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

51 Pages Posted: 28 May 2020 Last revised: 24 Jun 2021

See all articles by Truc (Peter) Do

Truc (Peter) Do

University of Queensland - Faculty of Business, Economics and Law

Huai Zhang

Nanyang Business School, Nanyang Technological University

Luo Zuo

Cornell University - Samuel Curtis Johnson Graduate School of Management

Date Written: June 24, 2021

Abstract

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

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

Truc (Peter) Do

University of Queensland - Faculty of Business, Economics and Law ( email )

4072 Brisbane, Queensland
Australia

Huai Zhang

Nanyang Business School, Nanyang Technological University ( email )

Singapore, 639798
Singapore
+65-6790-4097 (Phone)

Luo Zuo (Contact Author)

Cornell University - Samuel Curtis Johnson Graduate School of Management ( email )

349 Sage Hall
Ithaca, NY 14853
United States
607-255-4002 (Phone)

HOME PAGE: http://www.johnson.cornell.edu/faculty-research/faculty/lz352/

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