Product Market Competition and Relative Performance Evaluation: Evidence from a Quasi-Natural Experiment

• In Event: Doctoral Student-Faculty Interchange: Financial Reporting I

Abstract

I provide causal evidence that product market competition reduces use of relative performance evaluation
(RPE). Prior studies regarding the relation between product market competition and RPE have reached
mixed theoretical and empirical findings. Agency theory predicts that RPE is used more in highly
competitive environment to improve contract efficiency. Industrial organization theory suggests that
positive (negative) pay-for-peer-performance sensitivity can be used to discourage (encourage) competition
for strategic purposes. I supplement prior studies by finding that (1) naïve OLS regressions using a different
proxy for firm-level product market competition yield a positive effect of competition on RPE, but (2) a
difference-in-differences approach reverses the sign of this effect, suggesting that firms are less (more)
likely to use RPE in response to competition shocks induced by major industry-level tariff reduction
(increase).

Author

• Zhe Guo, Boston University