Executive compensation, strategic competition, and relative performance evaluation: Theory and evidence

We examine compensation contracts for managers in imperfectly competitive p roduct markets. We show that strategic interactions among firms can explain the lack of relative performance-based incentives in which compensation de creases with rival firm performance. The need to soften product market comp etition generates an optimal compensation contract that places a positive w eight on both own and rival performance. Firms in more competitive industri es place greater weight on rival firm performance relative to own firm perf ormance. We find empirical evidence of a positive sensitivity of compensati on to rival firm performance that is increasing in the degree of competitio n in the industry.