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Relative Performance Evaluation for Chief Executive Officers

  • Robert Gibbons
  • Kevin J. Murphy

Measured individual performance often depends on random factors which also affect the performances of other workers in the same firm, industry, or market. In these cases, relative performance evaluation (RPE) can provide incentives while partially insulating workers from the common uncertainty. Basing pay on relative performance, however, generates incentives to sabotage the measured performance of co-workers, to collude with co-workers and shirk, and to apply for jobs with inept co-workers. RPE contracts also are less desirable when the output of co-workers is expensive to measure or in the presence of production externalities, as in the case of team production. The purpose of this paper is to review the benefits and costs of RPE and to test for the presence of RPE in one occupation where the benefits plausibly exceed the costs: chief executive officers (CEOs). In contrast to previous research, our empirical evidence strongly supports the RPE hypothesis-CEO pay revisions and retention probabilities are positively and significantly related to firm performance, but are negatively and significantly related to industry and market performance, ceteris paribus. Our results also suggest that CEO performance is more likely to be evaluated relative to aggregate market movements than relative to industry movements.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 2944.

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Date of creation: Jan 1991
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Publication status: published as Industrial & Labor Relations Review, Vol. 43, No. 3, (Special Issue) pp. 30-51, (February 1990).
Handle: RePEc:nbr:nberwo:2944
Note: ITI IFM
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  1. HOLMSTROM, Bengt, . "Moral hazard and observability," CORE Discussion Papers RP -379, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
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  9. Lazear, Edward P, 1989. "Pay Equality and Industrial Politics," Journal of Political Economy, University of Chicago Press, vol. 97(3), pages 561-80, June.
  10. Dye, Ronald A, 1984. "The Trouble with Tournaments," Economic Inquiry, Western Economic Association International, vol. 22(1), pages 147-49, January.
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