Relative Performance Benchmarks: Do Boards Follow the Informativeness Principle?

Citation:

Ma, Paul, Jee Eun Shin, and Charles C.Y. Wang. “Relative Performance Benchmarks: Do Boards Follow the Informativeness Principle?” Working Paper.

Abstract:

Relative TSR (rTSR) is increasingly used by market participants to judge and incentivize managerial performance. We evaluate the efficacy, reasons, and implications of firms' benchmarks in rTSR-based contracts. Although compensation consultants suggest that a primary objective of rTSR is to filter shocks unrelated to managerial performance, following the informativeness principle, we document that a significant subset of firms that choose index-based benchmarks do not adequately achieve this objective. Further, the index-benchmark selection is associated with governance-related frictions and is not driven by plausible alternative theories. Both structural calibration and reduced-form estimates reveal significant negative performance implications from suboptimal peer-selection.

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