CEO Pay and the Lake Wobegon Effect
26 Pages Posted: 1 Mar 2007 Last revised: 8 Jan 2009
Date Written: December 11, 2008
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.
Keywords: Executive Compensation, Asymmetric Information, Corporate Governance
JEL Classification: G34, J33, K20, M12, M52
Suggested Citation: Suggested Citation