Identity in Family Firms: A Theoretical Analysis of Incentives and Contracts.
| Autor | Pagliarussi, Marcelo Sanches |
| Cargo | Report |
Introduction
The seminal works of Schulze, Lubatkin, Dino and Buchholtz (2001) and Gomez-Mejia, Nunez-Nickel and Gutierrez (2001) presented agency conflicts in family firms in a new perspective, and stimulated subsequent research efforts. Currently, it is fairly accepted that family firms are less impacted by problems that arise from the separation of ownership and management (Carney, Van Essen, Gedajlovic, & Heugens, 2015; Chrisman, Kellermanns, Chan, & Liano, 2010; Salvato & Moores, 2010; Songini, Gnan, & Malmi, 2013). Existing empirical evidence appears to support this view both for small (Chrisman, Chua, & Litz, 2004) and large family firms (Anderson & Reeb, 2003; Villalonga & Amit, 2006).
Complementarity, studies on executive compensation in family firms found out that family CEOs' compensation levels are lower and they receive less incentive-based pay in comparison with nonfamily CEOs (Cruz, Gomez-Meija, & Becerra, 2010; Gomez-Mejia, Larraza-Kintana, & Makri, 2003; McConaughy, 2000). The authors articulated distinct rationales to explain their results, such as the incentive alignment effect that results from family control (McConaughy, 2000), or the proposition that family ties shield the CEO's welfare and insulate her from bearing excessive personal risk (Cruz et al., 2010; Gomez-Mejia et al., 2003).
Block, Millan, Roman and Zhou (2015) also observed that family employees received lower wages, compared to regular employees. They articulate utility theory and the theory of compensating wage differentials to sustain that family employees derive utility from working in their own family firm, in complement to wages and nonpecuniary job characteristics. Baek and Fazio (2015) also found out that family firms are less prone to use incentives in agency contracts, especially when the family CEO is paid material dividends. The authors interpreted their results as evidence that family firms do not closely conform to the tenets of agency contracting in compensation, as suggested by Schulze et al. (2001) and Gomez-Mejia et al. (2001).
The precedent discussion suggests that the issue of incentive compensation in family firms merits further investigation, particularly with regard to the differential effects of incentive compensation in these firms, for both family and non-family executives (Prencipe, Bar-Yosef, & Dekker, 2014). Moreover, the existence of competing rationales that explain the same pattern of findings in the literature of executive compensation in family firms stresses the need for a unifying theoretical framework for the phenomenon.
Thus, we aimed at developing a principal-agent model that describes a situation in which a family firm needs to fill a managerial position, and the family principal has the option to choose a family member or an outsider manager. Figure 1 describes the sequence of events used in the model.
We show how the presence of family ties between principal and agent change the optimal incentive contract parameters. We further analyze two interrelated factors that may drive changes in contract parameters: an organizational factor, represented by the degree of altruism in the family firm, and a situational factor, represented by the level of collectivism of the society in which the firm is located. We use altruism as the "the endogenous propensity for parents to transfer predefined socially embedded values and norms to their offspring" (Lubatkin, Durand, & Ling, 2007, p. 1026). Collectivism, in this work, "pertains to societies in which people from birth onwards are integrated into strong, cohesive in-groups, which throughout people's lifetime continue to protect them in exchange for unquestioning loyalty" (Hofstede, 1991, p. 51).
We assume that the principal wants to design a contract with a wage profile that induces the agent to choose a high level of effort. In this situation, our model's main results indicate that family firms that are able to induce higher levels of organizational identification in their agents, by means of altruistic behavior towards family members, will bear lower agency costs in comparison with firms in which altruism is absent. In addition, we show that when the level of identification is positive, both the dispersion in the optimal wage profile and the expected wage associated with the agent's higher effort levels are reduced. Furthermore, in collectivist societies, the wage structure will also have a lower expected value and a lower dispersion across different outputs compared with individualist societies.
