CEOs' Outside Employment Opportunities and the Lack of Relative Performance Evaluation in Compensation Contracts

Although agency theory suggests that firms should index executive compensation to remove market-wide effects (i.e., RPE), there is little evidence to support this theory. Oyer (2004, "Journal of Finance" 59, 1619-1649) posits that an absence of RPE is optimal if the CEO's reservation wages from outside employment opportunities vary with the economy's fortunes. We directly test and find support for <link rid="b36">Oyer's (2004)</link> theory. We argue that the CEO's outside opportunities depend on his talent, as proxied by the CEO's financial press visibility and his firm's industry-adjusted ROA. Our results are robust to alternate explanations such as managerial skimming, oligopoly, and asymmetric benchmarking. Copyright 2006 by The American Finance Association.