CEO Talent, CEO Compensation, and Product Market Competition∗

I study how the distribution of CEO talent and that of CEO compensation vary across industries, and how product market characteristics affect these distributions. I develop a general equilibrium model that incorporates the competitive assignment of CEOs to firms in a framework in which firms engage in imperfect product market—specifically, monopolistic—competition. I use the model to address the following principal research questions: (i) How important is managerial talent when the product market environment in which firms operate is considered? (ii) How do product market characteristics, such as the entry cost and the elasticity of substitution between differentiated products, affect CEO compensation? (iii) How does the distribution of CEO talent vary across industries? (iv) To what extent can product market characteristics explain the wide variation in the levels and distributions of CEO compensation across industries? Adopting the method of Terviö (2003, 2008) to identify the unobserved factor distributions, I calibrate my structural model to a sample of firm-CEO observations industry by industry. I then conduct several counterfactual experiments using the respective calibrated models. I find that the distribution of CEO talent does, indeed, vary dramatically across industries. More importantly, contrary to the conclusions of earlier studies that abstract away from product market characteristics (Terviö, 2008 and Gabaix and Landier, 2008), the impact of CEO talent on firm value appears to be quite significant. My estimates of the effect of CEO talent on firm value for the industries in my sample are two orders of magnitude higher than those obtained by Terviö (2008) and Gabaix and Landier (2008). Further, my estimates suggest that the compensation of CEOs is quantitatively in line with their contributions to firms. Broadly, my study shows that it is important to incorporate characteristics of the product market when assessing the contributions of CEOs to firms. JEL Classification: D43, D59, G30, J24, J31, L11, L13, M52