Relative Performance Benchmarks: Do Boards Follow the Informativeness Principle?

56 Pages Posted: 12 Jul 2016 Last revised: 27 May 2017

Paul Ma

University of Minnesota - Carlson School of Management

Jee-Eun Shin

Harvard Business School

Charles C. Y. Wang

Harvard Business School

Date Written: May 26, 2017

Abstract

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 _ltration; search-based peers; board of directors; corporate governance

JEL Classification: G30, M12, M52

Suggested Citation

Ma, Paul and Shin, Jee-Eun and Wang, Charles C. Y., Relative Performance Benchmarks: Do Boards Follow the Informativeness Principle? (May 26, 2017). 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 - Carlson School of Management ( 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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