eThesis - School of Business electronic theses

Regardless of the strong theoretical justification for the use of relative performance evaluation in setting executive compensation, previous empirical results supporting relative performance evaluation are mixed. This study contributes to the existing literature by analyzing implicit relative performance evaluation in a specific form of compensation, performance share plans. Implicit relative performance evaluation is studied with the single-year relative performance evaluation model used also in the previous research, in addition to which an adjusted long-term relative performance evaluation model is developed to account for longer term (3-year) performance and to extend the analysis also to other executives besides the chief executive officer (CEO).

The proprietary and unique data cover all the performance share plans ever used (per August 2012) in Finnish companies listed on the Nasdaq OMX Helsinki stock exchange. A total of 87 companies and 543 share plan lots are included in the initial sample. The sample for the adjusted long-term relative performance evaluation analysis consists of 53 companies and 179 performance share plan lots. The sample for the single-year relative performance evaluation analysis includes a total of 167 performance share plan lots in 42 companies which correspond to 125 single-year changes. The data include observations from year 2000 to August 2012.

Although the Finnish companies do not usually use explicit relative performance evaluation in their performance share plans, the empirical evidence presented in this study indicates that companies use short-term as well as long-term implicit relative performance evaluation with respect to total shareholder returns in their performance share plans. Furthermore, CEO performance is more likely to be evaluated relative to industry performance than market performance. Relative performance evaluation is used either by implicitly setting the stock market based performance targets to a level which takes industry performance into account or by adjusting the number of granted shares from year to year.

Although I find that relative performance evaluation with respect to total shareholder returns is used in performance share plans, no evidence of the use of relative performance evaluation with respect to ROA is found either in the single-year analysis or the adjusted long-term analysis.

The results also show that performance share plan payout ratios are positively and statistically significantly associated with company performance even when the performance is measured during three years instead of one year which is the most common earning period length.