Relative Wealth Concerns and Executive Compensation

Abstract:     
Empirical studies find that relative wealth concerns (RWCs) affect CEO compensation. In this paper, I incorporate RWCs into a standard principal-agent model and study the implications on CEO compensation. I show that RWCs make CEOs less risk-averse, thus, RWCs not only increase the level of CEO pay, but also increase CEO incentives. This effect is larger if systemic risk is higher, so RWCs can lead to a positive relation between CEO incentives and systemic risk. Because RWCs help to reduce risk premium, they can be beneficial to shareholders' payoff under some conditions. Lastly, I study two extensions. One is the case where RWCs are not observable. I show that a pooling equilibrium on CEO types can exist. I also consider the case where relative performance evaluation is used. I provide a simple explanation for the pay-for-luck puzzle in this case.

Number of Pages in PDF File: 29

Keywords: relative wealth concerns, executive compensation

JEL Classification: G30, J33

working papers series