Exposures to Common Shocks Along Supply Chains and Relative Performance Evaluation in CEO Compensation Contracts

A fundamental prediction from principal-agent theory is that firms facing greater ex ante exposures to exogenous common shocks should more frequently utilize relative performance evaluation (RPE) in CEO compensation contracts. Recent advances in modeling the economy as a supply network consisting of sectors connected through input-output linkages establish that industries positioned more centrally or upstream face greater ex ante exposures to exogenous common shocks propagating through the network. This paper investigates the impact of firms' network positions on the use of RPE in CEO compensation. We find that firms in industries positioned more centrally or upstream use RPE more frequently and base greater fractions of CEO pay on RPE. We also document that network positions explain variation in firms' RPE-plan implementation via selection of peers. Our findings are consistent with boards using RPE to filter from CEO pay exogenous shocks to firm performance inherent in firms' supply network positions.

Keywords: Network centrality, Upstreamness, Suppliers, Relative performance evaluation, CEO Compensation, Input–output linkages, Peer groups

JEL Classification: D22, D23, J33, J41, M52

Suggested Citation: Suggested Citation

Wu, YiLin and Ieong, Richard Lok-Si and Thomas, Shawn, Exposures to Common Shocks Along Supply Chains and Relative Performance Evaluation in CEO Compensation Contracts (March 31, 2025). Journal of Corporate Finance, volume 94, 2025[10.1016/j.jcorpfin.2025.102827], Available at SSRN: https://ssrn.com/abstract=3576090 or http://dx.doi.org/10.1016/j.jcorpfin.2025.102827