Working Paper: CEPR ID: DP17782
Authors: Pierre Chaigneau; Alex Edmans; Daniel Gottlieb
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 Codes: D86; G32; G34; J33
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| CEO's perceived fair wage (M12) | CEO's utility (M12) |
| actual wage (J31) | CEO's perceived fair wage (M12) |
| CEO's effort (M12) | output (C67) |
| output (C67) | CEO's perceived fair wage (M12) |
| threat of low pay (J31) | CEO's effort (M12) |
| output (C67) | CEO's pay structure (M12) |
| fairness concerns (D63) | pay-for-performance structures (J33) |