CEO Pay and the Lake Wobegon Effect
University of Utah - Department of Finance
Rachel M. Hayes
University of Utah - David Eccles School of Business
December 11, 2008
Journal of Financial Economics (JFE), Forthcoming
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.
Number of Pages in PDF File: 26
Keywords: Executive Compensation, Asymmetric Information, Corporate Governance
JEL Classification: G34, J33, K20, M12, M52
Date posted: March 1, 2007 ; Last revised: January 8, 2009
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