Advanced Search
MyIDEAS: Login

A Simple Explanation of the Relative Performance Evaluation Puzzle

Contents:

Author Info

  • Marco Celentani

    (Universidad Carlos III de Madrid)

  • Rosa Loveira

    (Universidad Complutense de Madrid)

Abstract

We study a simple moral hazard model in which two risk-neutral owners establish incentives for their risk-averse managers to exert effort. Because the probability distributions over output realizations depend on a common aggregate shock, optimal contracts make the compensation of each manager contingent on own performance but also on a performance benchmark--the performance of the other firm. If the marginal return of effort depends on the aggregate state, optimal contracts are not monotonically decreasing in the performance benchmark. This provides a simple explanation of the Relative Performance Evaluation (RPE) Puzzle--the documented lack of a negative relationship between CEO compensation and comparative performance measures, such as industry or market performance. Our simple model can also explain one-sided RPE--the documented tendency to insulate a CEO's rewards from bad luck, but not from good luck. We clarify that our results are robust in several dimensions and we discuss other applications of our findings. (Copyright: Elsevier)

Download Info

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
File URL: http://dx.doi.org/10.1016/j.red.2006.04.001
Download Restriction: Access to full texts is restricted to ScienceDirect subscribers and institutional members. See http://www.sciencedirect.com/ for details.

As the access to this document is restricted, you may want to look for a different version under "Related research" (further below) or search for a different version of it.

Bibliographic Info

Article provided by Elsevier for the Society for Economic Dynamics in its journal Review of Economic Dynamics.

Volume (Year): 9 (2006)
Issue (Month): 3 (July)
Pages: 525-540

as in new window
Handle: RePEc:red:issued:05-109

Contact details of provider:
Postal: Review of Economic Dynamics Academic Press Editorial Office 525 "B" Street, Suite 1900 San Diego, CA 92101
Fax: 1-314-444-8731
Email:
Web page: http://www.EconomicDynamics.org/review.htm
More information through EDIRC

Order Information:
Email:
Web: http://www.EconomicDynamics.org/RED17.htm

Related research

Keywords: Relative performance evaluation; optimal contracts; executive compensation.;

Find related papers by JEL classification:

References

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
as in new window
  1. Gerald Garvey & Todd Milbourn, 2003. "Incentive Compensation When Executives Can Hedge the Market: Evidence of Relative Performance Evaluation in the Cross Section," Journal of Finance, American Finance Association, vol. 58(4), pages 1557-1582, 08.
  2. Garvey, Gerald T. & Milbourn, Todd T., 2006. "Asymmetric benchmarking in compensation: Executives are rewarded for good luck but not penalized for bad," Journal of Financial Economics, Elsevier, vol. 82(1), pages 197-225, October.
  3. Rothschild, Michael & Stiglitz, Joseph E, 1976. "Equilibrium in Competitive Insurance Markets: An Essay on the Economics of Imperfect Information," The Quarterly Journal of Economics, MIT Press, vol. 90(4), pages 630-49, November.
  4. Marco Celentani & Rosa Loveira-Pazó, 2004. "What form of relative performance evaluation?," Economics Working Papers 744, Department of Economics and Business, Universitat Pompeu Fabra.
  5. Holmstrom, Bengt & Ricart i Costa, Joan, 1986. "Managerial Incentives and Capital Management," The Quarterly Journal of Economics, MIT Press, vol. 101(4), pages 835-60, November.
Full references (including those not matched with items on IDEAS)

Citations

Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
as in new window

Cited by:
  1. Gueorgui I. Kolev & Robin Hogarth, 2008. "Illusory correlation in the remuneration of chief executive officers: It pays to play golf, and well," Economics Working Papers 1132, Department of Economics and Business, Universitat Pompeu Fabra.
  2. Kim, Kyonghee, 2010. "Blockholder monitoring and the efficiency of pay-performance benchmarking," Journal of Corporate Finance, Elsevier, vol. 16(5), pages 748-766, December.
  3. Jean-Daniel Guigou & Patrick De Lamirande & Bruno Lovat, 2011. "Strategic delegation and collusion: Do incentive schemes matter?," LSF Research Working Paper Series 11-02, Luxembourg School of Finance, University of Luxembourg.
  4. Simona Fabrizi & Steffen Lippert, 2011. "Due diligence, research joint ventures, and incentives to innovate," Working Papers 1113, University of Otago, Department of Economics, revised Dec 2011.
  5. Fleckinger, Pierre, 2012. "Correlation and relative performance evaluation," Journal of Economic Theory, Elsevier, vol. 147(1), pages 93-117.
  6. Arantxa Jarque, 2008. "CEO compensation : trends, market changes, and regulation," Economic Quarterly, Federal Reserve Bank of Richmond, issue Sum, pages 265-300.
  7. Arantxa Jarque, 2008. "Optimal CEO compensation and stock options," Working Papers. Serie EC 2008-04, Instituto Valenciano de Investigaciones Económicas, S.A. (Ivie).

Lists

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

Statistics

Access and download statistics

Corrections

When requesting a correction, please mention this item's handle: RePEc:red:issued:05-109. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Christian Zimmermann).

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.