Pay for Outsiders: Compensation Incentives for Nonfamily Executives in Family Firms

Abstract

We examine how the unique contracting environment with modified agency conflicts in family firms influences compensation incentives for nonfamily executives. Nonfamily executives receive weaker pay-for-performance incentives as family monitoring reduces the need to use costly performance-based incentives. Family firms offer nonfamily executives weaker risk-taking incentives to protect family’s concentrated wealth and private benefits of control. The CEO-VP pay gap in family firms does not include tournament incentives when there are family vice-presidents as potential heirs and thus, is not related to firm performance in these firms. Nonfamily executives receive higher fixed pay in exchange for a lower upside potential in promotion and pay. Family influence on incentives depends on both the founding family ownership and founding family involvement in management. The effect of family ownership is significantly stronger than that of nonfamily blockholders, which suggests that family influence goes beyond concentrated ownership.