Management Accounting Section Midyear Meeting

Customer RPE: Using Customer Performance to Filter Noise Out of CEO Incentive Contracts

• In Event: Product Markets and Customers (Mixed Methods)

Abstract

The “informativeness criterion” (Holmstrom 1982) states that any information item that is informative about a CEO’s effort be used in incentive contracting. Prior research documents negative incentive weights on industry peer performance in CEO contracting in what is known as “relative performance evaluation” (RPE). RPE improves the efficiency of incentive contracting by filtering noise from CEO performance measurement. We test whether the performance of a firm’s customer base is also used to improve incentive contracting, what we term “customer relative performance evaluation” (customer RPE). Consistent with customer RPE, we document a negative incentive weight on customer performance in CEO incentive contracts incremental to the negative incentive weight on performance of industry peers documented in prior research. Further, the negative incentive weight on customer performance is larger in absolute value for firms whose performance is more highly correlated with their customers’ performance, when the firm’s products/services are more specialized, and when the firm has lower operating flexibility. Moreover, the weight on customer performance decreases when the adverse incentives triggered by customer RPE are more costly.

Authors

• Mary Ellen Carter, Boston College

• Jen Choi, Emory University

• Karen L Sedatole, Emory University