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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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    7. Sattinger, Michael, 1993. "Assignment Models of the Distribution of Earnings," Journal of Economic Literature, American Economic Association, vol. 31(2), pages 831-80, June.
    8. Bentley W. MacLeod, 2003. "Optimal Contracting with Subjective Evaluation," American Economic Review, American Economic Association, vol. 93(1), pages 216-240, March.
    9. Stein, Jeremy C, 1988. "Takeover Threats and Managerial Myopia," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 96(1), pages 61-80, February.
    10. 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.
    11. Philip H. Dybvig & Jaime F. Zender, 1988. "Capital Structure and dividend Irrelevance with Asymmetric Information," Cowles Foundation Discussion Papers 878, Cowles Foundation for Research in Economics, Yale University.
    12. Park, Yun W & Nelson, Toni & Huson, Mark R, 2001. "Executive Pay and the Disclosure Environment: Canadian Evidence," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 24(3), pages 347-65, Fall.
    13. Stein, Jeremy C, 1989. "Efficient Capital Markets, Inefficient Firms: A Model of Myopic Corporate Behavior," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 104(4), pages 655-69, November.
    14. Persons, John C, 1994. "Renegotiation and the Impossibility of Optimal Investment," Review of Financial Studies, Society for Financial Studies, vol. 7(2), pages 419-49.
    15. Dewatripont, Mathias, 1988. "Commitment through Renegotiation-Proof Contracts with Third Parties," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 55(3), pages 377-89, July.
    16. 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, Elsevier, vol. 90(2), pages 152-168, November.
    17. 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.
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    Citations

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    Cited by:
    1. Giannetti, Mariassunta, 2007. "Serial CEO Incentives and the Structure of Managerial Contracts," CEPR Discussion Papers 6422, C.E.P.R. Discussion Papers.
    2. Oz Shy, 2010. "A short survey of network economics," Working Papers, Federal Reserve Bank of Boston 10-3, Federal Reserve Bank of Boston.
    3. Oyer, Paul & Schaefer, Scott, 2011. "Personnel Economics: Hiring and Incentives," Handbook of Labor Economics, Elsevier, Elsevier.
    4. 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, Elsevier, vol. 100(3), pages 538-555, June.
    5. Faulkender, Michael & Yang, Jun, 2010. "Inside the black box: The role and composition of compensation peer groups," Journal of Financial Economics, Elsevier, Elsevier, vol. 96(2), pages 257-270, May.
    6. 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.
    7. 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.
    8. Francis, Bill & Hasan, Iftekhar & John, Kose & Waisman , Maya, 2012. "Urban agglomeration and CEO compensation," Research Discussion Papers 17/2012, Bank of Finland.
    9. Parsons, Christopher A. & Van Wesep, Edward D., 2013. "The timing of pay," Journal of Financial Economics, Elsevier, Elsevier, vol. 109(2), pages 373-397.

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