A Theory of Fair CEO Pay

A Theory of Fair CEO Pay

Pierre Chaigneau, Alex Edmans, Daniel Gottlieb

Series number :

Serial Number: 
865/2022

Date posted :

January 04 2023

Last revised :

March 15 2023
SSRN Share

Keywords

  • executive compensation • 
  • Fairness • 
  • moral hazard

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 does not need effort incentives.

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Authors

Real name:
Pierre Chaigneau
Real name:
Daniel Gottlieb