Relative Performance Benchmarks : Do Boards Follow the Informativeness Principle?

We examine whether and to what extent managers are evaluated, in their relative performance contracts, on the basis of systematic performance. Focusing on relative total shareholder returns (rTSR), the predominant metric specified in these contracts and used by market participants to evaluate managers, we document that 60% of firms—those that choose specific peers—do a remarkable job of capturing the systematic component of returns in adherence to the informativeness principle. However, 40% of firms—those that choose index-based benchmarks—retain substantial systematic noise in their rTSR metrics, which they could have substantially corrected by using their self-chosen compensation-benchmarking peers. The selection of noisy benchmarks is economically important, is associated with lower ROA, and can be explained bycompensation consultants' tendencies and firms' governance weaknesses