The salaries of CEOs: Is it all about skills?

•Our model explains the abnormal compensation of CEO's.•The method we use identifies the abnormal compensation of CEO's.•The results can help in shaping a more efficient tax policy.

This research identifies mechanisms that could help achieve a deeper understanding of the abnormal compensation of CEOs. We construct a model in which the determination of compensation depends on three factors: the CEO's skills, the level of competition in the sector and the ownership structure of the firm. The model allows us to break down the components of the CEO's compensation into talent, and abnormal compensation justified by the level of competition and ownership structure. Furthermore, it facilitates breaking down the abnormal compensation into endogenous premium stemming from change in the CEO's effort, and net abnormal compensation. Breaking down the compensation into different components is crucial for establishing efficient tax or other socio-economic policies. Taxing compensation that is an outcome of talent and effort might result in relatively high economic burden, however taxing the net abnormal return would create almost no economic burden.