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What form of relative performance evaluation?

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Author Info

  • Marco Celentani
  • Rosa Loveira-Pazó

Abstract

We study relative performance evaluation in executive compensation when executives have private information about their ability. We assume that the joint distribution of an individual firm’s profit and market movements depends on the ability of the executive that runs the firm. In the equilibrium of the executive labor market, compensation schemes exploit this fact to sort executives of di ?erent abilities. This implies that executive compensation is increasing in own performance, but may also be increasing in industry performance-a sharp departure from standard relative performance evaluation. This result provides an explanation for the scarcity of relative performance considerations in executive compensation documented by the empirical literature.

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Bibliographic Info

Paper provided by Department of Economics and Business, Universitat Pompeu Fabra in its series Economics Working Papers with number 744.

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Date of creation: Jan 2004
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Handle: RePEc:upf:upfgen:744

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Web page: http://www.econ.upf.edu/

Related research

Keywords: Executive compensation; relative performance evaluation;

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References

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  1. Brian J. Hall & Jeffrey B. Liebman, 1997. "Are CEOs Really Paid Like Bureaucrats?," NBER Working Papers 6213, National Bureau of Economic Research, Inc.
  2. Lucian Arye Bebchuk & Jesse M. Fried & David I. Walker, 2002. "Managerial Power and Rent Extraction in the Design of Executive Compensation," NBER Working Papers 9068, National Bureau of Economic Research, Inc.
  3. Paul Oyer, 2000. "Why Do Firms Use Incentives that Have No Incentive Effects?," Econometric Society World Congress 2000 Contributed Papers 1440, Econometric Society.
  4. Robert Gibbons & Kevin J. Murphy, 1991. "Relative Performance Evaluation for Chief Executive Officers," NBER Working Papers 2944, National Bureau of Economic Research, Inc.
  5. Ricart I Costa, Joan E., 1989. "On managerial contracting with asymmetric information," European Economic Review, Elsevier, vol. 33(9), pages 1805-1829, December.
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  7. Barro, Jason R. & Barro, Robert J., 1990. "Pay, Performance, and Turnover of Bank CEOs," Scholarly Articles 3451300, Harvard University Department of Economics.
  8. Jaap H. Abbring & James J. Heckman & Pierre-André Chiappori & Jean Pinquet, 2003. "Adverse Selection and Moral Hazard In Insurance: Can Dynamic Data Help to Distinguish?," Journal of the European Economic Association, MIT Press, vol. 1(2-3), pages 512-521, 04/05.
  9. Jensen, M.C. & Murphy, K.J., 1988. "Performance Pay And Top Management Incentives," Papers 88-04, Rochester, Business - Managerial Economics Research Center.
  10. Sung Wook Joh, 1999. "Strategic Managerial Incentive Compensation In Japan: Relative Performance Evaluation And Product Market Collusion," The Review of Economics and Statistics, MIT Press, vol. 81(2), pages 303-313, May.
  11. Wilson, Charles, 1977. "A model of insurance markets with incomplete information," Journal of Economic Theory, Elsevier, vol. 16(2), pages 167-207, December.
  12. Canice Prendergast, 2002. "The Tenuous Trade-off between Risk and Incentives," Journal of Political Economy, University of Chicago Press, vol. 110(5), pages 1071-1102, October.
  13. repec:rus:hseeco:16303 is not listed on IDEAS
  14. 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.
  15. Canice Prendergast, 1999. "The Provision of Incentives in Firms," Journal of Economic Literature, American Economic Association, vol. 37(1), pages 7-63, March.
  16. John M. Abowd & David S. Kaplan, 1999. "Executive Compensation: Six Questions that Need Answering," NBER Working Papers 7124, National Bureau of Economic Research, Inc.
  17. Hellwig, Martin, 1987. "Some recent developments in the theory of competition in markets with adverse selection ," European Economic Review, Elsevier, vol. 31(1-2), pages 319-325.
  18. Sherwin Rosen, 1990. "Contracts and the Market for Executives," NBER Working Papers 3542, National Bureau of Economic Research, Inc.
  19. Rajesh Aggarwal & Andrew A. Samwick, 1998. "The Other Side of the Tradeoff: The Impact of Risk on Executive Compensation," NBER Working Papers 6634, National Bureau of Economic Research, Inc.
  20. 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.
  21. Murphy, Kevin J., 1999. "Executive compensation," Handbook of Labor Economics, in: O. Ashenfelter & D. Card (ed.), Handbook of Labor Economics, edition 1, volume 3, chapter 38, pages 2485-2563 Elsevier.
  22. Maskin, Eric & Tirole, Jean, 1992. "The Principal-Agent Relationship with an Informed Principal, II: Common Values," Econometrica, Econometric Society, vol. 60(1), pages 1-42, January.
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Citations

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Cited by:
  1. Michael Magill & Martine Quinzii, 2006. "Common Shocks and Relative Compensation," Annals of Finance, Springer, vol. 2(4), pages 407-420, October.
  2. Marcello D'Amato & Riccardo Martina & Salvatore Piccolo, 2005. "Competitive Pressure, Incentives and Managerial Rewards," CSEF Working Papers 148, Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy, revised 01 Jul 2006.
  3. Marco Celentani & Rosa Loveira, 2006. "A Simple Explanation of the Relative Performance Evaluation Puzzle," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 9(3), pages 525-540, July.

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