CEO Compensation in Private Family Firms Pay-for-Performance and the Moderating Role of Ownership and Management

Abstract

Although classical agency theorists claim that pay-for-performance is not relevant in the context of private family firms, the authors provide empirical evidence of the opposite, using a sample of 529 privately held U.S. family firms. The results suggest that objective performance-based measures play a significant role in CEO compensation. Additionally, the authors find that in private family firms CEO compensation is more responsive to firm performance in firms with low ownership dispersion and in the controlling-owner stage. Furthermore, the positive pay-for-performance relation is slightly stronger for nonfamily CEOs than for family CEOs.

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Family Business Review
XX(X) 1 –21
© The Author(s) 2012
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DOI: 10.1177/0894486512454731
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Introduction
In the past 20 years, CEO compensation is one of the
corporate governance topics that has initiated a lot of
public controversy (Denis, 2001). One of the prominent
research questions in this area is whether firm perfor-
mance has an effect on CEO compensation (Barkema &
Gomez-Mejia, 1998). Theoretical arguments for the pay-
for-performance debate are principally grounded in
agency theory. Agency theory assumes all individuals to
be rational, risk adverse, and inclined to take actions that
maximize their personal welfare with minimal effort
(Gomez-Mejia & Wiseman, 1997; Jensen & Meckling,
1976). As such, to motivate CEOs to act in the best inter-
est of the shareholders, one of the possible actions is to
make CEO pay dependent on firm performance (Murphy,
1986).
Most empirical research on pay-for-performance has
focused on large, public firms (for reviews, see Devers,
Cannella, Reilly, & Yoder, 2007; Gomez-Mejia, 1994;
Tosi, Werner, Katz, & Gomez-Mejia, 2000). Other forms
of organizations, such as small privately held family
firms, have often been overlooked because it is assumed
that pay-for-performance is not relevant because of the
absence of separation between ownership and control
and thus the absence of agency costs. However, recent
literature argues that concentrated (family) ownership
and owner-management can also be associated with sub-
stantial agency costs, which are mainly engendered by
altruism and self-control problems (Lubatkin, Schulze,
Ling, & Dino, 2005; Schulze, Lubatkin, & Dino, 2003b;
Schulze, Lubatkin, Dino, & Buchholtz, 2001). Therefore,
1Hasselt University, Research Center KIZOK, Agoralaan
2University of Antwerp, Belgium
3Research Foundation Flanders, Brussels, Belgium
Corresponding Author:
Wim Voordeckers, Hasselt University, Agoralaan—Building D,
Diepenbeek, B-3590, Belgium
Email: wim.voordeckers@uhasselt.be
CEO Compensation in Private Family
Firms: Pay-for-Performance and
the Moderating Role of Ownership
and Management
Anneleen Michiels1, Wim Voordeckers1, Nadine Lybaert1,2
and Tensie Steijvers1,3
Abstract
Although classical agency theorists claim that pay-for-performance is not relevant in the context of private family
firms, the authors provide empirical evidence of the opposite, using a sample of 529 privately held U.S. family
firms. The results suggest that objective performance-based measures play a significant role in CEO compensation.
Additionally, the authors find that in private family firms CEO compensation is more responsive to firm performance
in firms with low ownership dispersion and in the controlling-owner stage. Furthermore, the positive pay-for-
performance relation is slightly stronger for nonfamily CEOs than for family CEOs.
Keywords
family firm, CEO compensation, pay-for-performance, agency costs
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2 Family Business Review XX(X)
we argue in this article that the pay-for-performance
relationship is relevant in private family firms because
the complex agency relations make them benefit from
performance-related pay. Moreover, several surveys
(Chrisman, Chua, Kellermanns, & Chang, 2007; Schulze
et al., 2001; Welles, 1995) reveal that, in practice, the
majority of privately held family firms does indeed offer
performance-based pay to their managers.
The scant amount of evidence on pay in private (fam-
ily) firms finds inconsistent results (Banghøj, Gabrielsen,
Petersen, & Plenborg, 2010; Barkema & Pennings, 1998;
Cole & Mehran, 2010; Cooley, 1979; Ke, Petroni, &
Safieddine, 1999; Schulze et al., 2001). One potential
explanation for these mixed results could be provided
by the fact that these studies do not examine the
effects of potential moderating variables on the pay-
for-performance relation. As private family firms can-
not be treated as a homogeneous group (Habbershon,
Williams, & MacMillan, 2003; Westhead & Howorth,
2007), the nature and level of agency costs may vary
across different types of private family firms. Therefore,
the objective of this study is to examine how (and to
what extent) the pay-for-performance relation is moder-
ated by the ownership and management structures.
Private family firms are an interesting case to study,
because they have some characteristics that deviate from
large, publicly traded firms that may be reflected in the
design of pay contracts. First, owners in privately held
family firms are likely to have different incentives and
possibilities to monitor the CEO (Fama & Jensen, 1983)
because of the high level of ownership concentration.
