Performance Peer Groups in CEO Compensation Contracts

Abstract

We take advantage of comprehensive panel data available as a result of the 2006 SEC disclosure rules on relative performance evaluation (RPE) to (i) better understand how firms choose performance peer groups used in CEO RPE contracts and (ii) to investigate the causal impact of mandatory disclosure on the peer selection process. We find that while firms for the most part choose performance peers to better identify their CEOs’ impact on firms’ performance, they also tend to select underperforming peers. Dynamically, we find that peers that are added and retained every year are weaker than ones that were not chosen. These findings suggest managers may have some influence on the choice of performance peers. Lastly, using a quasi-natural experiment we find that the enhanced disclosure did not affect the tendency of firms to select underperforming peers.

Keywords: Executive Compensation, Relative Performance Evaluation, Performance Peer Group

JEL Classification: G34, J33, J41, D86