pdf - Nyenrode Business Universiteit
pdf - Nyenrode Business Universiteit pdf - Nyenrode Business Universiteit
1.3. RESEARCH QUESTIONS AND CONTRIBUTIONS 7 market returns. This leaves the cash compensation of boards of directors partially exposed to industry uncertainties. Gibbons & Murphy (1990) report strong support for RPE use, but the interpretation of their results has been criticized quite severely by Janakiraman et al. (1992). Janakiraman et al. (1992) argue that Gibbons & Murphy’s (1990) analysis of 7.757 cash compensation observations of 1.049 firms over a 12-year period only supports a ‘weak’ form of RPE. This weak form of RPE refers to situations where peer performance is not entirely, but only partially filtered out of the compensation contract. Janakiraman et al.’s (1992) own empirical results are generally negative regarding RPE’s presence. Other, more recent studies by Bertrand & Mullainathan (2001), Garvey & Milbourn (2006), and Himmelberg & Hubbard (2000) report no support for RPE. However, Albuquerque (2009) argues that this lack of support is due to misspecification of the analyses. According to Albuquerque (2009), most RPE studies suffer from a poor specification of the peer group, which blurs the results. After respecification of the analyses, Albuquerque (2009) finds partial support for RPE use amongst executives. Overall, the empirical evidence remains mixed at best, suggesting that RPE has limited empirical relevance, at least among executives. 1.3 Research Questions and Contributions From the literature review presented in the previous section, we see that RPE has a sound theoretical basis, but lacks overall conclusive empirical support. The objective of this research project is to fill this gap partially by: 1) seeking further empirical documentation about RPE; 2) explaining why organizations do or do not rely on RPE practices for the evaluation of business unit managers; and 3) studying whether RPE use increases the effectiveness of the Management Control System of its adopters. This results in the following research questions and accompanying contributions: 1. To what extent is RPE used for the performance evaluation of business unit managers? The first research question directly relates to the empirical puzzle presented in the previous section of this chapter: RPE seems theoretically sensible for business practice, but it lacks empirical support. However, the prior literature has several characteristics that may reduce the chance of finding support for RPE’s empirical existence.
8 CHAPTER 1. GENERAL INTRODUCTION First, the literature focuses almost exclusively on the executive level. However, RPE might be not very efficient if deployed at the highest organizational level, as Garvey & Milbourn (2003) argue. It is entirely possible that relatively wealthy executives can reduce noise in their incentive contracts more efficiently themselves by adjusting their own private investment portfolios. The option of managerial hedging may decrease the attractiveness of RPE, reducing its adoption amongst top managers. However, private hedging is costly. As a result, it is probably not an efficient option at the level of (less wealthy) business unit managers. In support of this argument, Garvey & Milbourn found that, although RPE is not an important feature in the compensation contract of the average manager, it is in fact present for younger and less wealthy executives (i.e., those managers for whom personal hedging is likely to be prohibitively costly (Garvey & Milbourn 2003:1557)). If personal hedging is indeed too costly for less wealthy executives, it is probably also too costly for managers at lower echelons. This fact increases the attractiveness of RPE at these levels. My thesis contributes to the literature by studying RPE at the level of business unit managers, where it may be more prevalent than it is at the executive level. The second characteristic of the extant RPE literature concerns the type of data that is used. Most currently available empirical studies rely on archival data from before 2006. Using archival data has several benefits (e.g., data availability, objectivity of the data, and sample size). However, prior to the SEC’s 2006 executive compensation disclosure rules, firms were not required to disclose detailed information about their compensation plans. As a result, pre-2006 archival data have the drawback of requiring indirect instead of direct analyses. Indirect analyses approach RPE as if performance was evaluated relative to competitors’ performance, as opposed to explicitly studying whether the performance evaluation system incorporates peer performance information. This approach is inevitable when using archival data to investigate a phenomenon on which firms do not specifically report, such as RPE use. Although this is likely to change in the near future, studies that incorporate the newly available disclosure information are still scarce. Currently, the prevalent archival approach provides mixed support for RPE’s empirical validity. As opposed to the prior literature described here, this thesis uses data from a survey. This survey instrument is specifically designed for the current study. This should add more detail and richness to the analyses, resulting in a better description of RPE in practice. The first research question is addressed in chapter 2 of this dissertation.
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8 CHAPTER 1. GENERAL INTRODUCTION<br />
First, the literature focuses almost exclusively on the executive level. However, RPE<br />
might be not very efficient if deployed at the highest organizational level, as Garvey<br />
& Milbourn (2003) argue. It is entirely possible that relatively wealthy executives<br />
can reduce noise in their incentive contracts more efficiently themselves by adjusting<br />
their own private investment portfolios. The option of managerial hedging may<br />
decrease the attractiveness of RPE, reducing its adoption amongst top managers.<br />
However, private hedging is costly. As a result, it is probably not an efficient option<br />
at the level of (less wealthy) business unit managers. In support of this argument,<br />
Garvey & Milbourn found that, although RPE is not an important feature in the<br />
compensation contract of the average manager, it is in fact present for younger and<br />
less wealthy executives (i.e., those managers for whom personal hedging is likely to<br />
be prohibitively costly (Garvey & Milbourn 2003:1557)). If personal hedging is indeed<br />
too costly for less wealthy executives, it is probably also too costly for managers<br />
at lower echelons. This fact increases the attractiveness of RPE at these levels. My<br />
thesis contributes to the literature by studying RPE at the level of business unit<br />
managers, where it may be more prevalent than it is at the executive level.<br />
The second characteristic of the extant RPE literature concerns the type of data<br />
that is used. Most currently available empirical studies rely on archival data from<br />
before 2006. Using archival data has several benefits (e.g., data availability, objectivity<br />
of the data, and sample size). However, prior to the SEC’s 2006 executive<br />
compensation disclosure rules, firms were not required to disclose detailed information<br />
about their compensation plans. As a result, pre-2006 archival data have the<br />
drawback of requiring indirect instead of direct analyses. Indirect analyses approach<br />
RPE as if performance was evaluated relative to competitors’ performance, as opposed<br />
to explicitly studying whether the performance evaluation system incorporates<br />
peer performance information. This approach is inevitable when using archival data<br />
to investigate a phenomenon on which firms do not specifically report, such as RPE<br />
use. Although this is likely to change in the near future, studies that incorporate<br />
the newly available disclosure information are still scarce. Currently, the prevalent<br />
archival approach provides mixed support for RPE’s empirical validity.<br />
As opposed to the prior literature described here, this thesis uses data from a survey.<br />
This survey instrument is specifically designed for the current study. This should add<br />
more detail and richness to the analyses, resulting in a better description of RPE in<br />
practice.<br />
The first research question is addressed in chapter 2 of this dissertation.
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