The Moderating Effect of Relative Performance Evaluation on the Risk Incentive Properties of Executives’ Equity Portfolios

Posted: 4 Mar 2016

See all articles by Hyungshin Park

Hyungshin Park

Santa Clara University; Southern Methodist University - Cox School of Business

Dimitris Vrettos

affiliation not provided to SSRN

Date Written: December 1, 2015

Abstract

We offer evidence that the use of Relative Performance Evaluation (RPE) in CEOs’ incentive contracts influences the effect of risk-taking incentives on both the magnitude and composition of firm risk. We find that when the incentive design lacks RPE features, the incentive portfolio vega motivates CEOs to increase total risk through the systematic component because it can be hedged. In contrast, when the incentive design includes RPE features, CEOs prefer idiosyncratic risk because RPE filters out the systematic component of firm performance. We also document that the use of RPE reinforces the incentive portfolio vega's effect on the total risk.

Keywords: Executive compensation, relative performance evaluation, risk incentives, systematic and idiosyncratic risk

JEL Classification: M20, M21, M40, M41, M52

Suggested Citation

Park, Hyungshin and Vrettos, Dimitris, The Moderating Effect of Relative Performance Evaluation on the Risk Incentive Properties of Executives’ Equity Portfolios (December 1, 2015). Journal of Accounting Research, Vol. 53, No. 5, 2015. Available at SSRN: https://ssrn.com/abstract=2741275

Hyungshin Park

Santa Clara University ( email )

500 El Camino Real
Santa Clara, CA 95053
United States

Southern Methodist University - Cox School of Business ( email )

6212 Bishop Blvd.
Dallas, TX 75275
United States
214-768-9464 (Phone)

Dimitris Vrettos (Contact Author)

affiliation not provided to SSRN

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