Relative Performance Benchmarks: Do Boards Follow the Informativeness Principle?
57 Pages Posted: 12 Jul 2016 Last revised: 21 Sep 2017
Date Written: September 20, 2017
Relative TSR (rTSR) is increasingly used by market participants to judge and incentivize managerial performance. We evaluate the efficacy, reasons, and implications of firms' benchmarks in rTSR-based contracts. Although compensation consultants suggest that a primary objective of rTSR is to filter shocks unrelated to managerial performance, following the informativeness principle, we document that a significant subset of firms, who choose index-based benchmarks, do not adequately achieve this objective. Further, the index-benchmark selection is associated with governance-related frictions, and not driven by plausible alternative theories. Both structural calibration and reduced-form estimates reveal significant negative performance implications from sub-optimal peer-selection.
Keywords: Empirical contract theory; executive compensation; relative TSR; common shock filtration; search-based peers; board of directors; corporate governance
JEL Classification: G30, M12, M52
Suggested Citation: Suggested Citation