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Current research shows that firms are more likely to benchmark against peers that pay their Chief Executive Officers (CEOs) higher compensation, reflecting self-serving behavior. We propose an alternative explanation: the choice of highly paid peers represents a reward for unobserved CEO talent. We test this hypothesis by decomposing the effect of peer selection into talent and selfserving components. Consistent with our prediction, we find that the association between a firm's selection of highly paid peers and CEO pay mostly represents compensation for CEO talent. Electronic copy available at: http://ssrn.com/abstract=1362047 Peer Choice in CEO CompensationAugust 2012 AbstractCurrent research shows that firms are more likely to benchmark against peers that pay their Chief Executive Officers (CEOs) higher compensation, reflecting self-serving behavior. We propose an alternative explanation: the choice of highly paid peers represents a reward for unobserved CEO talent. We test this hypothesis by decomposing the effect of peer selection into talent and selfserving components. Consistent with our prediction, we find that the association between a firm's selection of highly paid peers and CEO pay mostly represents compensation for CEO talent.

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