Explicit Relative Performance Evaluation in Performance-Vested Equity Grants

Abstract

Using data from FTSE 350 firms, we examine factors influencing explicit relative performance evaluation (RPE) conditions in performance-vested equity grants. We provide exploratory evidence on whether the use or characteristics of RPE are associated with efforts to improve incentives by removing common risk, other economic factors discussed in the RPE literature, or external pressure to implement RPE. We find that many of these economic factors, including common risk reduction, are more closely related to specific relative performance conditions than to the firm-level decision to use RPE in some or all of their equity grants. We also find that greater external monitoring by institutional investors or others is associated with plans with tougher overall RPE conditions. The relative performance conditions are binding in most RPE plans, with nearly two-thirds of the grants vesting only partially or not vesting at all. Further, we find evidence that vesting percentages vary in RPE and non-RPE plans.Keywords restricted stock grant, equity plan, dividend playout ratio, stock option grant, compensation risk, RPE, equitybased pay, dividend yield, executive compensation contract, equity incentive, institutional investor, stock return volatility, London stock exchange, stock market performance, share price performance Abstract ______________________________________________________________________________ Using data from FTSE 350 firms, we examine the factors influencing the explicit use of relative performance evaluation (RPE) in performance-vested equity grants, and whether RPE is used to improve incentives or to opportunistically increase vesting and/or placate external parties calling for its use. We find little evidence that the simple decision to use or not use RPE is associated with the economic factors identified in RPE theories. Instead, these factors are associated with specific RPE performance conditions. The relative performance conditions are binding in most RPE plans, with nearly two-thirds of the grants vesting only partially or not vesting at all. However, we find no evidence that vesting percentages are higher in RPE plans than in non-RPE plans, and no evidence that RPE is used opportunistically to increase vesting and compensation.

Preaching Water But Drinking Wine? Relative Performance Evaluation in International Banking

“…Gong et al (2011) investigate explicit disclosures on RPE in the U.S. to identify the factors that prompt the use of RPE in compensation contracts in 2006. Carter et al (2009) examine the use of RPE in performance-vested equity grants in a sample of U.K. firms in 2002. This section addresses this gap and examines international firms over a longer time span.…”

“…Indeed, RPE has become seemingly popular in practice. For example, recent studies suggest that roughly every fourth firm in the S&P 1500 openly claims to use RPE in their compensation contracts (Carter et al 2009, Gong et al 2011.…”

Preaching Water But Drinking Wine? Relative Performance Evaluation in International Banking

“…Prior studies have put forth a variety of factors that influence the usage of RPE in compensation contracts (Carter et al 2009, Gong et al 2011, Albuquerque 2014. These studies focus on RPE usage in U.K. or U.S. firms.…”

“…Gong et al (2011) investigate explicit disclosures on RPE in the U.S. to identify the factors that prompt the use of RPE in compensation contracts in 2006. Carter et al (2009) examine the use of RPE in performance-vested equity grants in a sample of U.K. firms in 2002. None of them investigate the use of RPE on an international level or over a longer time span.…”

“…Indeed, RPE has become seemingly popular in practice. Recent studies suggest, for example, that roughly every fourth firm in the S&P 1500 openly claim to use RPE in their compensation contracts (Carter et al 2009, Gong et al 2011. In this paper, we test the existence of RPE in international banking and pay particular attention to banks who purport its usage.…”