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CEO pay and the Lake Wobegon Effect

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  • Hayes, Rachel M.
  • Schaefer, Scott
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    Abstract

    The "Lake Wobegon Effect," which is widely cited as a potential cause for rising CEO pay, is said to occur because no firm wants to admit to having a CEO who is below average, and so no firm allows its CEO's pay package to lag market expectations. We develop a game-theoretic model of this Effect. In our model, a CEO's wage may serve as a signal of match surplus, and therefore affect the value of the firm. We compare equilibria of our model to a full-information case and derive conditions under which equilibrium wages are distorted upward.

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    Bibliographic Info

    Article provided by Elsevier in its journal Journal of Financial Economics.

    Volume (Year): 94 (2009)
    Issue (Month): 2 (November)
    Pages: 280-290

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    Handle: RePEc:eee:jfinec:v:94:y:2009:i:2:p:280-290

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    Web page: http://www.elsevier.com/locate/inca/505576

    Related research

    Keywords: CEO pay Asymmetric information Signaling;

    References

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    5. Bizjak, John M. & Lemmon, Michael L. & Naveen, Lalitha, 2008. "Does the use of peer groups contribute to higher pay and less efficient compensation?," Journal of Financial Economics, Elsevier, vol. 90(2), pages 152-168, November.
    6. Bentley MacLeod, 2001. "Optimal Contracting with Subjective Evaluation," Theory workshop papers 357966000000000036, UCLA Department of Economics.
    7. Edward P. Lazear & Paul Oyer, 2007. "Personnel Economics," NBER Working Papers 13480, National Bureau of Economic Research, Inc.
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    9. Sattinger, Michael, 1993. "Assignment Models of the Distribution of Earnings," Journal of Economic Literature, American Economic Association, vol. 31(2), pages 831-80, June.
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    12. Stewart C. Myers & Nicholas S. Majluf, 1984. "Corporate Financing and Investment Decisions When Firms Have InformationThat Investors Do Not Have," NBER Working Papers 1396, National Bureau of Economic Research, Inc.
    13. Fershtman, Chaim & Judd, Kenneth L, 1987. "Equilibrium Incentives in Oligopoly," American Economic Review, American Economic Association, vol. 77(5), pages 927-40, December.
    14. Stein, Jeremy C, 1989. "Efficient Capital Markets, Inefficient Firms: A Model of Myopic Corporate Behavior," The Quarterly Journal of Economics, MIT Press, vol. 104(4), pages 655-69, November.
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    16. Moran, John & Morgan, John, 2003. "Employee recruiting and the Lake Wobegon effect," Journal of Economic Behavior & Organization, Elsevier, vol. 50(2), pages 165-182, February.
    17. Miller, Merton H & Rock, Kevin, 1985. " Dividend Policy under Asymmetric Information," Journal of Finance, American Finance Association, vol. 40(4), pages 1031-51, September.
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    Citations

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    Cited by:
    1. Oz Shy, 2010. "A short survey of network economics," Working Papers 10-3, Federal Reserve Bank of Boston.
    2. Parsons, Christopher A. & Van Wesep, Edward D., 2013. "The timing of pay," Journal of Financial Economics, Elsevier, vol. 109(2), pages 373-397.
    3. Faulkender, Michael & Yang, Jun, 2010. "Inside the black box: The role and composition of compensation peer groups," Journal of Financial Economics, Elsevier, vol. 96(2), pages 257-270, May.
    4. Hongfei Tang, 2014. "Are CEO stock option grants optimal? Evidence from family firms and non-family firms around the Sarbanes–Oxley Act," Review of Quantitative Finance and Accounting, Springer, vol. 42(2), pages 251-292, February.
    5. Giannetti, Mariassunta, 2007. "Serial CEO Incentives and the Structure of Managerial Contracts," CEPR Discussion Papers 6422, C.E.P.R. Discussion Papers.
    6. Paul Oyer & Scott Schaefer, 2010. "Personnel Economics: Hiring and Incentives," NBER Working Papers 15977, National Bureau of Economic Research, Inc.
    7. Bizjak, John & Lemmon, Michael & Nguyen, Thanh, 2011. "Are all CEOs above average? An empirical analysis of compensation peer groups and pay design," Journal of Financial Economics, Elsevier, vol. 100(3), pages 538-555, June.
    8. Francis, Bill & Hasan, Iftekhar & John, Kose & Waisman , Maya, 2012. "Urban agglomeration and CEO compensation," Research Discussion Papers 17/2012, Bank of Finland.
    9. Laschever, Ron A., 2013. "Keeping up with CEO Jones: Benchmarking and executive compensation," Journal of Economic Behavior & Organization, Elsevier, vol. 93(C), pages 78-100.

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