Board interlock networks and the use of relative performance evaluation

Abstract

Purpose – The purpose of this paper is to explore how networks of boards of directors affect relative performance evaluation (RPE) in chief executive officer (CEO) compensation. Design/methodology/approach – In this study, the authors propose that an interlocking network is an important inter-corporate setting, which has a bearing on whether boards decide to use RPE in CEO compensation. They adopt four typical graph measures to depict the centrality/position of each board in the interlock network: degree, betweenness, eigenvector and closeness, and study their impacts on RPE use. Findings – The authors find that firms that have more connected board members and whose board members are connected to better connected firms are more likely to reward their CEOs contingent on their peers’ performance, indicating that information transmission along the board interlock network facilitates the adoption of RPE. This result is robust to alternative measures for board interlock networks and various types of CEO compensation. It highlights the role of interlocking directorates in disseminating information and practice of RPE use along board network. Originality/value – The authors use social network analysis to measure the relationships and flows between the connected nodes and study the impact on executive compensation design.