Second, compensation policy poses one of the most
complex1 and sensitive problems family firms face
(Aronoff & Ward, 1993) because of family consider-
ations such as family history, expectations, and sibling
rivalries (Coleman & Carsky, 1999; Nuno Pereira &
Paulo Esperança, 2008). Third, because private firms
are insulated from regulatory pressures to disclose CEO
pay, they tend to use less sophisticated2 CEO compensa-
tion plans (Bebchuk & Fried, 2003; Bitler, Moskowitz,
& Vissing-Jorgensen, 2005).
Our hypotheses are tested using a cross-sectional
sample of 529 private family firms (C-Corporations),
gathered by the 2003 Survey of Small Business Finance
(hereafter SSBF).
The results suggest that in these firms, objective
performance-based measures play a significant role in
CEO compensation. Additionally, we find that a
CEO’s compensation is more responsive to firm per-
formance in firms with low ownership dispersion and
in the controlling-owner stage. Furthermore, the posi-
tive pay-for-performance relation is slightly stronger
for nonfamily CEOs than for family CEOs. Therefore,
our findings suggest that private family firms cannot be
considered as a homogeneous group when studying
CEO compensation.
As such, our article contributes to the literature in
several ways. First, although traditional agency theorists
claim the pay-for-performance relation to be irrelevant in
the context of private family firms, we provide empirical
evidence that suggests the opposite. Second, we respond
to recent calls to investigate the conditions or characteris-
tics under which performance determines executive com-
pensation (Chrisman et al., 2007; Finkelstein, Hambrick,
& Cannella, 2009) by taking into account ownership and
management characteristics of the private family firm.
Third, although previous studies used samples of both
family and nonfamily firms (Banghøj et al., 2010;
McConaughy, 2000), or both private and public firms (Ke
et al., 1999), we focus on privately held family-owned
firms. This focus on private family firms should reveal
more clearly the differences within this group of family
firms. Fourth, existing literature on executive pay in pri-
vately held family firms is scarce, because data has gener-
ally not been accessible (Ke et al., 1999; Wasserman,
2006). In 2003, the Federal Reserve Board released its
SSBF, which collected data from a sample of U.S.-based
private firms. The survey provides compensation infor-
mation on a group of firms, which are all 100% family-
owned, which is exactly the case where classical agency
theorists expect no agency costs. The database also
enables us to test the pay-for-performance relationship
in firms with a wide range of ownership and manage-
ment structures. Finally, from a methodological point of
view, our findings are an excellent illustration of the
importance of the calculation of marginal effects for the
interpretation of interaction models as our results show
that it is indeed possible that these effects are significant
for relevant values of the moderating variable, even if
the coefficient of the interaction term is nonsignificant
(Brambor, Clark, & Golder, 2006; Kam & Franzese,
2007).
The article proceeds as follows. In the next section,
we discuss the pay-for-performance relationship theo-
retically and derive testable hypotheses. We then test
these hypotheses using our sample of 529 privately
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Michiels et al. 3
held U.S. family firms. The results and conclusions
follow.
Theory Development and
Hypotheses
Agency Theory on CEO Compensation:
The Optimal Contracting Perspective
Agency theory is the theoretical framework that is most
frequently used to characterize CEO compensation
(Devers et al., 2007). This theory focuses on the con-
flict of interest that arises from the separation of own-
ership and control (Berle & Means, 1991), often
referred to as Agency Problem I. This conflict arises
because agency theory assumes all individuals (both
agents and principals) to be rational, risk adverse, and
inclined to take actions that maximize their personal
welfare (Jensen & Meckling, 1976). As a result of this
conflict of interest between managers (agents) and
shareholders (principals), agency costs can arise
(Jensen & Meckling, 1976). CEOs, as being agents, are
thus also assumed to be entirely driven by self-interest
and motivated primarily by financial incentives
(Lubatkin, Durand, & Ling, 2007). This raises the pos-
sibility for opportunistic actions by the CEO because
she/he might pursue a self-serving agenda, which does
not necessarily include the same objectives as those of
the shareholders. For example, a CEO might undertake
aggressive mergers and acquisitions, with modest or
even negative returns to the shareholders, just for
increasing the size of the firm and, as a result, increas-
ing the level of CEO pay (Kroll, Simmons, & Wright,
1990). When this incongruence of objectives occurs,
shareholders will have to find a way to reduce the pos-
sibility of opportunistic actions undertaken by the
CEO. As such, to motivate CEOs to act in the best
interest of the shareholders, agency theory claims that
CEO pay should (partly) depend on firm performance
(Murphy, 1986). An “optimal contract” will therefore
tie the CEO’s expected utility to shareholder’s wealth
by depending on verifiable performance benchmarks
(Jensen & Murphy, 1990; Ross, 1973). As a result, this
optimal contract can reduce Agency Problem I because
it encourages CEOs to act on behalf of the shareholders
(Conyon, 2006; Setia-Atmaja, Tanewski, & Skully,
2009) and thus aligns the incentives of both parties. In
other words, agency theory considers performance-
dependent CEO pay as a tool to alleviate agency prob-
lems stemming from the separation between ownership
and control.
As discussed above, agency theory claims that pay-
for-performance contracts are needed to reduce the
agency costs resulting from the owner–manager agency
conflict. These owner–manager agency conflicts are
considered to be prevalent in private family firms when
ownership and control are separated, that is, when a non-
family CEO (without ownership) leads the firm. But the
question remains whether there also exist agency prob-
lems when ownership and control are coupled (when a
family owner-manager leads the firm) in the context of
private family firms. There are two opposing views
regarding this question.
