CEO pay slice and the sunk-cost effect

Abstract

The sunk-cost effect refers to obsessive attachment to prior investments, possibly impairing corporate-value sustainability. This paper explores whether CEOs become susceptible to the sunk-cost effect as their pay slice (a pay gap among a CEO and the other top managers) increases. In situations where information is insufficient to determine an option because of lower collaboration with other top executives (caused by a sense of unfairness), high CEO pay slice induces the CEO to feel burdened and not confess her/his investment failures. This may more likely lead to the justification of previous decisions and continuous reinvestment despite negative consequences. Supporting this conjecture, we find that a CEO’s susceptibility to the sunk-cost effect increases with CEO pay slice. Our evidence, which adds to the understanding of the sunk-cost effect in the corporate environment, suggests a vital clue for the mechanisms of how a relatively overpaid CEO affects corporate-value sustainability. © 2019, Allied Business Academies. All rights reserved.