Relative Performance Benchmarks: Do Boards Follow the Informativeness Principle?

50 Pages Posted: 12 Jul 2016 Last revised: 22 Apr 2018

Paul Ma

University of Minnesota - Carlson School of Management

Jee-Eun Shin

Harvard Business School

Charles C. Y. Wang

Harvard Business School

Date Written: February 13, 2018

Abstract

Relative total shareholder return (rTSR) is increasingly used to incentivize and evaluate managers. Although compensation experts acknowledge a primary objective is to filter shocks unrelated to managerial performance, we document that a significant subset of firms, who choose index-based rTSR-benchmarks in lieu of specific peers, do not adequately achieve this objective. Structural estimates reveal that noisy-benchmark selection implies significant negative performance consequences. Reduced-form analysis shows that a firm's choice of index-based benchmarking is 1) driven by its compensation consultants' systematic tendencies and governance-related frictions, and 2) associated with lower ROA, suggesting noisy-benchmark selection is a novel indicator of weak governance.

Keywords: Empirical contract theory; executive compensation; relative TSR; common shock filtration; search-based peers; board of directors; corporate governance; compensation consultants

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? (February 13, 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 - 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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