CEOs Are Paid for Talent

Abstract

A few economists still believe that the extraordinary high and yearly increasing salaries for CEOs can at least be partially explained by talent. Underlying this are elaborate theories and models such as an increasing demand by a simultaneous shortage of talented people, which is driven by external factors like globalization, technological progress, demographic change, or a general shift from firm-specific to transferable skills. All these explanations share the assumption that marginal differences in talent get extraordinarily paid in the CEO market because of Zipf’s law. Such superstar effects in salaries are driven by “imperfect substitution”—meaning that firms prefer to have the best CEO rather than the second and third best together—and by “scale” in production—implying that in international companies consisting of thousands of employees, one CEO can reach and manage a large and diverse work force.