Peer Group Composition, Peer Performance Aggregation, and Detecting Relative Performance Evaluation
Dirk E. Black
Dartmouth College - Tuck School of Business
Shane S. Dikolli
Duke University - Fuqua School of Business
Ludwig-Maximilians-Universität München - Faculty of Business Administration (Munich School of Management)
February 16, 2011
AAA 2012 Management Accounting Section (MAS) Meeting Paper
We find that 17.32% of S&P 500 firms explicitly disclose the use of relative performance evaluation (RPE) in their first proxy statement filed on or after December 15, 2006, the effective date of an SEC rule mandating expanded compensation disclosures. We provide evidence on the completeness of these explicit disclosures by conducting implicit tests for RPE to detect if RPE-disclosing firms indeed filter out systematic risk from CEO compensation and RPE-non-disclosers do not. Recent work suggests that inferences from implicit tests for RPE may be sensitive to empirical choices about (1) peer group composition and (2) peer performance aggregation. We incorporate variations in these empirical design choices into our implicit tests for RPE. For the sub-sample of RPE disclosers, we find consistent implicit evidence of RPE as long as the peer group is composed either of firms in the same industry/size quartile or of firms named as peers in the explicit RPE disclosures. However, we also detect implicit RPE in RPE-non-disclosers, using, for example, industry/size peer groups and weighting each peer’s performance by each peer’s correlation with systematic risk relative to each peer’s idiosyncratic risk. These results imply that relying on explicit disclosures of RPE may understate the prevalence of RPE in practice and that implicit tests for RPE remain important in detecting RPE. Moreover, researchers may need to (1) control for both industry and size when forming peer groups to implicitly test for RPE and (2) adopt more sophisticated peer performance aggregation methods if a researcher’s objective is to control for the systematic determinants of firm performance.
Number of Pages in PDF File: 36
Keywords: relative performance evaluation, peer performance, aggregation, peer composition
JEL Classification: J33, J41
Date posted: August 17, 2011
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