Relative Performance Evaluation and Related Peer Groups in Executive Compensation Contracts

Posted: 3 Nov 2010

See all articles by Guojin Gong

Guojin Gong

University of Connecticut

Laura Yue Li

University of Illinois at Urbana-Champaign

Jae Yong Shin

Seoul National University - College of Business Administration

Multiple version iconThere are 2 versions of this paper

Date Written: November 2, 2010

Abstract

This study examines the explicit use of relative performance evaluation (RPE) in executive compensation contracts and the selection of RPE peers. Using S&P 1500 firms’ first proxy disclosures under the SEC’s 2006 executive compensation disclosure rules, we find that about 25 percent of our sample firms explicitly use RPE in setting executive compensation. We demonstrate that a lack of knowledge of both actual peer group composition and the link between RPE-based performance targets and future peer performance significantly hinder the traditional implicit test from detecting RPE use. We also find that firms consider both costs and benefits of RPE as an incentive mechanism when deciding to use RPE. Finally, both efficient contracting and rent extraction considerations influence RPE peer selection, with the relative importance of these competing considerations depending on RPE firms’ performance.

Keywords: executive compensation, relative performance evaluation, peer group, SEC regulation

JEL Classification: J33, J44, M41, M52

Suggested Citation

Gong, Guojin and Li, Yue Laura and Shin, Jae Yong, Relative Performance Evaluation and Related Peer Groups in Executive Compensation Contracts (November 2, 2010). Accounting Review, Forthcoming, Available at SSRN: https://ssrn.com/abstract=1701821

Guojin Gong (Contact Author)

University of Connecticut ( email )

Storrs, CT 06269
United States

Yue Laura Li

University of Illinois at Urbana-Champaign ( email )

283 Wohlers hall 1206 South Sixth Street
1206 South Sixth Street
Champaign, IL 61820
United States
2172655086 (Phone)

Jae Yong Shin

Seoul National University - College of Business Administration ( email )

Seoul, 151-742
Korea, Republic of (South Korea)

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