English, Article edition: A Simple Explanation of the Relative Performance Evaluation Puzzle Marco Celentani; Rosa Loveira

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Bookmark: http://trove.nla.gov.au/version/112352
Physical Description
  • article
Language
  • English

Edition details

Title
  • A Simple Explanation of the Relative Performance Evaluation Puzzle
Author
  • Marco Celentani
  • Rosa Loveira
Physical Description
  • article
Notes
  • We study a simple moral hazard model in which two risk-neutral owners establish incentives for their risk-averse managers to exert effort. Because the probability distributions over output realizations depend on a common aggregate shock, optimal contracts make the compensation of each manager contingent on own performance but also on a performance benchmark--the performance of the other firm. If the marginal return of effort depends on the aggregate state, optimal contracts are not monotonically decreasing in the performance benchmark. This provides a simple explanation of the Relative Performance Evaluation (RPE) Puzzle--the documented lack of a negative relationship between CEO compensation and comparative performance measures, such as industry or market performance. Our simple model can also explain one-sided RPE--the documented tendency to insulate a CEO's rewards from bad luck, but not from good luck. We clarify that our results are robust in several dimensions and we discuss other applications of our findings. (Copyright: Elsevier)
  • Relative performance evaluation, optimal contracts, executive compensation.
  • RePEc:red:issued:05-109
Language
  • English
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