Implementing Relative Performance Evaluation: The Role of Life Cycle Peers

2019 ◽  
Vol 32 (2) ◽  
pp. 107-135
Author(s):  
Katharine D. Drake ◽  
Melissa A. Martin
Keyword(s):  
Performance Evaluation ◽  
Life Cycle ◽  
Peer Group ◽  
Life Cycle Stage ◽  
Relative Performance ◽  
Data Availability ◽  
Relative Performance Evaluation ◽  
Peer Selection ◽  
Exogenous Shocks

ABSTRACT The effectiveness of relative performance evaluation (RPE) in compensation contracts depends on a firm's ability to identify peers that are subject to similar exogenous shocks with similar abilities to respond to such shocks. We expand the RPE literature by considering whether firms routinely select peers sharing a life cycle stage in RPE implementation. We argue that life cycle captures similarities in underlying economics and homogeneity along a number of dimensions relevant in filtering systematic performance. Using explicit peer firm disclosures and a peer selection model, we show that firms routinely select life cycle peers. Further, using implicit RPE tests, we document evidence of life cycle peers filtering common performance incremental to previously identified peer groups. We provide some of the first evidence that peer group composition differs with differing characteristics of the firm and its industry, highlighting that peer selection is a dynamic process evolving with the firm's changing nature. JEL Classifications: E32; J33; L2. Data Availability: All data are available from public sources.

scholarly journals Do Growth-Option Firms Use Less Relative Performance Evaluation?

2013 ◽  
Vol 89 (1) ◽  
pp. 27-60 ◽  
Author(s):  
Ana Maria Albuquerque
Keyword(s):  
Performance Evaluation ◽  
Peer Group ◽  
Principal Component ◽  
Relative Performance ◽  
Data Availability ◽  
Growth Options ◽  
Relative Performance Evaluation ◽  
Compensation Contracts ◽  
Growth Option ◽  
The Impact

ABSTRACT The use of relative performance evaluation (RPE) in compensation contracts for CEOs at growth-option (GO) firms that operate in more volatile environments can provide insurance against common exogenous shocks and thus reduce the amount of risk that CEOs face. However, the implementation of RPE for high-GO firms can be impaired by these firms' inability to find a peer group that captures common risk exposure. This paper studies GO firms' reliance on RPE and finds that the use of RPE in CEO compensation contracts varies negatively with a firm's level of growth options. The tests use three proxies for growth options: the market-to-book value of assets, research and development expenses scaled by assets, and a factor obtained from a principal component analysis. The results are robust to controlling for the impact of other firm characteristics on pay-for-performance sensitivities. Data Availability: All data are obtained from publicly available sources.

Product Market Peers and Relative Performance Evaluation

2020 ◽  
Author(s):  
Sudarshan Jayaraman ◽  
Todd Milbourn ◽  
Florian Peters ◽  
Hojun Seo
Keyword(s):  
Performance Evaluation ◽  
Stock Returns ◽  
Product Market ◽  
Relative Performance ◽  
Relative Performance Evaluation ◽  
Common Shocks ◽  
Ceo Pay ◽  
Forced Turnover ◽  
Definition Of

We investigate the role of Relative Performance Evaluation (RPE) theory in CEO pay and turnover using a product similarity-based definition of peers (Hoberg and Phillips 2016). RPE predicts that firms filter out common shocks (i.e., those affecting the firm and its peers) while evaluating CEO performance and that the extent of filtering increases with the number of peers. Despite the intuitive appeal of the theory, previous tests of RPE find weak and inconsistent evidence, which we argue is due to the imprecise categorization of peers. Using product market peers, we find three pieces of evidence consistent with RPE in relation to CEO pay and forced turnover: (i) on average, firms partially filter out common shocks to stock returns, (ii) the extent of filtering increases with the number of peers, and (iii) firms completely filter out common shocks in the presence of a large number of peers.

What determines the variation in relative performance evaluation usage across US industries?

2014 ◽  
Vol 37 (5) ◽  
pp. 502-514
Author(s):  
James J. Cordeiro ◽  
Rong Yang ◽  
D. Donald Kent Jr ◽  
Charles Callahan III
Keyword(s):  
Performance Evaluation ◽  
Firm Performance ◽  
Peer Group ◽  
Relative Performance ◽  
Relative Performance Evaluation ◽  
Managerial Control ◽  
Content Type ◽  
Industry Level ◽  
Industry Competition ◽  
Industry Homogeneity

Purpose – Relative performance evaluation (RPE) involves board comparisons of firm performance to that of a peer group when evaluating CEO performance. To date, research on RPE in the USA has typically relied on models where RPE is implicitly assumed. In contrast, Bannister and Newman provide some direct evidence on the explicit RPE usage by US firms showing that it is limited and there is significant inter-industry variation in its use. The authors aim to focus on why boards in some industries employ RPE to a greater extent than those in other industries do using measures of industry discretion, industry homogeneity, industry competition. Design/methodology/approach – The authors utilize the sample use in the Bannister and Newman study of RPE usage in industries (160 firms from the 1992 Fortune 250 with proxy statements for 1992 and 1993). The authors compile measures of industry membership (using SIC codes), industry discretion, industry homogeneity, and industry competition from Compustat a well. Multiple regression is used to test the hypotheses. Findings – The authors find that the use of RPE at the industry level is significantly related to industry discretion (i.e. the degree of latitude that managers have over strategic and operational choices in the particular industry environment) and industry homogeneity, but not to industry competition. Research limitations/implications – The study is limited in terms of a dated sample (necessary to be consistent with the Bannister and Newman paper). It would bear updating. In addition, multi-year panel data could be used to generate more robust results. It would also be useful to replicate the study in other national (and hence governance) contexts. Practical implications – The findings should help boards when deciding how to reward or punish CEOs and top managers for their firm performance by filtering out relative performance in a more rational manner (e.g. by taking relevant industry context into account). Originality/value – In terms of originality, this is the first study, to the authors' knowledge, that investigates RPE at the industry level. It is valuable because industry discretion is an important contextual variable that a board of directors will find useful in evaluating managers since this type of discretion is beyond managerial control.

Relative Performance Evaluation and Related Peer Groups in Executive Compensation Contracts

2011 ◽  
Vol 86 (3) ◽  
pp. 1007-1043 ◽  
Author(s):  
Guojin Gong ◽  
Laura Yue Li ◽  
Jae Yong Shin
Keyword(s):  
Performance Evaluation ◽  
Executive Compensation ◽  
Peer Group ◽  
Relative Performance ◽  
Relative Performance Evaluation ◽  
Rent Extraction ◽  
Compensation Contracts ◽  
Performance Targets ◽  
Peer Group Composition ◽  
Selection Of

ABSTRACT: This study examines the explicit use of relative performance evaluation (RPE) in executive compensation contracts and the selection of RPE peers. Using S&P 1500 firms’ first proxy disclosures under the SEC’s 2006 executive compensation disclosure rules, we find that about 25 percent of our sample firms explicitly use RPE in setting executive compensation. We demonstrate that a lack of knowledge of both actual peer-group composition and the link between RPE-based performance targets and future peer performance significantly hinder the traditional implicit test from detecting RPE use. We also find that firms consider both costs and benefits of RPE as an incentive mechanism when deciding to use RPE. Finally, both efficient contracting and rent extraction considerations influence RPE peer selection, with the relative importance of these competing considerations depending on RPE firms’ performance.

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