rTSR: When Do Relative Performance Metrics Capture Relative Performance?

Paul  Ma; Jee-Eun  Shin; Charles C. Y. Wang

Working Paper | HBS Working Paper Series | 2019

rTSR: When Do Relative Performance Metrics Capture Relative Performance?

by Paul Ma, Jee-Eun Shin and Charles C. Y. Wang

Abstract

Relative total shareholder returns (rTSR) has become the predominant metric to isolate managers' idiosyncratic performance. Among firms that explicitly use rTSR in relative performance contracts, 60%—those that choose specific peers as benchmarks—select rTSR metrics that do a remarkable job of filtering out the systematic component of returns in adherence to the informativeness principle. However, firms that choose index-based benchmarks retain substantial systematic noise in their rTSR metrics. We document that the selection of noisy benchmarks is associated with compensation consultants' preferences, which are uncorrelated with observable firm attributes. Firms with weak governance are more likely to choose indexes, not because of opportunism, but because they do not adequately scrutinize outside experts' advice. Collectively, our findings provide a new explanation for why some executives are evaluated based on systematic noise and novel evidence on how compensation consultants can impact firms.

Keywords: Relative TSR; Relative performance evaluation; systematic risk; board of directors; Compensation Consultants; style effects; Executive Compensation; Performance Evaluation; Corporate Governance;

Language: English

Format: Print

57 pages

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Citation:

Ma, Paul, Jee-Eun Shin, and Charles C. Y. Wang. "rTSR: When Do Relative Performance Metrics Capture Relative Performance?" Harvard Business School Working Paper, No. 19-112, April 2019. (Revised May 2019.)

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rTSR: When Do Relative Performance Metrics Capture Relative Performance?

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