rTSR: When Do Relative Performance Metrics Capture Relative Performance?

57 Pages Posted: 30 Apr 2019 Last revised: 19 Jun 2019

See all articles by Paul Ma

Paul Ma

University of Minnesota

Jee-Eun Shin

University of Toronto - Rotman School of Management

Charles C. Y. Wang

Harvard Business School

Date Written: May 24, 2019


Relative total shareholder returns (rTSR) has become the predominant metric to isolate managers' idiosyncratic performance. Among firms that explicitly use rTSR in relative performance contracts, 60%―those that choose specific peers as benchmarks―select rTSR metrics that do a remarkable job of filtering out the systematic component of returns in adherence to the informativeness principle. However, firms that choose index-based benchmarks retain substantial systematic noise in their rTSR metrics. We document that the selection of noisy benchmarks is associated with compensation consultants' preferences, which are uncorrelated with observable firm attributes. Firms with weak governance are more likely to choose indexes, not because of opportunism, but because they do not adequately scrutinize outside experts' advice. Collectively, our findings provide a new explanation for why some executives are evaluated based on systematic noise, and novel evidence on how compensation consultants can impact firms.

Keywords: Relative TSR; relative performance evaluation; systematic risk; board of directors; compensation consultants; style effects

JEL Classification: G30, J33, M12, M52

Suggested Citation

Ma, Paul and Shin, Jee-Eun and Wang, Charles C. Y., rTSR: When Do Relative Performance Metrics Capture Relative Performance? (May 24, 2019). Harvard Business School Accounting & Management Unit Working Paper No. 19-112. Available at SSRN: https://ssrn.com/abstract=3380516 or http://dx.doi.org/10.2139/ssrn.3380516

Paul Ma

University of Minnesota ( email )

19th Avenue South
Minneapolis, MN 55455
United States

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

Jee-Eun Shin

University of Toronto - Rotman School of Management ( email )

105 St. George Street
Toronto, Ontario M5S 3E6 M5S1S4

Charles C. Y. Wang (Contact Author)

Harvard Business School ( email )

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

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