A Theory of Fair CEO Pay

Daniel Gottlieb, Pierre Chaigneau and Alex Edmans

No 17782, CEPR Discussion Papers from C.E.P.R. Discussion Papers

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 (search for similar items in EconPapers)
JEL-codes: D86 G32 G34 J33 (search for similar items in EconPapers)
Date: 2023-01
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