Tests for Relative Performance Evaluation Based on Assumptions Derived from Proxy Statement Disclosures

Posted: 11 Aug 2010

See all articles by James W. Bannister

James W. Bannister

Barney School of Business

Harry Newman

Fordham University - Gabelli School of Business

Joseph Weintrop

City University of New York - Baruch College - Stan Ross Department of Accountancy

Date Written: June 30, 2010

Abstract

The main purpose of this paper is to explore the empirical evidence supporting the use of relative performance evaluation (RPE) in executive compensation which is mixed. This is puzzling since studies of firm disclosures indicate that firms claim to use RPE based on both accounting measures and stock returns. Those few studies that do find empirical support observe it either with an accounting performance measure or stock returns, but not both. The lack of strong consistent empirical support for RPE is due, in part, to the fact that the preponderance of tests for RPE incorporate unsubstantiated assumptions about the way firms apply RPE. This includes the compensation measure to which RPE is applied and the way in which firms use firm-own and peer group performance when determining compensation.

In this study, our empirical tests for RPE are based on assumptions derived from an examination of firms’ disclosures about their RPE use. Our test results provide support for the use of RPE among 1998 S&P 500 firms with both stock returns and return on equity. To our knowledge, this is the first study to find support for RPE with both stock returns and an accounting performance measure. Through a series of sensitivity analyses, we also provide insight into the amount of detail researchers need to build into their empirical tests in order to find support for RPE.

Keywords: Relative Performance Evaluation, Agency Theory, Compensation Committee Report.

JEL Classification: J33, M41, M52

Suggested Citation

Bannister, James W. and Newman, Harry and Weintrop, Joseph, Tests for Relative Performance Evaluation Based on Assumptions Derived from Proxy Statement Disclosures (June 30, 2010). Review of Quantitative Finance and Accounting, Forthcoming. Available at SSRN: https://ssrn.com/abstract=1656515

James W. Bannister

Barney School of Business ( email )

West Hartford, CT 06117-1599
United States

Harry Newman (Contact Author)

Fordham University - Gabelli School of Business ( email )

113 West 60th Street
Bronx, NY 10458
United States

Joseph Weintrop

City University of New York - Baruch College - Stan Ross Department of Accountancy ( email )

One Bernard Baruch Way, Box B12-225
New York, NY 10010
United States
212-802-6443 (Phone)
212-802-6423 (Fax)

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