Relative Performance Evaluation and Strategic Competition
45 Pages Posted: 26 Nov 2018 Last revised: 13 Dec 2020
Date Written: November 19, 2018
This paper examines how the use of relative performance evaluation (RPE) affects industry competition. Using data from the U.S. airline industry, we estimate a dynamic game of competition with heterogenous firms in an oligopolistic market with the presence of RPE contracts. As is standard, RPE makes CEO compensation less sensitive to market conditions. Therefore, the CEO's propensity to operate in a given market is determined by a tradeoff arises between the reduction in compensation based on market conditions and the gain from being compared to competing agents. The estimation results show that the use of RPE decreases a firm's tendency to be active under bad market conditions by 10.1%. Conversely, the tendency to be active rises in good market conditions by 12.4%. These effects are stronger for firms with lower fixed operating costs.
Keywords: relative performance evaluation, entry and exit, competition
JEL Classification: G32, G34, L41, L10
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