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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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    File URL: http://www.sciencedirect.com/science/article/pii/S0304-405X(09)00128-7
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    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
    Contact details of provider: Web page: http://www.elsevier.com/locate/inca/505576

    Keywords: CEO pay Asymmetric information Signaling;

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    1. 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.
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    9. 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.
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    11. 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.
    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. Edward P. Lazear & Paul Oyer, 2012. "Personnel Economics
      [The Handbook of Organizational Economics]      ," Introductory Chapters, Princeton University Press.
    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.
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    Cited by:

    1. Parsons, Christopher A. & Van Wesep, Edward D., 2013. "The timing of pay," Journal of Financial Economics, Elsevier, vol. 109(2), pages 373-397.
    2. Oz Shy, 2011. "A Short Survey of Network Economics," Review of Industrial Organization, Springer, vol. 38(2), pages 119-149, March.
    3. repec:hhs:bofrdp:2012_017 is not listed on IDEAS
    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. 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.
    6. Francis, Bill & Hasan, Iftekhar & John, Kose & Waisman, Maya, 2012. "Urban agglomeration and CEO compensation," Research Discussion Papers 17/2012, Bank of Finland.
    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. Matousek, Roman & Tzeremes, Nickolaos G., 2016. "CEO compensation and bank efficiency: An application of conditional nonparametric frontiers," European Journal of Operational Research, Elsevier, vol. 251(1), pages 264-273.
    9. Giannetti, Mariassunta, 2011. "Serial CEO incentives and the structure of managerial contracts," Journal of Financial Intermediation, Elsevier, vol. 20(4), pages 633-662, October.
    10. 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.
    11. Paul Oyer & Scott Schaefer, 2010. "Personnel Economics: Hiring and Incentives," NBER Working Papers 15977, National Bureau of Economic Research, Inc.

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