rTSR: When Do Relative Performance Metrics Capture Relative Performance?
57 Pages Posted: 30 Apr 2019 Last revised: 19 Jun 2019
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: Suggested Citation