Relative Performance Benchmarks: Do Boards Follow the Informativeness Principle?

55 Pages Posted: 12 Jul 2016 Last revised: 20 Jun 2018

Paul Ma

University of Minnesota

Jee-Eun Shin

Harvard Business School

Charles C. Y. Wang

Harvard Business School

Date Written: June 20, 2018

Abstract

We examine whether and to what extent managers are evaluated, in their relative-performance contracts, on the basis of systematic performance. Focusing on relative total shareholder returns (rTSR), the predominant metric specified in these contracts and used by market participants to evaluate managers, we document that 60% of firms―those that choose specific peers―do a remarkable job of capturing the systematic component of returns. However, 40% of firms―those that choose index-based benchmarks―retain substantial systematic noise in their rTSR metrics, which they could have substantially corrected by using their self-chosen compensation-benchmarking peers. We show that selection of noisy benchmarks is economically important, is driven by compensation consultants' tendencies and by firms' governance-related frictions, and is associated with lower ROA.

Keywords: Executive compensation; relative performance evaluation; relative TSR; common shock filtration; systematic risk; search-based peers; board of directors; corporate governance; compensation consultants

JEL Classification: G30, J33, M12, M52

Suggested Citation

Ma, Paul and Shin, Jee-Eun and Wang, Charles C. Y., Relative Performance Benchmarks: Do Boards Follow the Informativeness Principle? (June 20, 2018). Harvard Business School Accounting & Management Unit Working Paper No. 17-039. Available at SSRN: https://ssrn.com/abstract=2807655 or http://dx.doi.org/10.2139/ssrn.2807655

Paul Ma (Contact Author)

University of Minnesota ( email )

19th Avenue South
Minneapolis, MN 55455
United States

HOME PAGE: http://www.paulma.org

Jee-Eun Shin

Harvard Business School ( email )

Soldiers Field Road
Morgan 270C
Boston, MA 02163
United States

Charles C. Y. Wang

Harvard Business School ( email )

Soldiers Field Road
Morgan 270C
Boston, MA 02163
United States

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