The use of formal models to analyze governance and incentives issues in family firms is very scarce, with the notable exceptions of Block (2011), and Berghe and Carchon (2003). The use of agency theory in the domain of family firms is sometimes criticized with the argument that such firms have more complex goal systems, including non-economic objectives besides economic incentives (Astrachan & Jaskiewicz, 2008; Zellweger & Astrachan, 2008). Another critic is that principal-agent models do not account for the behavioral learning effects that arise from repeated social interactions, such as the emergence of trust between the parties (Jaskiewicz & Klein, 2007).
By introducing organizational identification in the principal-agent framework we built a model that can be more generally used in the analysis of executive compensation in family firms, since our model captures the influence of the degree of altruism, trust, emotions and sentiments on the contracts between family principals and managers of the family firm. The inclusion of organizational identification in our model also increases its cross-cultural relevance. Our rationale suggests that organizational identification is affected by the level of collectivism that characterizes a society, both directly and indirectly through the influence of the altruism towards family and nonfamily managers in the family firm.
Therefore, our model is both family firm specific and it fills a gap in the knowledge about how formal and informal institutions at a country level affect behaviors in family firms (Carney et al., 2015; Pindado & Requejo, 2014). In consonance with Whetten (1989), we show that the inclusion of organizational identification in the model significantly alters our understanding of the phenomena of executive compensation in family firms.
Related Literature
Executive pay and incentive compensation in family firms
Economic organizations confront the challenge of coordinating specialized producers in a cooperative way, in order to capture the efficiency gains of specialization (Milgrom & Roberts, 1992). An important part of the challenge arises from the fact that self-interested individuals do not bear the full responsibility of their actions, and thus may not feel motivated to act in accordance with a plan. Studies based on agency theory suggest the use of incentives, linking performance with payment, as a remedy for the problem of motivation.
In the domain of family firms, McConaughy (2000) argued that executives who are members of the controlling family already have greater incentives for maximizing firm value, since they have claims on family resources. Thus, it is expected that family CEOs will demand lower compensation levels than nonfamily CEOs. The author examined CEO compensation in 82 founding-family-controlled firms in which 47 CEOs were members of the founding family and 35 were not, and observed that family CEOs' compensation levels are lower and that they receive less incentive-based pay.
In the same vein, Block et al. (2015) presented evidences suggesting that family employees earn less and exhibit greater job satisfaction than nonfamily employees. The authors interpret their findings as evidence that family employees extract utility from working in their family business, which makes them willing to accept lower wages in exchange for the additional utility.
Similarly, Speckbacher and Wentges (2012) observed that founding family involvement in the top management team is associated with less use of incentive practices. The authors explain that employment relationships between family members are characterized by trust, reciprocal altruism, and shared values, which can serve as a substitute for incentive contracts, since they help to align interests between the parties.
Baek and Fazio (2015) also observed that family firms design agency contracts with less incentive mechanisms for family CEOs, especially when they receive material dividends. Interestingly, the authors offer a distinct rationale to explain their results, suggesting that family firms deviate from the tenets of agency contracting, as suggested by Schulze et al. (2001) and Gomez-Mejia et al. (2001).
Complementarily, Cruz, Gomez-Mejia and Becerra (2010) reasoned that agency relationships in family firms involve parties that are highly interdependent, work closely with each other and are emotionally attached. Consequently, the principal's perception of agents' benevolence will be greater, thus reducing the perceived threat of opportunism. The authors observed, in a sample of 122 Spanish family-owned firms, that when the firm's CEO (as principal) and its top management team (as agents) share family ties, the resulting agency contract contains features that weaken firm protection and strengthen the agent's position.
In sum, issues regarding the level of compensation and the intensity of incentives offered to family managers still constitute interesting research opportunities, since there are several contending explanations for the same pattern of results. In the next section, we present the basic principal-agent model that is widely used in the corporate governance literature to analyze incentive problems in organizations.
Principal-agent models under moral hazard
An agency relationship refers to several types of situations in which an individual legally appoints another individual to act or conduct business on her...
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