rTSR: When Do Relative Performance Metrics Capture Relative Performance?

58 Pages Posted: 30 Apr 2019 Last revised: 28 Sep 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: September 25, 2019

Abstract

We develop a measurement-error framework for assessing the quality of relative-performance metrics designed to filter out the systematic component of performance, and analyze relative total shareholder return (rTSR)-the predominant metric market participants use to isolate managers' idiosyncratic performance-chosen by boards to evaluate managers. Among firms that explicitly use rTSR in relative performance contracts, 60%-those that choose specific peers-select rTSR metrics that do a remarkable job of filtering out the systematic component of returns in adherence to the informativeness principle. Firms that choose index-based benchmarks retain substantial systematic noise in their rTSR metrics. The choice 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. These findings provide novel evidence on why some executives are evaluated on systematic noise and on compensation consultants' impact on firms.

Keywords: Relative TSR, measurement error, 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? (September 25, 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
Canada

Charles C. Y. Wang (Contact Author)

Harvard Business School ( email )

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

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