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Relative Versus Absolute Performance Evaluation and CEO Decision-Making

Published online by Cambridge University Press:  10 May 2022

Karen H. Wruck Open the ORCID record for Karen H. Wruck [Opens in a new window]  and
YiLin Wu
Karen H. Wruck*
Affiliation:
The Ohio State University Fisher College of Business
YiLin Wu
Affiliation:
National Taiwan University, College of Social Sciences, Department of Economics yilinwu@ntu.edu.tw
*
wruck.1@osu.edu (corresponding author)
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Abstract

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We provide new evidence on how performance-based compensation plans affect CEO decision-making, especially risk-taking. Our main finding is that relative performance evaluation (RPE) plans provide incentives for CEOs to make decisions that generate more idiosyncratic performance outcomes; absolute performance evaluation (APE) plans do not. After switches from APE to RPE, the correlation between firm stock return and industry index return falls and firm idiosyncratic risk increases. Further, switches to RPE are followed by larger deviations in financial, investment, and operating policies from industry norms (i.e., more idiosyncratic strategies). All results are opposite for switches to APE.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 57 , Issue 7 , November 2022 , pp. 2591 - 2626
Creative Commons
Creative Common License - CCCreative Common License - BY
This is an Open Access article, distributed under the terms of the Creative Commons Attribution licence (https://creativecommons.org/licenses/by/4.0), which permits unrestricted re-use, distribution and reproduction, provided the original article is properly cited.
Copyright
© The Author(s), 2022. Published by Cambridge University Press on behalf of the Michael G. Foster School of Business, University of Washington

Footnotes

We thank John Graham, Lok-Si Ieong, Swaminathan Kalpathy (discussant), Yen-Jung Lee (discussant), and Yan Luo (discussant) for helpful comments. We also thank participants at the 2017 Annual Meeting of the Financial Management Association International and 2018 International Conference of Taiwan Finance Association and seminar participants at The Ohio State University, National Taiwan University, Yuan Ze University, and Chung Yuan Christian University. We offer special thanks to Jeffrey Coles (the referee) and Paul Malatesta (the editor) for their insightful comments. Wruck is grateful for research support from the Dice Center for Financial Economics at The Ohio State University Fisher College of Business. Wu is grateful for research support from the Center for Research in Econometric Theory and Applications (grant no. 108L900201) and from The Featured Areas Research Center Program within the framework of the Higher Education Sprout Project by the Ministry of Education (MOE) in Taiwan. Wu also acknowledges financial support from the Ministry of Science and Technology in Taiwan (MOST 107-2410-H-002-057-MY2).

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