According to classical agency theorists, Agency
Problem I is not a major problem in private family firms
because family involvement in both ownership and
management should align the interests of owners and
managers (Fama & Jensen, 1983). The effects of concen-
trated ownership and owner-management will lead to a
minimized, or even zero, level of agency costs (Ang, Cole,
& Lin, 2000; Jensen & Meckling, 1976). Several authors
(R. C. Anderson, Mansi, & Reeb, 2003; Ang et al., 2000;
Fama & Jensen, 1983; Jensen & Meckling, 1976) argue
that family firms are the most efficient form of organiza-
tional governance, because the concentrated ownership
that characterizes private family firms implies several
agency benefits.
Possible acts of self-interest will be tempered by kin-
ship and by altruism (Schulze, Lubatkin, & Dino,
2003a). Kinship tempers the acts of self-interest with
feelings of loyalty and commitment to the firm and the
family (Schulze et al., 2003a). Altruism reduces infor-
mation asymmetry (the basis of many agency problems)
by increasing the cooperation and communication
within the family firm (“the bright side of altruism;”
Daily & Dollinger, 1992). Additionally, several studies
(e.g., Karra, Tracey, & Phillips, 2006; Lubatkin et al.,
2005) suggest that altruism especially reduces agency
costs in the early stages of family business. Thus,
although family members might be self-interested, this
does not mean that they are selfish because feelings of
altruism will motivate the family agent to work in the best
interest of the owners (Fiegener, 2010) and other family
members. The interdependence among family agents is
an important agency benefit as well because their welfare
is directly linked to firm performance through their
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4 Family Business Review XX(X)
employment (Schulze et al., 2003b). These benefits,
together with family ties, loyalty, and stability, can be
effective in lengthening the horizons of decision making
and in providing incentives for efficient investments in
family firms (James, 1999). Especially privately held
family firms are expected to have a long-term perspec-
tive since they are not “haunted by quarterly results” and
do not have to worry about hostile takeovers (Devries,
1993). In sum, family control is a potential agency cost-
reducing mechanism in itself.
This minimum (or absence) of agency costs will
imply that performance-based pay is not needed in pri-
vately held family firms, as the main goal of pay-for-
performance is to reduce the firm’s agency costs.
Moreover, shareholders in private family firms have both
the incentive (high ownership concentration) and the
opportunity (better access to the CEO) to monitor the
CEO more closely than public firm shareholders (Fama
& Jensen, 1983). This may further reduce the need to
make CEO pay dependent on firm performance.
In the last decennium, however, literature argues that
private family firms are anything but immune to agency
problems (Burkart, Panunzi, & Shleifer, 2003; Lubatkin
et al., 2005; Schulze et al., 2003b; Schulze et al., 2001;
Sharma, 2004). These studies focus on the negative
effects of concentrated (family) ownership and owner-
management. The agency costs in private family firms
are primarily engendered by altruism and self-control
problems. Although altruism may be an advantage of
family ownership, it does not make a perfect agent of a
manager (Jensen, 1994). Lubatkin et al. (2005) state that
parental altruism, combined with private ownership and
owner-management, negatively influences the ability of
the owner-manager to exercise self-control. Indeed, fam-
ily logic often overrides business reason (Devries, 1993)
because families have noneconomic goals as well (Karra
et al., 2006). Altruism can thus engender agency costs
generated by, for example, moral hazard, which
includes free riding, shirking, or consuming perquisites
(Karra et al., 2006); by adverse selection in the labor
market, for example, by hiring family members with
insufficient qualifications (Chrisman, Chua, & Litz,
2004); or by hold-up, when owner-managers use their
power to force agents to accept changes that are not in
their best interest (Lubatkin et al., 2005). For example, a
CEO’s altruistic efforts to improve the welfare of his or
her relatives via involvement in the family firm can also
be considered as an expression of self-interest that may
counter the economic interests of the (other) family
owners (Fiegener, 2010). Moreover, the emotions asso-
ciated with family ties may reduce the monitoring effec-
tiveness in family firms as the family status of executives
will distort the judgments on the appropriateness of their
actions and decisions (Gomez-Mejia, Nunez-Nickel, &
Gutierrez, 2001). As such, not only nonfamily managers
but also family executives may behave as agents in pri-
vate family firms (Chrisman et al., 2007).
Whereas traditional agency theorists would argue
that family agents in private family firms do not need
performance-based pay because they do not face any (or
very little) agency costs (Jensen & Meckling, 1976),
recent theory and evidence thus states that private fam-
ily firms do face agency costs but of a different kind
(Lubatkin et al., 2005; Schulze et al., 2003b; Schulze
et al., 2001; Sharma, 2004). For example, parental altru-
ism makes it very difficult for family agents to take the
necessary disciplining actions in reaction to potential
free riding behavior of other family members. A possi-
ble solution to this kind of agency problems is “to tie a
portion of the family agent’s wage to outcomes that can
be effectively monitored, such as firm performance”
(Schulze et al., 2001, p. 103). Performance-based pay to
family agents then serves a double purpose: (a) it eases
the risk of moral hazard behavior of these family agents
and (b) it reduces the probability that the agent will take
altruistic, noneconomic efforts that threaten his or her
own welfare as well as those around him or her (Schulze
et al., 2001). Consequently, following Schulze et al.
