Relative Performance Evaluation and Project Selection

The article presents information on the benefits of relative performance evaluation (RPE)-based schemes as it relates to agency theory. RPE determines compensation relative to the output of one's peers. When other firms' outputs reveal information about the manager's actions, agency theory predicts that managerial compensation will use relative performance. The author contends that under certain circumstances, RPE can be very effective in reducing moral hazard between principal and agent, regardless of the number of projects available to the agent.