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The Choice of Peers for Relative Performance Evaluation in Executive Compensation
[Peer choice in CEO compensation]

Author

Listed:
  • John Bizjak
  • Swaminathan Kalpathy
  • Zhichuan Frank Li
  • Brian Young

Abstract

Relative performance evaluation (RPE) awards have become an important component of executive compensation. We examine whether RPE awards, particularly the peer group, are structured in a manner consistent with economic theory. For RPE awards using a custom peer group, we find that the custom group is significantly more effective than four plausible alternative peer groups at filtering out common shocks, lowering the cost of compensation, and increasing managerial incentives. For RPE awards using a market index, we find some evidence that firms could have selected a custom set of peers with better filtering properties at a lower cost with similar incentives. For example, firms could have saved around $118,000 in present value terms, on average, for an RPE award had they chosen a custom group comprising their product market peers instead of a market index.

Suggested Citation

  • John Bizjak & Swaminathan Kalpathy & Zhichuan Frank Li & Brian Young, 2022. "The Choice of Peers for Relative Performance Evaluation in Executive Compensation [Peer choice in CEO compensation]," Review of Finance, European Finance Association, vol. 26(5), pages 1217-1239.
    • Handle: RePEc:oup:revfin:v:26:y:2022:i:5:p:1217-1239.
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    File URL: http://hdl.handle.net/10.1093/rof/rfac016
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    References listed on IDEAS

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    Cited by:

    1. Grinstein, Yaniv & Lauterbach, Beni & Yosef, Revital, 2022. "Benchmarking of pay components in CEO compensation design," Journal of Corporate Finance, Elsevier, vol. 77(C).

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    More about this item

    Keywords

    Executive compensation; Relative performance; RPE; Peer groups; Compensation benchmarking; Performance measures; CEO pay; Corporate governance;
    All these keywords.

    JEL classification:

    • M52 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Personnel Economics - - - Compensation and Compensation Methods and Their Effects
    • M55 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Personnel Economics - - - Labor Contracting Devices
    • J31 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Wage Level and Structure; Wage Differentials
    • J33 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Compensation Packages; Payment Methods
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • M12 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Business Administration - - - Personnel Management; Executives; Executive Compensation

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