(2001), we posit that pay-for-performance is an important
instrument to mitigate different kinds of agency problems
in private family firms, not only when ownership and
control are separated but also when ownership and con-
trol are coupled. Therefore, we postulate the following:
Hypothesis 1: Firm performance is positively
related to CEO compensation in privately held
family firms.
The Moderating Role of Ownership
and Management on the Pay-for-
Performance Relation
Previous empirical studies on the influence of firm
performance on managerial pay in private (family)
firms provide inconsistent results. On the one hand,
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Michiels et al. 5
some authors find evidence supporting optimal con-
tracting theory, in that firm performance has a sub-
stantial effect on managerial salary (Cooley, 1979) or
bonus (Barkema & Pennings, 1998). For instance,
Schulze et al. (2001) find that a large percentage of
the private family firms in their sample offer pay
incentives (in the form of cash bonuses) to their
agents. Other findings are in contrast to predictions of
this theory and find no relation whatsoever between
firm performance and CEO pay (Banghøj et al., 2010;
Ke et al., 1999).
However, these studies typically do not take into
account the heterogeneity of family firms (with the
exception of Schulze et al., 2001, who differentiate
between family and nonfamily agents). Yet research
has highlighted that (private) family firms may have
various goals, resources, and needs (Habbershon et al.,
2003) as well as diverse ownership and management
structures (Chrisman, Chua, & Sharma, 2005; Westhead
& Howorth, 2007). As a result, there seems to be a
growing consensus that private family firms should be
treated as a heterogeneous entity. According to
Finkelstein et al. (2009), it is therefore much more
productive to investigate the conditions or character-
istics under which performance affects compensation.
Filatotchev and Allcock (2010) confirm this view by
mentioning that there is too little attention to the dis-
tinct contexts in which firms are embedded. Evidence
from meta-analyses by Tosi et al. (2000) and van Essen
et al. (in press) indicate that moderator variables may
affect the relationship between performance and total
pay.
Since private family firms cannot be seen as a homo-
geneous group, they will not all face the same type and
amount of agency costs. As a result, we must acknowl-
edge this heterogeneity when investigating CEO pay-for-
performance in private family firms. After all, the need
and impact of performance-related pay will be contingent
on the amount and type of agency costs. We distinguish
several types of family firms, based on different owner-
ship and management structures, in order to take into
account this heterogeneity (Figure 1). Hence, we examine
whether the pay-for-performance relation depends (a) on
the ownership structure (Balkin & Gomez-Mejia, 1990;
Lawler, 1981; Lubatkin et al., 2005), (b) on the genera-
tional stage of the firm (Gersick, Davis, Hampton, &
Lansberg, 1997; Lubatkin et al., 2005), and (3) on
whether the CEO is a family member or not
(Gomez-Mejia, Larraza-Kintana, & Makri, 2003;
McConaughy, 2000). With this subdivision, we also
respond to a call of Chrisman et al. (2007) for further
research that investigates whether the pay-for-perfor-
mance relation in private family firms depends on the
level and types of family involvement.
Ownership dispersion has a different effect on (a) the
“traditional” agency costs related with diverging inter-
ests between the controlling owner and other owners
and (b) agency costs associated with self-control and
parental altruism. When there is a sole owner, the former
agency costs are expected to be minimal whereas the
latter could be significant. When ownership slightly dis-
perses, that is, when the family owner is being accompa-
nied by some owners of the same nuclear family, the net
outcome of these two agency effects does not materially
change: The probability of agency problems of self-control
and parental altruism remains significant and the risk of
agency problems of diverging conflicts of interest
remains rather minimal. But as ownership further dis-
perses, many of the altruistic features that characterize a
private family firm including its “dark agency effects”
will gradually disappear (Lubatkin et al., 2005). As
such, ownership dispersion is expected to decrease
agency costs related with parental altruism. However,
this decreasing effect in agency costs may be weakened
by potential emerging conflicts of interest between con-
trolling owners and minority shareholders. Indeed, fur-
ther ownership dispersion beyond the nuclear family
could change the nature of altruism (Lubatkin et al.,
2005) and may drive a wedge between controlling own-
ers and other family owners (Schulze et al., 2003a).
Furthermore, as the number of owners increases, the
existence of passive family shareholders becomes more
likely (Jaffe & Lane, 2004). Consequently, conflicts of
interest between controlling owners and these passive
Firm performance CEO compensaon
Ownership structure Generaonal stage CEO family status
OWNERSHIP AND MANAGEMENT CONFIGURATIONS
H1
H2 H3 H4
Figure 1. Research design
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6 Family Business Review XX(X)
family shareholders could arise (Miller & Le Breton-
Miller, 2006).
We argue that, contrary to agency problems of self-
control and parental altruism (e.g., hiring incompetent
relatives, allowing free riding), the potential owner–
owner agency conflicts could be easily dealt with by
family governance (e.g., family council) and corporate
governance mechanisms (e.g., controlling board of
directors with family shareholders represented).
