Keeping It In The Family

FAYETTEVILLE, Ark. - Executives in family-owned firms make significantly less in both cash and total compensation than corresponding officers in similar nonfamily companies, according to University of Arkansas professor Tomas Jandik.

Jandik conducted his study of 39 family-owned firms along with Thomas Bates of the University of Western Ontario and Kenneth Lehn of the University of Pittsburgh. He presented their findings recently at the national meeting of the Financial Management Association International.

Their work is one of the first to look at executive compensation in family-owned firms. Although they are the dominant form of business organization in the world, family-owned firms have received very little analysis. This research included family-owned companies such as Dillard’s, Ethyl, Comcast, Nordstrom, Smucker, Tecumseh, Werner, Playboy and the Washington Post.

The researchers looked at large publicly traded firms where a single family owned controlling interest and a child succeeded a parent as president, chief executive officer or chairman. They paired these companies with a control sample of firms matched on size and industry to study incentives for top management.

"Family firms are the predominant form of business organization throughout the world," said Jandik, "but little is known about the types of incentive problems these firms face or how they are resolved."

An initial review of compensation found that the difference in total compensation between top managers and their direct subordinates was significantly less in family-owned firms. Further investigation revealed that this was due to lower compensation for top managers.

Among the firms studied, top managers in family-owned firms averaged $508,555 in total compensation, compared with $752,090 for nonfamily firms. However, at $289, 433, the average total compensation for lower-level managers in family firms is also lower than the $444,231 for those in the control group.

"It is widely accepted as fact that higher salaries stimulate managers to work more efficiently," said Jandik. "But it is not only your own salary that motivates you to work harder - it’s that of your superior as well. A high compensation of one’s boss can be considered a 'prize’ that makes lower managers strive for promotion."

This presents "a potentially thorny incentive problem," according to Jandik. The compensation of lower managers in family firms is smaller, yet they also have much less to gain if they are promoted. How can family firms retain top managers when a child succeeds a parent in the top position?

This is further complicated because usually there is no "fight for promotion" in family firms - the company’s management is transferred from parent to child. In addition, the typically young age of the succeeding children means they will probably hold the position longer than in a firm with more diffuse ownership. Among the 39 family-owned firms studied, ages of top executives ranged from 30 to 52 and the median age was 38. However, in the control group the median age of a new top manager was 55.

"Many of our findings regarding promotion incentives may be extended to the more general case of firms run by young CEOs or CEOs with voting control over the firm," said Jandik. "A good example of this would be some large e-commerce firms with young CEOs and concentrated ownership."

Family-owned firms were far less likely to use stock options as compensation for top managers. However, in some firms, dual classes of common stock are issued. Although both classes of stockholder share in the firm’s profits and losses, one class has voting rights and the other has low or no voting rights. In companies with dual classes of common stock, low-voting stock served as an important compensation device for top managers.

"It means that families are reluctant to dilute their ownership blocks by granting options to non-family members," explained Jandik.

Because family-owned firms rely less on promotion or stock options for incentives, the researchers expected that cash bonuses might be a significant form of incentive. However, they found that the difference in reliance on bonuses was not significant.

"These results suggest that family firms do not substitute a greater reliance on use of performance-based cast bonuses for dampened promotion incentives," Jandik said. "The way in which family firms resolve their incentive problems remains puzzling to a large degree."

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