Implementing Relative Performance Evaluation: The Role of Life Cycle Peers

• In Event: Relative Performance Evaluation

Abstract

Although empirical academic evidence of RPE relies almost exclusively on industry-based classifications of performance peers, we suggest that because static industry classifications fail to capture dynamic firm economics, compensation committees select non-industry peers to effectively remove systematic performance from CEO pay. We expand the RPE literature by providing evidence that firms choose peers outside their industry, and exclude peers within their industry in favor of peers sharing the same life cycle stage. Additionally, we find that firms are more likely to utilize life cycle peers when there is heterogeneity in life cycle stages within their industry. Further, we show that cross-sectional differences in RPE use documented in prior literature stem from differential common shocks not fully absorbed by industry peers, but adequately captured using life cycle peers. Overall, life cycle offers a significant advancement in our understanding of RPE implementation in the firm.

Authors

• Katharine Diane Drake, University of Arizona-Tucson

• Melissa Martin, University of Illinois - Chicago