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Incentive Compensation When Executives Can Hedge the Market: Evidence of Relative Performance Evaluation in the Cross Section

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  • Gerald Garvey

    (Peter F. Drucker School of Management, Claremont Graduate University)

  • Todd Milbourn

    (John M. Olin School of Business, Washington University in St. Louis.)

Abstract

Little evidence exists that firms index executive compensation to remove the influence of marketwide factors. We argue that executives can, in principle, replicate such indexation in their private portfolios. In support, we find that market risk has little effect on the use of stock-based pay for the average executive. But executives' ability to "undo" excessive market risk can be hindered by wealth constraints and inalienability of human capital. We replicate the standard result that there is little relative performance evaluation (RPE) for the average executive, but find strong evidence of RPE for younger executives and executives with less financial wealth. Copyright (c) 2003 by the American Finance Association.

Suggested Citation

  • 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, August.
  • Handle: RePEc:bla:jfinan:v:58:y:2003:i:4:p:1557-1582
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