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A Theory of Fair CEO Pay

Author

Listed:
  • Edmans, Alex
  • Chaigneau, Pierre
  • Gottlieb, Daniel

Abstract

This paper studies optimal executive pay when the CEO is concerned about fairness: if his wage falls below a perceived fair share of output, the CEO suffers disutility that is increasing in the discrepancy. Fairness concerns do not lead to fair wages always being paid -- to induce effort, the firm threatens the CEO with unfair wages if output is sufficiently low. The optimal contract sometimes involves performance shares: the CEO is paid a constant share of output if it is sufficiently high, but the wage drops discontinuously to zero if output falls below a threshold. Even if the incentive constraint is slack, the optimal contract continues to involve pay-for-performance, to address the CEO's fairness concerns and ensure his participation. Thus, the firm can implement strictly positive levels of effort "for free." This rationalizes pay-for-performance even if the CEO is intrinsically motivated and does not need effort incentives.

Suggested Citation

  • Edmans, Alex & Chaigneau, Pierre & Gottlieb, Daniel, 2023. "A Theory of Fair CEO Pay," CEPR Discussion Papers 17782, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:17782
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    More about this item

    Keywords

    Executive compensation;

    JEL classification:

    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G34 - Financial Economics - - Corporate Finance and Governance - - - Mergers; Acquisitions; Restructuring; Corporate Governance
    • J33 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Compensation Packages; Payment Methods

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