Relative versus Absolute Performance Evaluation and CEO Decision-Making

Fisher College of Business Working Paper No. 2017-03-020

Charles A. Dice Center Working Paper No. 2017-20

Journal of Financial and Quantitative Analysis, forthcoming

82 Pages Posted: 9 Oct 2017 Last revised: 23 Apr 2021

See all articles by Karen H. Wruck

Karen H. Wruck

Ohio State University - Fisher College of Business, Department of Finance

YiLin Wu

National Taiwan University - Department of Economics

Date Written: March 21, 2021

Abstract

We provide new evidence on how performance-based compensation plans affect CEO decision-making, especially risk-taking. Our main finding is that relative performance evaluation (RPE) plans provide incentives for CEOs to make decisions that generate more idiosyncratic performance outcomes; absolute performance evaluation (APE) plans do not. After switches from APE to RPE, the correlation between firm stock return and industry index return falls and firm idiosyncratic risk increases. Further, switches to RPE are followed by larger deviations in financial, investment, and operating policies from industry norms (i.e., more idiosyncratic strategies). All results are opposite for switches to APE.

Keywords: CEO Compensation, Performance Measurement, Performance Metrics, Performance-Based Compensation, Relative Performance Evaluation; Absolute Performance Evaluation, CEO Incentives, CEO Stock Options, Governance, Risk, Systematic Risk, Idiosyncratic Risk, Industry Index Correlation, CEO Risk Taking, CEO

JEL Classification: D22, G12, G32, G34, J33, J41, O31

Suggested Citation

Wruck, Karen H. and Wu, YiLin, Relative versus Absolute Performance Evaluation and CEO Decision-Making (March 21, 2021). Fisher College of Business Working Paper No. 2017-03-020, Charles A. Dice Center Working Paper No. 2017-20, Journal of Financial and Quantitative Analysis, forthcoming, Available at SSRN: https://ssrn.com/abstract=3048401 or http://dx.doi.org/10.2139/ssrn.3048401

Karen H. Wruck (Contact Author)

Ohio State University - Fisher College of Business, Department of Finance ( email )

2100 Neil Avenue
Columbus, OH 43210-1144
United States
614-292-4330 (Phone)
614-292-2418 (Fax)

HOME PAGE: http://https://fisher.osu.edu/people/wruck.1

YiLin Wu

National Taiwan University - Department of Economics ( email )

21 Hsiu Chow Rd
Taipei, 10020
Taiwan

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