Intra‐industry Performance Ranking and Relative Performance Evaluation

This study examines the association between firms’ intra‐industry performance ranking and the use of relative performance evaluation (RPE) in executive compensation plans. It finds an inverted U‐shape association between firms’ intra‐industry performance ranking and the use of RPE (i.e., compared to bottom‐ and top‐ranked firms, middle‐ranked firms are more likely to use RPE). This effect could be explained by the availability of similar peers in RPE incentive contracting: I find that both bottom‐ and top‐ranked firms have fewer similar peers, limiting their opportunities to efficiently practise RPE compared to middle‐ranked firms. Finally, the inverted U‐shape association is more pronounced for firms with higher potential costs induced by heterogeneous peers and for RPE that uses self‐selected peer groups. Overall, this study provides new evidence of the determinants of RPE use and suggests that the incentivization effect of RPE compensation plans varies with firms’ intra‐industry performance ranking.