However, pay-for-performance could be used to solve
agency problems related to parental altruism and self-
control. Therefore, we propose that ownership disper-
sion will have a diminishing effect on agency costs
related to parental altruism and self-control in privately
held family firms. Therefore, we posit that performance-
based pay is a more important instrument when agency
costs associated with self-control and parental altru-
ism are highest in private family firms, that is, when
family ownership is more concentrated. Or, stated
otherwise:
Hypothesis 2: Ownership dispersion will mod-
erate the relationship between firm perfor-
mance and CEO compensation in such a way
that firm performance will have a less positive
effect on CEO compensation when ownership
disperses.
Although the former hypothesis focuses on the
division of ownership, no matter what stage the firm is
situated in, ownership dispersion is often assumed to
be entangled with the generational stage. Gersick et al.
(1997) distinguish three broad stages of ownership
across generations: (a) the controlling-owner stage in
which the founder also exercises control rights, (b) a
sibling partnership in which ownership is in hands of
several members of a single generation, and (c) a
cousin consortium in which ownership is further frac-
tionalized when it is passed on to third and later
generations.
As a consequence of parental altruism, the controlling-
owner stage may suffer from potential moral hazard and
free riding behavior of family members on the controlling
owner’s equity (Schulze et al., 2003b). Although sibling
partnerships are not immune for this kind of agency
problems, more extended sibling partnerships are
expected to anticipate the dysfunctional effects of altru-
ism (Lubatkin et al., 2005). We expect that these
dysfunctional effects will further disappear in the cousin
consortium stage because more outside family members
(not employed by the firm) become shareholders (Jaffe &
Lane, 2004) and, hence, behave more as rational diversi-
fied investors (Schulze et al., 2003a). Moreover, many of
the altruistic attributes, which make family firms theo-
retically distinct, will disappear during the cousin con-
sortium stage. Hence, and in line with the previous
hypothesis, we posit that since agency costs associated
with self-control and parental altruism will be higher in
the controlling-owner stage than in later generational
stages (sibling partnership and cousin consortium
stage), we expect the relation between firm perfor-
mance and CEO compensation to be stronger in the
controlling-owner stage than in later generational stages.
Or, stated differently:
Hypothesis 3: Generational stage will moderate
the relationship between firm performance
and CEO compensation in such a way that
firm performance will have a less positive
effect on CEO compensation in later gen-
erational stages compared to the controlling-
owner stage.
The relationship between firm performance and CEO
compensation might also depend on the CEO’s relation
with the controlling family, that is, whether the CEO is a
member of the controlling family or a nonfamily CEO.
In case of a family CEO, traditional agency theory pro-
poses that there is no need for performance-based pay
because their interests are aligned to those of the owners
and because their personal wealth is already closely tied
to the value of the firm (Jensen & Meckling, 1976;
Schulze et al., 2003a). This is what McConaughy (2000)
refers to as the “family control incentive alignment
hypothesis”: family CEOs derive superior incentives for
maximizing firm value and therefore have less need for
incentive compensation to align their interests with the
firm than do nonfamily CEOs (Gomez-Mejia et al.,
2003; McConaughy, 2000).
Yet surveys by Schulze et al. (2001) and Chrisman
et al. (2007) reveal that private family firms’ managers
are partly rewarded in the form of cash bonuses. There
are several reasons why this may occur. First, contrary
to traditional agency theory, private family firms do
face significant agency costs associated with altruism
(hold-up, adverse selection) and issues of self-control.
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Michiels et al. 7
Because family CEOs have noneconomic goals as well
(Schulze et al., 2001), they may behave suboptimal in
terms of firm performance. For example, according to
Gomez-Mejia, Haynes, Nunez-Nickel, Jacobson, and
Moyano-Fuentes (2007), family managers are willing
to accept a significant risk to their performance in
order to avoid losses of their socioemotional wealth.
Hence, it is likely that the other family shareholders
will prefer that a portion of the CEO’s salary will be
tied to firm performance in order to reduce the possible
negative effects on firm performance. Second, includ-
ing firm performance in the family CEO’s compensa-
tion contract will give a sign of professional
management and increases the firm’s attractiveness
toward banks, lenders of federal sources, and perhaps
individual investors or private equity funds (Chrisman
et al., 2007; McConaughy, 2000). Finally, even though
family CEOs are likely to have a great deal of wealth
through share ownership compared to their compensa-
tion, performance-based pay might have a sizable
impact on the cash available for them to spend, given
the illiquidity of their shares (McConaughy, 2000).
Therefore, performance-based pay may be a relevant
incentive mechanism for the family CEO.
In case of a nonfamily CEO, significant agency
costs are expected to prevail (Lubatkin et al., 2005).
