A Theory of Fair CEO Pay

47 Pages Posted: 11 Dec 2022 Last revised: 4 Jan 2023

See all articles by Pierre Chaigneau

Pierre Chaigneau

Queen's University; Queen’s University

Alex Edmans

London Business School - Institute of Finance and Accounting; European Corporate Governance Institute (ECGI); Centre for Economic Policy Research (CEPR)

Daniel Gottlieb

London School of Economics

Date Written: December 21, 2022

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.

Keywords: Executive compensation, fairness, moral hazard

JEL Classification: D86, G32, G34, J33

Suggested Citation

Chaigneau, Pierre and Edmans, Alex and Gottlieb, Daniel, A Theory of Fair CEO Pay (December 21, 2022). European Corporate Governance Institute – Finance Working Paper No. 865/2022, Available at SSRN: https://ssrn.com/abstract=4294589 or http://dx.doi.org/10.2139/ssrn.4294589

Pierre Chaigneau

Queen's University ( email )

Smith School of Business - Queen's University
143 Union Street
Kingston, Ontario K7L 3N6
Canada

Queen’s University ( email )

Alex Edmans (Contact Author)

London Business School - Institute of Finance and Accounting ( email )

Sussex Place
Regent's Park
London NW1 4SA
United Kingdom

European Corporate Governance Institute (ECGI) ( email )

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Daniel Gottlieb

London School of Economics ( email )

New Academic Building 5.30
Houghton Street
London, WC2A 2AE
United Kingdom

HOME PAGE: http://https://personal.lse.ac.uk/gottlied/

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