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2.1. INTRODUCTION 15
is not a prominent feature of executive compensation contracts. Antle & Smith (1986)
and Liu & Stark (2008) find some support for RPE, but they also present results that are
inconsistent with RPE. Gibbons & Murphy (1990) report strong support, but the interpretation
of their results has been criticized quite severely by Janakiraman et al. (1992).
Even less in favour of RPE, Janakiraman et al.’s own empirical results (1992) are generally
negative about RPE’s presence. Additionally, Bertrand & Mullainathan (2001), Garvey &
Milbourn (2006), and Himmelberg & Hubbard (2000) report no support for RPE. However,
Albuquerque (2009) argues that this is due to misspecification of the analyses. After
respecification of the analyses, she finds partial support for RPE use amongst executives.
Overall, the empirical evidence remains mixed at best, suggesting that RPE has limited
empirical relevance 1 .
However, the empirical evidence may be limited due to several characteristics that prior
RPE studies have in common. A first reason for the prior literature’s limited support
for RPE may lie in its focus on the executive level. If deployed at the highest organizational
level, RPE might be less efficient, 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 in lower echelons.
This fact may render RPE more attractive at these levels.
Another important characteristic of the extant RPE literature that may have caused the
literature’s negative findings, concerns the type of data being used. Most empirical studies
that are currently available in the literature 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 typically regress executive pay on firm performance
and peer performance (e.g., Aggarwall & Samwick 1999, Albuquerque 2009, Janakiraman
et al. 1992, Liu & Stark 2008). In these analyses, a positive coefficient for firm performance
together with a negative coefficient for peer performance provides support for the
1 The empirical RPE literature is discussed in more detail in the introductory chapter of this thesis in
section 1.2.2 on page 6.