Rocking the Boat: How Relative Performance Evaluation Affects Corporate Risk Taking

We argue that relative performance evaluation (RPE) contracts introduce a tournament among the focal firm and peer firms. We test whether a firm’s riskiness is altered by its CEO’s incentive to win the tournament. We find that a firm that performed poorly relative to its peers during an interim period takes more risk in the remainder of the evaluation period than a firm with better interim performance. This effect is stronger when the interim assessment date is closer to the end of the evaluation period and when winning the competition is more important to the CEO. Together, our results suggest that RPE contracts create tournament incentives for CEOs and significantly affect corporate risk taking.

Keywords: Relative performance evaluation, tournament incentives, interim performance, risk taking.

JEL Classification: G30, J33.

Suggested Citation: Suggested Citation

Do, Truc (Peter) and Zhang, Huai and Zuo, Luo, Rocking the Boat: How Relative Performance Evaluation Affects Corporate Risk Taking (June 24, 2021). Journal of Accounting & Economics (JAE), Forthcoming, Nanyang Business School Research Paper No. 20-08, Available at SSRN: https://ssrn.com/abstract=3610499 or http://dx.doi.org/10.2139/ssrn.3610499