This study offers evidence that the use of RPE (Relative Performance Evaluation) in CEO incentive contracting depends on the type of strategic competition between a firm and its peers. Specifically, CEO pay is negatively (positively) associated with peer-group performance when firms compete as strategic substitutes (complements). This finding suggests that firms provide CEO incentives in order to influence strategic interaction with peer firms. Further, the directionally opposite pay-for-peer-group-performance sensitivities, i.e., negative (positive) for substitutes (complements), cancel each other in aggregate, which may explain the lack of consistent support found in prior research for the role of RPE in filtering out common noise from the CEO's performance. I also document that the weight on both substitute and complement peer performance increases, in absolute value, with the intensity of industry competition relative to the weight on own-firm performance. Finally, taking firms' explicit RPE disclosures into account does not affect the results.
We offer evidence that the use of relative performance evaluation (RPE) in CEOs' incentive contracts influences the effect of risk-taking incentives on both the magnitude and composition of firm risk. We find that, when the incentive design lacks RPE features, the incentive portfolio vega motivates CEOs to increase total risk through the systematic component because it can be hedged. In contrast, when the incentive design includes RPE features, CEOs prefer idiosyncratic risk because RPE filters out the systematic component of firm performance. We also document that the use of RPE reinforces the incentive portfolio vega's effect on the total risk. JEL codes: M20; M21; M40; M41; M52 Keywords: executive compensation; relative performance evaluation; risk incentives; systematic and idiosyncratic risk * Southern Methodist University.Accepted by Douglas Skinner. We are grateful to Jeffrey Wooldridge for his guidance regarding the estimation techniques used. We appreciate the helpful comments from an anonymous referee and the seminar participants of the 2014 Accounting Lone Star Conference. 1055
Using archival data from the U.S. passenger airline industry, this study examines whether management control mechanisms aimed at mitigating moral hazard explain outsourcing decisions over and above transaction cost economics (TCE) determinants documented in prior research. Consistent with TCE theory, we find that in-house production efficiencies and our proxy for transaction risk (i.e., deriving from transaction infrequency, transaction complexity, and relationship-specific investments) significantly explain the extent of outsourcing of aircraft maintenance. We extend TCE insights to show that incentive delta (i.e., the sensitivity of CEO portfolio holdings to stock price changes) strengthens the negative association between production efficiencies and outsourcing while incentive vega (i.e., the sensitivity of CEO holdings to stock return volatility) weakens the negative association between transaction risk and outsourcing. Monitoring strengthens the negative association between in-house production efficiencies and outsourcing, but has no effect on the transaction risk-outsourcing relation. The results suggest that the use of outsourcing to achieve cost savings is promoted through both incentive contracts and monitoring, but outsourcing to achieve the desired risk level is promoted only through incentive contracts.
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