An Empirical-Investigation Of The Relative Performance Evaluation Hypothesis

The principal-agent framework has become a widely used paradigm in accounting and economics for analyzing issues in performance evaluation, management control, and the design of incentive systems. While recent work in experimental economics has begun to examine empirically some of the underlying assumptions and implications of agency theory (see Baiman and Lewis [1989] and Kirby [forthcoming]), few precise hypotheses have been tested using real-world or naturally-occurring data. One exception has been the empirical investigation of the relative performance evaluation (RPE) hypothesis. Agency theory suggests that there are benefits associated with evaluating agents on the basis of their relative performances when the agents' performances are affected by a common "shock" term (e.g., see Diamond and Verrecchia [1982] and Holmstrom [1979; 1982]). Specifically, a relative performance-based contract can remove the common shock term from an agent's performance, which enables a better evaluation of the agent's actions.

[1]  S. Sklivas The Strategic Choice of Managerial Incentives , 1987 .

[2]  David F. Larcker,et al.  AN ANALYSIS OF THE USE OF ACCOUNTING AND MARKET MEASURES OF PERFORMANCE IN EXECUTIVE-COMPENSATION CONTRACTS , 1987 .

[3]  Bengt Holmstrom,et al.  Moral Hazard in Teams , 1982 .

[4]  Ronald A. Dye,et al.  THE TROUBLE WITH TOURNAMENTS , 1984 .

[5]  Robert E. Verrecchia,et al.  Optimal Managerial Contracts and Equilibrium Security Prices , 1982 .

[6]  Incentive compensation schemes: Experimental calibration of the rationality hypothesis* , 1992 .

[7]  Abbie J. Smith,et al.  An Empirical-Investigation Of The Relative Performance Evaluation Of Corporate-Executives , 1986 .

[8]  Richard A. Lambert Long-Term Contracts and Moral Hazard , 1983 .

[9]  Rajiv D. Banker,et al.  Sensitivity, Precision, and Linear Aggregation of Signals for Performance Evaluation , 1989 .

[10]  Kevin J. Murphy,et al.  Relative Performance Evaluation for Chief Executive Officers , 1989 .

[11]  Ronald A. Dye,et al.  Relative Performance Evaluation And Project Selection , 1992 .

[12]  J. Patell CORPORATE FORECASTS OF EARNINGS PER SHARE AND STOCK-PRICE BEHAVIOR - EMPIRICAL TESTS , 1976 .

[13]  Barry L. Lewis,et al.  AN EXPERIMENT TESTING THE BEHAVIORAL EQUIVALENCE OF STRATEGICALLY EQUIVALENT EMPLOYMENT CONTRACTS , 1989 .

[14]  Bengt Holmstrom,et al.  Moral Hazard and Observability , 1979 .

[15]  Robert J. Barro,et al.  Pay, Performance, and Turnover of Bank CEOs , 1990, Journal of Labor Economics.

[16]  C. Fershtman,et al.  Equilibrium Incentives in Oligopoly , 1984 .