After all, as a nonfamily CEO generally has no (or very
low) ownership, his personal wealth is not essentially
tied to firm value. The owners of the firm will there-
fore try to ensure that the nonfamily CEO makes effort
to maximize firm value and will therefore reward him
with performance-based compensation (McConaughy,
2000). A possibility to minimize this owner–manager
conflict of interest is thus via an “optimal contract,”
which ties CEO compensation to firm performance
(Jensen & Murphy, 1990). Nonfamily CEOs, as any
other agents, are expected to be risk-averse, and one
might thus expect them not to be keen on performance-
related pay. However, they will have less influence on
the pay-setting process compared with family CEOs
because they are expected to have less power in the
firm and will typically be less entrenched in their posi-
tion (Shleifer & Vishny, 1997). Moreover, nonfamily
CEOs might not necessarily be opposed to receiving
performance-related pay because they typically have a
short-term focus. After all, a nonfamily CEO will not
necessarily stay in the family firm for the rest of his or
her career. Therefore, it is important for him or her to
be able to leave the firm with a successful track record
and thus with results of strong short-term performance
(Block, 2011). Therefore, linking compensation with
short-term firm performance will be in line with their
short-term focus.
In conclusion, both private family firms with a
family CEO as well as those with a nonfamily CEO
have various motives to offer their CEO performance-
based compensation. However, the strength of the
pay-for-performance relationship is not expected to
be similar for both CEO types. While nonfamily
CEOs mainly have a short-term focus, family CEOs
usually have a longer-term focus because family ties,
loyalty, and stability will lengthen their horizon
(James, 1999). As shorter CEO horizons are found to
be related with higher agency costs (Antia, Pantzalis,
& Park, 2010), we expect the relation between short-
term firm performance and CEO compensation to be
weaker for family CEOs, compared with nonfamily
CEOs. Thus,
Hypothesis 4: CEO family versus nonfamily sta-
tus will moderate the relationship between firm
performance and CEO compensation in such
a way that firm performance will have a less
positive effect on CEO compensation for fam-
ily CEOs than for nonfamily CEOs.
Data and Methodology
Sample
This study draws on data of the 2003 SSBF, which is
sponsored by the Federal Reserve Board. This survey
provides detailed information on more than 4,000 pri-
vate, nonfinancial, nonagricultural, small (fewer than
500 employees) businesses in the U.S. economy. The
sample was designed to represent the population of
about five million small privately held U.S. firms in
2003. The SSBF database provides us with the neces-
sary information on family firms, including perfor-
mance, compensation, ownership, and management
characteristics.
We impose several restrictions on the database. We
exclude all firms that do not fit our definition of a private
family firm, being “a non-publicly traded firm which is
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8 Family Business Review XX(X)
exclusively (100%) owned by members of the same fam-
ily (where family refers to spouses, parents/guardians,
brothers, sisters, or close relatives).” Although there
exists a lot of different opinions about what exactly
defines a family firm (Chua, Chrisman, & Sharma, 1999),
this definition suits the purpose of our study. According to
Astrachan, Klein, and Smyrnios (2002), the employed
definition of a family firm should measure what it intends
to measure and assists in providing reliable research
results. By using this definition, we are able to keep our
focus on those firms that are entirely owned by members
of the same nuclear family. As a result, there are no non-
family shareholders who can influence the firm’s com-
pensation policy (e.g., individual investors, venture
capitalists, etc.). This is exactly the case where agency
theory expects agency costs (and thus, the pay-for-
performance relationship) to be irrelevant (Jensen &
Meckling, 1976), which we question. In conclusion,
this definition provides us with the opportunity to test
whether there is a pay-for-performance relationship
and, more specifically, for which specific types of fam-
ily firms there is a pay-for-performance relationship.
Next, we exclude all proprietorships, partnerships, and
S-corporations from our analyses, because we want to
compare firms of similar organizational form3 in order
to avoid possible bias in both the compensation and
performance measures. Thus, our final sample entirely
consists of C-corporations. Finally, we exclude firms
with missing data, because they did not know or
refused to disclose the information needed to obtain
our variables of interest. These restrictions leave us
with a final sample of data on 529 privately held U.S.
family firms.
Research Design
Our baseline hypothesis tests whether CEO compensa-
tion is related to firm performance. A high pay-for-
performance sensitivity in an econometric model means
that total compensation contracts contain high-powered
incentives (e.g., variable pay incentives such as cash
bonuses) and therefore are often called high-powered
total compensation contracts (Li & Srinivasan, 2011).
For example, when all total compensation contracts in a
sample only contain fixed salary, there will be probably
a weak or even no significant relationship between total
compensation and performance. Thus, when a CEO
compensation contract contains a high percentage of
variable pay, there will be a strong statistical relationship
between total compensation and firm performance
(ROA), revealing the existence of high-powered com-
pensation contracts.
