme was damaging their reputations.

Participants in the scheme, which offers 16- to 24-year-olds eight weeks of work experience, receive their benefits while on the scheme. Until the government's change of heart, they would have lost two weeks' jobseeker's allowance if they withdrew after a week.

In a statement issued by the DWP, which announced that Airbus, Center Parcs and HP Enterprise Services were joining the scheme, Grayling claimed the "sanction regime" would remain in place, because participants would lose their benefits if they were guilty of gross misconduct.

Grayling had earlier acknowledged the change, but later issued the carefully worded statement amid unease from Iain Duncan Smith, the work and pensions secretary, over dropping the sanctions.

News of the change was conveyed by Anne Marie Carrie, chief executive of Barnardo's, one of those who attended a 90-minute meeting with Grayling to discuss the scheme.

She told Channel 4 News: "Two things that have come out of it are really important. One is the removal of sanctions for anyone at any time if they leave this voluntary work experience scheme, to make sure we understand it is completely voluntary.

"The second thing that Barnardo's proposed is that we produce a young person's guide to work experience, so they understand what is expected of them."

Grayling acknowledged that the sanctions had been withdrawn. He said: "The employers said to us: 'Look we would like to modify it. At the moment you've got a situation where people can leave voluntarily after the first week. We would like them to be able to sit down later with us in the work placement if it is not working out and say we want to opt out.' We thought that was reasonable. We want to keep the scheme going. It is a positive scheme for young people and so we said fine, we will accept that."

The government's change of heart, which follows a series of investigations by the Guardian into the work placements, came shortly after David Cameron denounced as "Trotskyites" some of those campaigning against the scheme.

"It is time for businesses in Britain, and everyone in Britain who wants to see people have work experience, to stand up against the Trotskyites of the Right to Work campaign, and perhaps recognise the deafening silence there has been from the Labour party," he told MPs.

However, the prime minister was forced to announce a review of Whitehall procedures over the appointment of Emma Harrison, the former chair of A4e, as his troubled families tsar. Some employees of her company, which finds work for the long-term unemployed in the separate Work Programme, were subject to a fraud investigation before her appointment. There is no suggestion that Harrison did anything wrong.

"I am concerned that subsequent to Emma Harrison's appointment, information needed to be passed up the line to ministers more rapidly," he said, announcing that the cabinet secretary, Sir Jeremy Heywood, would review Whitehall guidelines.

His move came hours before the government's flagship welfare reform bill passed all its stages in parliament after a bumpy ride in the House of Lords.

The bill will introduce a blanket £26,000 cap on household welfare benefits and lead to the introduction of Duncan Smith's universal credit, which wraps most benefits into one payment.

The prime minister said: "Past governments have talked about reform, while watching the benefits bill sky rocket and generations languish on the dole and dependency. This government is delivering it. Our new law will mark the end of the culture that said a life on benefits was an acceptable alternative to work."

Grayling amended the rules for the voluntary work scheme, which falls outside the new bill, after business leaders expressed their frustration to him in their 90 minute meeting.

One executive, who was present but asked to remain nameless, said: "They were not angry with Grayling himself, but they were very concerned that they had been trying to do 'the right thing' for unemployed youngsters and yet it had turned into bad publicity. The protests were threatening to damage the reputations of their businesses and undermine morale among their existing staff through accusations that working for some employers was 'not a real job'."

Some of the large supermarkets were particularly vociferous, added the executive, who said there was a feeling that the debate had been lost by the DWP to protesters in the media. "Most people at the meeting told Grayling they supported the general scheme and said their local managers got positive feedback from the youngsters, but they made clear the government had to make changes to it or they would be forced to pull out."

Brendan Barber, the TUC general secretary, said: "We welcome the government's climbdown on the use of sanctions in work experience. Of course proper work experience can be useful and helpful for many young people, but it needs to be designed to help the young person, not provide free labour for employers or displace paid staff. Making absolutely clear that it is voluntary at all times will help safeguard against abuse."

Grayling denied he had caved in to the "Trotskyists", saying: "The real argument of the Trotskyist is that unpaid work experience is wrong, and is denying people the right to work; they are wrong." Grayling pointed out that only 220 participants in the scheme had had their benefits withdrawn. This sanction was at the discretion of jobcentre staff.

Critics of Grayling and the DWP will say that they should have acted earlier to get rid of any accusation that the scheme amounted to "workfare", since he has been under pressure from employers for more than a week on the issue.

Mark Dunk, from the Right to Work campaign, said: "The dropping of sanctions for the work-experience scam is one battle won, but the wider fight goes on. Forced unpaid work still continues in the form of the mandatory work activity and community activity programme. We demand that the government immediately drops not just one of its forced labour schemes [but] all of them.

"There should not be any young person anywhere forced to work for no pay. Everyone on any training scheme should receive minimum wage or above. We demand real jobs now for all."

Katja Hall, the CBI's chief policy director, said: "It's good to hear that many more employers are signing up to give young people a chance to get experience of work."

"Gaining hands-on experience of the workplace is vital to giving young jobseekers a foot in the door, and it can make such a difference when they are applying for interviews. The advantage of this scheme is that they gain work experience while remaining on benefits."