Implementing Relative Performance Evaluation: The Role of Life Cycle Peers

Abstract

ABSTRACTThe effectiveness of relative performance evaluation (RPE) in compensation contracts depends on a firm's ability to identify peers that are subject to similar exogenous shocks with similar abilities to respond to such shocks. We expand the RPE literature by considering whether firms routinely select peers sharing a life cycle stage in RPE implementation. We argue that life cycle captures similarities in underlying economics and homogeneity along a number of dimensions relevant in filtering systematic performance. Using explicit peer firm disclosures and a peer selection model, we show that firms routinely select life cycle peers. Further, using implicit RPE tests, we document evidence of life cycle peers filtering common performance incremental to previously identified peer groups. We provide some of the first evidence that peer group composition differs with differing characteristics of the firm and its industry, highlighting that peer selection is a dynamic process evolving with the firm's changing nature.JEL Classifications: E32; J33; L2.Data Availability: All data are available from public sources.