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Limits to relative performance evaluation: evidence from bank executive turnover

  • Irina Barakova
  • Ajay Palvia

Purpose – The paper aims to revisit the topic of relative performance evaluation (RPE) of top management using a large panel of community banks. Design/methodology/approach – The empirical tests for RPE utilized a two-stage approach in a unique dataset of community banks executive turnover over a ten-year period. This allowed the authors to better estimate the benchmark performance relative to which bank executives should be evaluated under RPE. Moreover, bank regulatory evaluations allowed the authors to control for the impact of poor governance. Findings – The paper shows that penalizing executives for poor performance arising from economic downturns is not necessarily inconsistent with the theory. The empirical results indicate that weak downturn-linked performance is strongly related to increased executive turnover. Furthermore, this relationship is more pronounced in better-governed banks, which are more likely to engage in value-enhancing disciplinary actions. Research limitations/implications – The analysis suggests that executive dismissals during adverse economic conditions are not necessarily a result of bad luck; rather, the analysis implies that bad times are informative about management quality. Practical implications – The main practical implication is that both relative and absolute performance should be incorporated in the incentive structure of bank executives. Originality/value – The paper shows that the assumptions used in prior RPE studies may not be applicable to top executives which could explain the inconsistency between the theory and the empirical evidence. Further, the finding that better governed firms are more likely to penalize management for bad exogenously driven performance is unique and strengthens the case that disciplinary actions amid adverse economic times may not be due to bad luck.

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Article provided by Emerald Group Publishing in its journal Journal of Financial Economic Policy.

Volume (Year): 2 (2010)
Issue (Month): 3 (August)
Pages: 214-236

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Handle: RePEc:eme:jfeppp:v:2:y:2010:i:3:p:214-236
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  1. Gunther, Jeffery W. & Moore, Robert R., 2003. "Loss underreporting and the auditing role of bank exams," Journal of Financial Intermediation, Elsevier, vol. 12(2), pages 153-177, April.
  2. Parrino, Robert, 1997. "CEO turnover and outside succession A cross-sectional analysis," Journal of Financial Economics, Elsevier, vol. 46(2), pages 165-197, November.
  3. 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.
  4. DeFond, Mark L. & Park, Chul W., 1999. "The effect of competition on CEO turnover1," Journal of Accounting and Economics, Elsevier, vol. 27(1), pages 35-56, February.
  5. Paul A. Gompers & Joy L. Ishii & Andrew Metrick, 2002. "Corporate Governance and Equity Prices," Center for Financial Institutions Working Papers 02-32, Wharton School Center for Financial Institutions, University of Pennsylvania.
  6. Jay Dahya & John J. McConnell & Nickolaos G. Travlos, 2002. "The Cadbury Committee, Corporate Performance, and Top Management Turnover," Journal of Finance, American Finance Association, vol. 57(1), pages 461-483, 02.
  7. Bengt Holmstrom, 1997. "Moral Hazard and Observability," Levine's Working Paper Archive 1205, David K. Levine.
  8. Weisbach, Michael S., 1988. "Outside directors and CEO turnover," Journal of Financial Economics, Elsevier, vol. 20(1-2), pages 431-460, January.
  9. Albuquerque, Ana, 2009. "Peer firms in relative performance evaluation," Journal of Accounting and Economics, Elsevier, vol. 48(1), pages 69-89, October.
  10. Cook, Douglas O. & Hogan, Arthur & Kieschnick, Robert, 2004. "A study of the corporate governance of thrifts," Journal of Banking & Finance, Elsevier, vol. 28(6), pages 1247-1271, June.
  11. Stephen D. Prowse, 1995. "Alternative methods of corporate control in commercial banks," Economic and Financial Policy Review, Federal Reserve Bank of Dallas, issue Q III, pages 24-36.
  12. Stephen Prowse, 1995. "Alternative methods of corporate control in commercial banks," Working Papers 9507, Federal Reserve Bank of Dallas.
  13. Blackwell, David W. & Brickley, James A. & Weisback, Michael S., 1994. "Accounting information and internal performance evaluation : Evidence from Texas banks," Journal of Accounting and Economics, Elsevier, vol. 17(3), pages 331-358, May.
  14. Borokhovich, Kenneth A. & Parrino, Robert & Trapani, Teresa, 1996. "Outside Directors and CEO Selection," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 31(03), pages 337-355, September.
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