Choice of relative performance evaluation for strategic reasons

This paper presents a new perspective for the use of relative performance evaluation. It argues that firms may want to evaluate their CEOs relative to their competitors for strategic reasons. It considers a competitive industry and with the help of a multiple agency model arrives at a set of hypotheses regarding the weights on firm performance and industry performance. These hypotheses do not have an analogue in a traditional single agency model framework. The empirical hypotheses relating the compensation contract parameters to the cost and market structures of the industry are tested with cash compensation data from 272 firms over a period of 18 years. Some of the empirical hypotheses find support from the data. Finally the paper also investigates whether the data supports alternate hypotheses arrived at by considering competing explanation for the use of RPE based on Holmstrom’s informativeness criterion.