Managerial Ability and Peer Selection in Relative Performance Evaluation

Abstract

The purpose of this study is to find out whether companies consider CEO ability to choose peer groups in relative performance evaluation. For empirical analysis, this study used US listed companies, and the primary empirical results are as follows. First, the performance of peers is significantly related with CEO compensation scheme when peers are selected by reflecting the similarity of CEO ability between companies within the same industry. Second, the performance of peer companies significantly affects CEO performance evaluation when peers are chosen by taking into account the similarity of the industry, firm size, and CEO ability. These results imply that firms consider similarity of CEO ability in peer group as well as common risk factors of peers to increase the usefulness of relative performance evaluation. This study enhances the understanding of the relative performance evaluation in CEO compensation by finding that CEO ability can be reflected as a selection criterion for peer companies in relative performance evaluation.