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CEO Pay and the Lake Wobegon Effect

26 Pages Posted: 1 Mar 2007 Last revised: 8 Jan 2009

Scott Schaefer

University of Utah - Department of Finance

Rachel M. Hayes

University of Utah - David Eccles School of Business

Date Written: December 11, 2008

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.

Keywords: Executive Compensation, Asymmetric Information, Corporate Governance

JEL Classification: G34, J33, K20, M12, M52

Suggested Citation

Schaefer, Scott and Hayes, Rachel M., CEO Pay and the Lake Wobegon Effect (December 11, 2008). Journal of Financial Economics (JFE), Forthcoming. Available at SSRN: https://ssrn.com/abstract=966332 or http://dx.doi.org/10.2139/ssrn.966332

Scott Schaefer (Contact Author)

University of Utah - Department of Finance ( email )

David Eccles School of Business
Salt Lake City, UT 84112
United States

Rachel M. Hayes

University of Utah - David Eccles School of Business ( email )

1645 E Campus Center Dr
Salt Lake City, UT 84112-9303
United States

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