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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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File URL: http://www.sciencedirect.com/science/article/B6VBX-4WW2SR9-1/2/5cd563cad756353cbd26c2d4e0ca337b
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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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1. Stein, Jeremy C., 1988. "Takeover Threats and Managerial Myopia," Scholarly Articles 3708937, Harvard University Department of Economics.
   
   • Stein, Jeremy C, 1988. "Takeover Threats and Managerial Myopia," Journal of Political Economy, University of Chicago Press, vol. 96(1), pages 61-80, February.
2. Miller, Merton H & Rock, Kevin, 1985. " Dividend Policy under Asymmetric Information," Journal of Finance, American Finance Association, vol. 40(4), pages 1031-51, September.
3. Chaim Fershtman & Kenneth L Judd, 1984. "Equilibrium Incentives in Oligopoly," Discussion Papers 642, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
   
   • Fershtman, Chaim & Judd, Kenneth L, 1987. "Equilibrium Incentives in Oligopoly," American Economic Review, American Economic Association, vol. 77(5), pages 927-40, December.
4. Myers, Stewart C. & Majluf, Nicolás S., 1945-, 1984. "Corporate financing and investment decisions when firms have information that investors do not have," Working papers 1523-84., Massachusetts Institute of Technology (MIT), Sloan School of Management.
5. 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.
6. Myers, Stewart C. & Majluf, Nicholas S., 1984. "Corporate financing and investment decisions when firms have information that investors do not have," Journal of Financial Economics, Elsevier, vol. 13(2), pages 187-221, June.
7. 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.
8. Sattinger, Michael, 1993. "Assignment Models of the Distribution of Earnings," Journal of Economic Literature, American Economic Association, vol. 31(2), pages 831-80, June.
9. Bentley W. MacLeod, 2003. "Optimal Contracting with Subjective Evaluation," American Economic Review, American Economic Association, vol. 93(1), pages 216-240, March.
   
   • Bentley MacLeod, 2001. "Optimal Contracting with Subjective Evaluation," Theory workshop papers 357966000000000036, UCLA Department of Economics.
10. Edward P. Lazear, 1995. "Personnel Economics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262121883.
    
    • Edward P. Lazear & Paul Oyer, 2007. "Personnel Economics," NBER Working Papers 13480, National Bureau of Economic Research, Inc.
11. Michael L. Katz., 1991. "Game-Playing Agents: Unobservable Contracts as Precommitments," Economics Working Papers 91-172, University of California at Berkeley.
    
    • Michael L. Katz, 1991. "Game-Playing Agents: Unobservable Contracts as Precommitments," RAND Journal of Economics, The RAND Corporation, vol. 22(3), pages 307-328, Autumn.
    • Katz, Michael L., 1991. "Game-Playing Agents: Unobservable Contracts as Precommitments," Department of Economics, Working Paper Series qt79b870w0, Department of Economics, Institute for Business and Economic Research, UC Berkeley.
12. Dybvig, Philip H & Zender, Jaime F, 1991. "Capital Structure and Dividend Irrelevance with Asymmetric Information," Review of Financial Studies, Society for Financial Studies, vol. 4(1), pages 201-19.
    
    • 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.
13. 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.
14. 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.
15. 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.
16. 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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Cited by:

1. Oz Shy, 2010. "A short survey of network economics," Working Papers 10-3, Federal Reserve Bank of Boston.
   
   • Oz Shy, 2011. "A Short Survey of Network Economics," Review of Industrial Organization, Springer, vol. 38(2), pages 119-149, March.
2. 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.
3. Giannetti, Mariassunta, 2007. "Serial CEO Incentives and the Structure of Managerial Contracts," CEPR Discussion Papers 6422, C.E.P.R. Discussion Papers.
   
   • Giannetti, Mariassunta, 2011. "Serial CEO incentives and the structure of managerial contracts," Journal of Financial Intermediation, Elsevier, vol. 20(4), pages 633-662, October.
4. 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.
5. Francis, Bill & Hasan, Iftekhar & John, Kose & Waisman , Maya, 2012. "Urban agglomeration and CEO compensation," Research Discussion Papers 17/2012, Bank of Finland.

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