The subsequent hypothesis examine whether this
relation is moderated by the ownership and management
characteristics of the firm (number of owners, generational
stage, and CEO family status). Therefore, interaction terms
Owners * ROA, Generation * ROA, and FamilyCEO *
ROA are used to test, respectively, Hypothesis 2 (H2),
Hypothesis 3 (H3), and Hypothesis 4 (H4). This yields
the following four regression models:
ln(CEOcomp) = α + β1 ROA + δ Controls + ε (H1)
ln(CEOcomp) = α + β1 ROA+ β2 Owners +
β3 Owners * ROA +
δ Controls + ε
ln(CEOcomp) = α + β1 ROA+ β2 Generation +
β3 Generation * ROA +
δ Controls + ε
ln(CEOcomp) = α + β1 ROA+ β2 FamilyCEO +
β3 FamilyCEO * ROA +
δ Controls + ε
Although the objective of our study is to investi-
gate the impact of firm performance on CEO com-
pensation, firm performance itself can also be
dependent on CEO compensation. According to
agency theory, a pay-for-performance contract might
also lead to improved firm performance (Thach &
Kidwell, 2009). However, most previous research
only considered the impact of performance on pay,
without considering the simultaneous effect of pay on
performance (M. C. Anderson, Banker, & Ravindran,
2000). Yet ignoring this simultaneous relationship
might cause simple ordinary least squares (OLS)
regressions to lead to biased and inconsistent coeffi-
cients because Xi (the regressor) and ui (the error
term) are correlated and OLS picks up both forwards
and backwards effects (M. C. Anderson et al., 2000;
Bascle, 2008). Simultaneous causality is a form of
endogeneity that is common in accounting and
finance research (Chenhall & Moers, 2007) and can
be adequately addressed by applying instrumental
variable methods (Bascle, 2008). Specifically, instru-
mental variables methods focus on the variations in X
that are uncorrelated with the error term (Bascle,
2008).
(H3)
(H4)
(H2)
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Michiels et al. 9
First, we need to find valid instruments in order to
produce consistent and efficient estimators. That is: the
instruments should be relevant and exogenous (Bascle,
2008). To instrument for “ROA,” we used sales growth
and leverage, following Banghøj et al. (2010). We argue
that sales growth is a good instrument for ROA in pri-
vate family firms, as it is often used as a proxy for firm
performance and positively correlated with ROA
(Maury, 2006; Schulze et al., 2003). Intuitively, it is
very unlikely that a CEO’s present pay can influence the
firm’s past sales growth and therefore we believe this
instrument is valid. We added “leverage” as an instru-
ment because leverage is often indicated to as an impor-
tant determinant of ROA (Campello, 2006; Maury,
2006). Again, we do not expect a CEO’s pay to influ-
ence the firm’s leverage. Second, we performed a
Hausman test (Cruz and Moreira, 2005), which con-
firmed our theoretical predictions that there is indeed an
endogeneity issue with the pay–performance relation (p
value of .008) and thus that our hypotheses should be
tested via an instrumental variables method. To produce
consistent and efficient estimators, instrumental vari-
ables estimation requires that the relevance and exoge-
neity conditions are fulfilled. The results from the 2SLS
regression indicate that our instruments are relevant
(the Kleibergen-Paap LM statistic of 5.18 with a p
value of .07) and exogenous (the Hansen J statistic of
.30 with a p value of .58). Yet the low first-stage
F-statistic (2.85) shows that our instruments have rela-
tively weak explanatory power in the first-stage regres-
sion. 2SLS with weak instruments can suffer from finite
sample bias and thus yield misleading estimates of statis-
tical significance (L. M. Cruz & Moreira, 2005; Hahn &
Hausman, 2003; Murray, 2006). Therefore, we use
Fuller’s modified LIML (Fuller, 1977), which is robust
to weak instruments (Bascle, 2008; Stock & Yogo,
2002).
The next section lists the definitions of the depen-
dent, independent, and control variables that are used in
the present study. A summary is provided in Table 1.
Dependent variable. CEO compensation is described
in the SSBF questionnaire as total CEO compensation.
This measure contains one figure that comprises both
base salary and cash bonuses.4 This dependent variable
is also in line with the majority of previous studies
investigating the pay-for-performance relation (e.g.,
Capezio, Shields, & O’Donnell, 2011; Iyengar, Williams,
& Zampelli, 2005; Ke et al., 1999; Ozkan, 2011; Tosi
et al., 2000). For example, in their meta-analysis of
137 CEO pay studies, Tosi et al. (2000) conclude that
total CEO compensation was used as a dependent vari-
able to measure the pay-for-performance relation when
available. Additionally, the use of total CEO compensa-
tion seems to be fully justified in the particular case of
private family firms since Schulze et al. (2003, p. 478)
define pay incentives as “tied transfers that make a por-
tion of an agent’s pay contingent upon some perfor-
mance objective, usually firm performance.” As explained
in the beginning of this Research Design section, it is
unnecessary to distinguish the portion of pay that may be
incentive based to test the pay-for-performance relation-
ship, as high-powered compensation contracts (contracts
Table 1. Definition of the Variables
CEOcomp Total CEO cash compensation as reported on the IRS Form 1120(A) Line 12, expressed in USD
ROA Return on assets, calculated by income after expenses excluding taxes divided by total assets
Owners The number of shareholders
FamilyCEO Dummy variable, equals one when the CEO is a member of the controlling family, zero otherwise
(nonfamily CEO)
Generation Dummy variable, equals one when the firm can be classified as a firm in a later generational stage, zero
otherwise (controlling-owner firm)
Firm size The total number of employees in the firm
Firm age The number of years since the firm was founded
Industry Seven dummy variables, based on 2-digit SIC codes
Risk Measured by three dummy variables based on the D&B credit risk scores (high credit risk, moderate credit
risk, and low credit risk)
Sites Measured by the number of sites, offices, plants, or stores the firm has
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10 Family Business Review XX(X)
with a significant part of variable pay) will be displayed
by a strong statistical relationship between total CEO
compensation and firm performance (Li & Srinivasan,
2011).
