Peer-Specific Knowledge and Peer Group Properties in Relative Performance Evaluation

Abstract

ABSTRACT Although relative performance evaluation (RPE) represents an important compensation practice, selecting a relevant peer firm poses a challenge for compensation committees. We study the implications of a committee’s peer-specific knowledge for the peer group property (i.e., RPE relevance). Committees likely know more about firms within their networks, and such peer-specific knowledge increases with their connections to potential peer firms. Our findings suggest that peer-specific knowledge facilitates not only the inclusion of more relevant peer firms, but also the exclusion of less relevant ones. Moreover, the committees incorporate connected peers’ performance information to a greater extent for risk removal. We address identification challenges by including an intensive set of fixed effects to control for characteristics of the focal and the peer firms and by exploiting exogenous changes to the connections between the committees and the peer firms. Our findings suggest that the compensation committee’s peer-specific knowledge facilitates the RPE practice. Data Availability: All data used in this study are publicly available. JEL Classifications: D22; M52; I19.