Relative performance evaluation and investment efficiency

We investigate the impact of incorporating relative performance targets in long-term equity plans on investment efficiency in China. Using data on 1642 long-term equity incentive plans implemented in 1186 Chinese listed companies from 2001 to 2020, we find that the reduction in inefficient investments after the equity grant is higher for RPE (relative performance evaluation) firms than non-RPE firms. We establish a direct connection between the improved investment efficiency and RPE by assessing the essential conditions and implementation extent of RPE in equity plans. Our findings remain robust after addressing concerns related to endogeneity, potential confounding effects from the simultaneous use of absolute performance evaluation and sample selection bias. Collectively, our analyses demonstrate that benchmarking firms' performance against industry peers through RPE encourages more efficient allocation of investment resources.