Jia-Wen Liang
National Chengchi University
Abstract: From different perspectives, Aggarwal and Samwick (1999) and DeFond and Park (1999), investigate the effect of competition on relative performance evaluation and, interestingly, make completely opposite predictions. This paper addresses the issue of how firms consider the tradeoffs between risk-sharing and strategic competition in contract design. By distinguishing rival firms from peer firms, I find evidence that CEO compensation is negatively related to peer firm performance, consistent with RPE. I also find that, when a rival firm considers the strategic interaction as a strategic substitute, CEO compensation is negatively linked to the performance of the rival firm. This is consistent with the use of the performance of the strategic substitute rival firm to filter out common risks and with providing managers with incentives to take aggressive actions in product market competition. In addition, I find that CEO compensation is not negatively related to the performance of strategic complement rival firm. This result suggests that Boards of Directors consider the strategic implications of rival firm performance in setting CEO compensation. This study contributes to the literature by providing evidence consistent with risk-sharing and strategic implication of rival firm performance being considered in CEO compensation.
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