The Presence, Value, and Incentive Properties of Relative Performance Evaluation in Executive Compensation Contracts

80 Pages Posted: 9 Feb 2014

See all articles by J. Carr Bettis

J. Carr Bettis

Arizona State University (ASU) - Finance Department; Fathom Lab; Verus Analytics, Inc

John M. Bizjak

Texas Christian University

Jeffrey L. Coles

University of Utah - Department of Finance; Arizona State University (ASU) - Finance Department

Brian Young

Southern Methodist University

Date Written: February 8, 2014

Abstract

Using data that includes specific contractual details of Relative Performance Evaluation (RPE) contracts granted to executives for 1,833 firms for the period 1998 to 2012, we develop new methods to characterize RPE awards and measure their value and incentive properties. The frequency in the use of these awards has grown over time with 37% of the firms in our sample granting an RPE award in 2012. When RPE awards are used they are typically granted to the five named executive officers and they represent about 32% of total recipient compensation. Stock is most frequently the instrument conveyed, followed by cash, and options are almost never granted. RPE awards are more likely to be used at firms with diversified business lines, less concentrated industries, greater exposure to systematic risk, larger size, lower M/B, higher dividend yield, fewer insiders on the board, greater institutional ownership, and that engage a compensation consultant.

The typical award is a rank-order tournament based on three year stock returns compared to a select group of 13 peers (median) and is paid out with stock. Payout functions typically include regions of concavity, convexity, explicit inelasticity, and implicit inelasticity. The median firm achieves a threshold for at least some payout of stock or cash about 70% of the time and target payout about 50% of the time. In general, RPE grant value differs significantly from the fair market value reported by firms. We find that RPE awards convey to executives the incentive to increase shareholder wealth. RPE awards of stock contingent on either stock or accounting performance and RPE awards of cash contingent on accounting performance convey the incentive to increase firm risk, while RPE cash awards do not. These incentives can be significant in comparison to those conveyed by APE grants with similar attributes.

Keywords: relative performance awards, performance-vesting provisions, executive compensation, stock awards, option awards, time-vesting, performance measures, CEO pay, corporate governance

JEL Classification: G30, J33, M52, M55, G34, G32, G13, M41

Suggested Citation

Bettis, J. Carr and Bizjak, John M. and Coles, Jeffrey L. and Young, Brian, The Presence, Value, and Incentive Properties of Relative Performance Evaluation in Executive Compensation Contracts (February 8, 2014). Available at SSRN: https://ssrn.com/abstract=2392861 or http://dx.doi.org/10.2139/ssrn.2392861

J. Carr Bettis

Arizona State University (ASU) - Finance Department ( email )

W. P. Carey School of Business
PO Box 873906
Tempe, AZ 85287-3906
United States

Fathom Lab ( email )

16211 N. Scottsdale Rd
#A6A-628
Scottsdale, AZ 85254
United States

Verus Analytics, Inc ( email )

15210 N Scottsdale Rd
Suite 250
Scottsdale, AZ 85254
United States

John M. Bizjak (Contact Author)

Texas Christian University ( email )

Fort Worth, TX 76129
United States
817-257-4260 (Phone)

Jeffrey L. Coles

University of Utah - Department of Finance ( email )

David Eccles School of Business
Salt Lake City, UT 84112
United States
801-587-9093 (Phone)

Arizona State University (ASU) - Finance Department ( email )

W. P. Carey School of Business
P.O. Box 873906
Tempe, AZ 85287-3906
United States
480-965-4475 (Phone)
480-965-8539 (Fax)

Brian Young

Southern Methodist University ( email )

United States

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