Relative versus Absolute Performance Evaluation and CEO Decision-Making

We provide new evidence on how performance-based compensation plans affect CEO decision-making, especially risk-taking. Our main finding is that relative performance evaluation (RPE) plans provide incentives for CEOs to make decisions that generate more idiosyncratic performance outcomes; absolute performance evaluation (APE) plans do not. After switches from APE to RPE, the correlation between firm stock return and industry index return falls and firm idiosyncratic risk increases. Further, switches to RPE are followed by larger deviations in financial, investment, and operating policies from industry norms (i.e., more idiosyncratic strategies). All results are opposite for switches to APE.

Keywords: CEO Compensation, Performance Measurement, Performance Metrics, Performance-Based Compensation, Relative Performance Evaluation; Absolute Performance Evaluation, CEO Incentives, CEO Stock Options, Governance, Risk, Systematic Risk, Idiosyncratic Risk, Industry Index Correlation, CEO Risk Taking, CEO

JEL Classification: D22, G12, G32, G34, J33, J41, O31

Suggested Citation: Suggested Citation

Wruck, Karen H. and Wu, YiLin, Relative versus Absolute Performance Evaluation and CEO Decision-Making (March 21, 2021). Fisher College of Business Working Paper No. 2017-03-020, Charles A. Dice Center Working Paper No. 2017-20, Journal of Financial and Quantitative Analysis, forthcoming, Available at SSRN: https://ssrn.com/abstract=3048401 or http://dx.doi.org/10.2139/ssrn.3048401