Product Market Peers and Relative Performance Evaluation

62 Pages Posted: 19 Jul 2015 Last revised: 17 May 2018

See all articles by Sudarshan Jayaraman

Sudarshan Jayaraman

University of Rochester - Simon Business School

Todd T. Milbourn

Washington University in Saint Louis - Olin Business School

Florian S. Peters

University of Amsterdam

Hojun Seo

National University of Singapore

Date Written: May 15, 2018

Abstract

We investigate the role of Relative Performance Evaluation (RPE) theory in CEO pay and turnover. RPE predicts that firms will filter out common shocks (i.e., those affecting the firm and its peers) while evaluating CEO performance and that the extent of filtering increases with the number of firms in the peer group. Despite the intuitive appeal of the theory, previous tests of RPE find weak and inconsistent evidence. To examine this hypothesis, we exploit recent advances in textual analysis and define peers based on firms’ product descriptions in their 10-K filings (Hoberg and Phillips, 2016). This alternative classification not only captures common shocks to firms’ product markets more effectively but also tracks the evolving nature of these markets as 10-Ks are updated annually. Using product market peers, we find three pieces of evidence consistent with RPE in relation to CEO pay – (i) firms on average filter out common shocks to stock returns, (ii) the extent of filtering increases with the number of peers, and (iii) firms completely filter out common shocks in the presence of a large number of peers. We also find consistent evidence for forced CEO turnover.

Keywords: Product market peers, Relative Performance Evaluation, CEO compensation, and Forced CEO Turnovers

JEL Classification: M40; M41; G30; J33

Suggested Citation

Jayaraman, Sudarshan and Milbourn, Todd T. and Peters, Florian S. and Seo, Hojun, Product Market Peers and Relative Performance Evaluation (May 15, 2018). Simon Business School Working Paper No. FR 15-25. Available at SSRN: https://ssrn.com/abstract=2632153 or http://dx.doi.org/10.2139/ssrn.2632153

Sudarshan Jayaraman (Contact Author)

University of Rochester - Simon Business School ( email )

Rochester, NY 14627
United States

Todd T. Milbourn

Washington University in Saint Louis - Olin Business School ( email )

1 Brookings Drive
Campus Box 1133
St. Louis, MO 63130-4899
United States
314-935-6392 (Phone)
314-935-6359 (Fax)

HOME PAGE: http://www.olin.wustl.edu/faculty/milbourn/

Florian S. Peters

University of Amsterdam ( email )

Plantage Muidergracht 12
Amsterdam, 1018 TW
Netherlands

Hojun Seo

National University of Singapore ( email )

15 Kent Ridge Drive, Singapore 119245

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