Relative Performance Evaluation for Chief Executive Officers

40 Pages Posted: 18 Jul 2007 Last revised: 20 Jul 2010

See all articles by Robert S. Gibbons

Robert S. Gibbons

Massachusetts Institute of Technology - Sloan School and Department of Economics; National Bureau of Economic Research (NBER)

Kevin J. Murphy

University of Southern California - Marshall School of Business; USC Gould School of Law

Date Written: April 1989

Abstract

Measured individual performance often depends on random factors which also affect the performances of other workers in the same firm, industry, or market. In these cases, relative performance evaluation (RPE) can provide incentives while partially insulating workers from the common uncertainty. Basing pay on relative performance, however, generates incentives to sabotage the measured performance of co-workers, to collude with co-workers and shirk, and to apply for jobs with inept co-workers. RPE contracts also are less desirable when the output of co-workers is expensive to measure or in the presence of production externalities, as in the case of team production. The purpose of this paper is to review the benefits and costs of RPE and to test for the presence of RPE in one occupation where the benefits plausibly exceed the costs: chief executive officers (CEOs). In contrast to previous research, our empirical evidence strongly supports the RPE hypothesis-CEO pay revisions and retention probabilities are positively and significantly related to firm performance, but are negatively and significantly related to industry and market performance, ceteris paribus. Our results also suggest that CEO performance is more likely to be evaluated relative to aggregate market movements than relative to industry movements.

Suggested Citation

Gibbons, Robert S. and Murphy, Kevin J., Relative Performance Evaluation for Chief Executive Officers (April 1989). NBER Working Paper No. w2944. Available at SSRN: https://ssrn.com/abstract=461382

Robert S. Gibbons (Contact Author)

Massachusetts Institute of Technology - Sloan School and Department of Economics ( email )

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MIT
Cambridge, MA 02142
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617-253-0283 (Phone)
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National Bureau of Economic Research (NBER)

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Kevin J. Murphy

University of Southern California - Marshall School of Business ( email )

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United States
213-740-6553 (Phone)
213-740-6650 (Fax)

USC Gould School of Law

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Los Angeles, CA 90089
United States

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