Abstract

Measured individual performance often depends on random factors which also affect the performances of other workers in the same firm, industry, or market. In these cases, relative performance evaluation (RPE) can provide incentives while partially insulating workers from the common uncertainty. Basing pay on relative performance, however, generates incentives to sabotage the measured performance of co-workers, to collude with co-workers and shirk, and to apply for jobs with inept co-workers. RPE contracts also are less desirable when the output of co-workers is expensive to measure or in the presence of production externalities, as in the case of team production. The purpose of this paper is to review the benefits and costs of RPE and to test for the presence of RPE in one occupation where the benefits plausibly exceed the costs: toplevel management. Rewarding chief executive officers (CEOs) based on performance measured relative to the industry or market creates incentives to take actions increasing shareholder wealth while insuring executives against the vagaries of the stock and product markets that are beyond their control. We expect RPE to be a common feature of

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