Do CEOs Make Their Own Luck? Relative Versus Absolute Performance Evaluation and Firm Risk

Karen H. Wruck and YiLin Wu
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Karen H. Wruck: Ohio State University
YiLin Wu: National Taiwan University

Working Paper Series from Ohio State University, Charles A. Dice Center for Research in Financial Economics

Abstract: Influenced by their compensation plans, CEOs make their own luck through decisions that affect future firm risk. After adopting a relative performance evaluation (RPE) plan, total and idiosyncratic risk are higher, and the correlation between firm and industry performance is lower. The opposite is true for firms that adopt absolute performance evaluation (APE) plans. Plans including accounting-based performance metrics and/or cash payouts have weaker risk-related incentives. The higher idiosyncratic risk associated with RPE increases a firm's exposure to downside stock return risk and lowers credit quality. Our findings are economically consistent with observed differences in firms' financial and investment policies.

JEL-codes: D22 G12 G32 G34 J33 J41 O31 (search for similar items in EconPapers)
Date: 2017-10
New Economics Papers: this item is included in nep-bec, nep-cfn, nep-hrm and nep-rmg
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Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:ecl:ohidic:2017-20

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