The Diminishing Returns of CEO Pay

Building upon labor market theory, we investigate whether under- or over-investing in CEOs (i.e., strategically paying above or below a CEO’s predicted labor market wage) affects long-term firm value and whether there are diminishing returns to these investments. Our results indicate that investments in CEOs are positively related to long-term firm value and that the relationship diminishes, eventually becoming negative, as investments increase. The results suggest that investments in CEOs have long-term firm performance consequences.