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Relative Performance Evaluation and Peer- Performance Summarization Errors

Authors/Editors: Dikolli, Shane S.
Hofmann, Christian
Pfeiffer, Thomas
Published: 2013
Type: Articles in Refereed Journals (International)
ISBN/ISSN: 1380-6653
Published by: Review of Accounting Studies
Additional information: 18 (1), 2013, 34-65


In tests of the relative performance evaluation (RPE) hypothesis,
empiricists rarely aggregate peer performance in the same way as a firm’s board of
directors. Framed as a standard errors-in-variables problem, a commonly held view
is that such aggregation errors attenuate the regression coefficient on systematic firm
performance towards zero, which creates a bias in favor of the strong-form RPE
hypothesis. In contrast, we analytically demonstrate that aggregation differences
generate more complicated summarization errors, which create a bias against
finding support for strong-form RPE (potentially inducing a Type-II error). Using
simulation methods, we demonstrate the sensitivity of empirical inferences to the
bias by showing how an empiricist can conclude erroneously that boards, on
average, do not apply RPE, simply by selecting more, fewer, or different peers than
the board does. We also show that when the board does not apply RPE, empiricists
will not find support for RPE (that is, precluding a Type-I error).