Relative Performance Evaluation: Does Reducing Exposure to Common Risks Provide Performance Benefits in Multi-period Settings?

Abstract

Extant research suggests relative performance evaluation increases performance in single-period settings. The principal mechanism for this increase is relative performance evaluation’s ability to reduce exposure to common risks. However, I predict that in multi-period settings this reduction in exposure to common risks will not increase performance. In a laboratory experiment, I isolate the performance effects of reducing common risks and find that the benefits do not persist in multi-period settings. This occurs because individuals who fail in the current period attribute that failure to reasons they believe are more likely to affect future periods. Thus, they lower their expectancy. Expectancy’s positive correlation with future period effort and performance means that future period performance does not increase for individuals who fail in the current period. These findings suggest that we focus attempts to improve the multi-period performance effectiveness of relative performance evaluation on its other benefits.

Keywords: Relative Performance Incentives, Common Risks, Social Comparison, Targets

JEL Classification: M40, M41, M52