CEO Power and Relative Performance Evaluation
43 Pages Posted: 20 Aug 2013 Last revised: 27 May 2016
Date Written: May 1, 2016
We model relative performance evaluation (RPE) when a Chief Executive Officer (CEO) has the power to opportunistically influence the design of RPE by choosing the weight on an index-based peer group or by customizing the selection of peers comprising a peer group. A powerful CEO compares the benefits of reducing common risk affecting his compensation with the benefits of receiving a higher bonus by economizing on expected peer-group performance. The Board of Directors (BoD) is less likely to use RPE if a powerful CEO can influence RPE design. Our analytical model yields hypotheses predicting that powerful CEOs choose to reduce common risk only partially and that BoDs choose to not implement RPE if expected peer performance is sufficiently high. Our model has further empirical implications in (1) providing new interpretations of tests for detecting strong-form and weak-form RPE in the presence of powerful CEOs, and (2) suggesting a new empirical measure of CEO power with a focus on the delegation of RPE decision rights.
Keywords: Relative performance evaluation, Managerial power, Incentive compensation
JEL Classification: M41, M52, J33
Suggested Citation: Suggested Citation