The Effect of Relative Performance Evaluation on the Joint Choice of Risk and Effort

Abstract

The use of Relative Performance Evaluation (RPE) is widely observed across academic and corporate settings. While the use of RPE is commonly justified by the theoretical prediction that it can increase employee risk-taking and effort beyond that of an incentive plan that rewards based only on individual performance, there is no empirical evidence documenting the effect of RPE on individuals’ joint choice of risk and effort. Prior research has been either unable to untangle the effect of RPE on effort and risk-taking or have focused on only one or the other. Using an experiment, this paper examines if the impact of RPE is different in a setting whereby employees’ performance is jointly affected by their concurrent risk and effort choices versus a setting whereby employees’ risk and effort choices are independent and evaluated separately. The results of this experiment show the impact of RPE to be different in the joint setting. I also find that RPE can potentially encourage more extreme risk-taking behavior. In addition, I do not find on average that RPE is more effective than an individual performance based incentive plan in motivating higher effort and lower risk-aversion in the joint setting.