Relative performance evaluation (RPE) provides employees with an incentive to perform well while insulating their compensation from shocks that also affect the performances of other workers in the same firm, industry, or market. This paper reviews the benefits and costs of RPE and tests for the presence of RPE in the compensation contracts of chief executive officers (CEOs) using data on 1,668 CEOs from 1,049 corporations from 1974 to 1986. The results, in contrast to the findings of previous research, strongly support the hypothesis that RPE is used in compensation and retention decisions affecting CEOs: the revision in a CEO's pay and the probability that a CEO remains in his position for the following year are positively and significantly related to firm performance, but are negatively and significantly related to industry and market performance.
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