Following Conyon (2006), Ke et al. (1999), and
Cheng and Firth (2006), we take the logarithm of the
CEO compensation variable to reduce the impact
of outliers. Additionally, the log transformation is
the most common way to correct for nonnormality,
especially when the variable has a positive skewness
(Hair, Anderson, Tatham, & Black, 2006), which
is the case for our variable CEO compensation
(CEOcomp).
Independent variables. Firm performance is operation-
alized through the accounting return measure “return on
assets” (ROA, income after expenses excluding taxes
divided by total assets) because the majority of studies
investigating the pay-for-performance relation use ROA
as the measure of firm performance (Banghøj et al.,
2010; Basu, Hwang, Mitsudome, & Weintrop, 2007;
Capezio et al., 2011; Finkelstein & Boyd, 1998; Gomez-
Mejia et al., 2003; He, 2008; Jensen & Murphy, 1990; Ke
et al., 1999; Werner & Tosi, 1995). Using assets in the
denominator makes this measurement less influenced
by poor or outstanding performance than other denomi-
nators such as, for example, sales. This is because sales
tend to decrease (increase) when firms are performing
poorly (outstanding), which will make return on sales an
underestimation (overestimation) of firm performance
(Harris & Helfat, 1997).
Ownership structure is measured by the variable
Owners, which indicates the number of shareholders.
We use the natural logarithm of the number of owners to
account for the nonlinear effect of an increasing number
of owners. We expect that the relationship is stronger at
smaller values of the variable “number of owners,” for
example, increasing the number of owners from 1 owner
to 2 owners is expected to have a stronger effect than
increasing the number of owners from 9 to 10.
Family CEO is operationalized by the dummy vari-
able FamilyCEO, which equals one if the CEO is a mem-
ber of the controlling family and zero if the firm has a
nonfamily CEO. As per definition, family member refers
to spouse, parent/guardian, brother, sister, or close rela-
tive. As the database defines a family firm as a firm that
is exclusively owned by members of one family, nonfa-
mily CEOs thus have no ownership share in the firm.
The generational stage is measured by a variable
indicating whether the family firm was established by
the current ownership, purchased, inherited, or acquired
as a gift. We classify this variable into two groups to
obtain a dummy variable that proxies for Generation.
This dummy equals one for firms that are in a later gen-
erational stage (inherited or acquired as a gift), whereas
the dummy equals zero if the firm can be classified as a
controlling-owner firm (established or purchased by the
current owners).
Control variables. Consistent with prior studies, we
include several control variables in our model to account
for other factors that might affect CEO compensation
(see reviews of Finkelstein et al., 2009; Gomez-Mejia &
Wiseman, 1997; Tosi et al., 2000).
Firm size has proven to be of large impact on CEO
compensation. Results of a meta-analysis by Tosi et al.
(2000) even show that firm size accounts for more than
40% of the variance in total CEO compensation. Larger
firms are assumed to require more talented and costly
management (Rosen, 1982), and thus several authors
document that larger firms pay their executives more
(Baker, Jensen, & Murphy, 1988; Banghøj et al., 2010;
Basu et al., 2007; Gomez-Mejia et al., 2003; Ke et al.,
1999; Young & Tsai, 2008). We use the natural loga-
rithm of the total number of employees (Totemp) as a
proxy for firm size, as this measure is less likely to suf-
fer from collinearity problems than “total sales,” which
is often used in the literature (Brunello, Graziano, &
Parigi, 2001; Ciscel & Carroll, 1980). Analogous to the
studies of Schulze et al. (2003a), Wasserman (2006),
and He (2008), we add a variable that contains informa-
tion on firm age. We take the natural logarithm to reduce
heteroscedasticity concerns (Firmage). To control for
possible industry effects, we add seven dummy vari-
ables based on the firm’s SIC code (mining and con-
struction; manufacturing; transportation and public
utilities; wholesale trade; retail trade; insurance and real
estate; and services). Firms with a high credit risk rank-
ing may be monitored more by financial institutions. As
this may impact the level of their compensation and the
pay-for-performance sensitivity (Brunello et al., 2001),
we include three dummy variables that are based on the
Dun & Bradstreet credit score: high credit risk (score
0-25), moderate credit risk (score 26-75), and low credit
risk (score 76-100).5 We also need to control for the
CEO’s job complexity, as higher managerial talent is
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Michiels et al. 11
required when a firm’s CEO has to make more complex
decisions. According to the managerial talent hypothe-
sis, higher quality management will have higher com-
pensation levels (Finkelstein & Hambrick, 1989;
Rosen, 1982). Additionally, Gomez-Mejia, Tosi, and
Hinkin (1987) note that complexity is a potentially
important omitted variable in their analysis of CEO
compensation. In an attempt to capture additional effects
of a CEO’s job complexity that are not already included
in the variable measuring firm size, we add a variable
Sites that measures the number of sites, offices, plants, or
stores the firm has.
Data Analyses and Discussion
Descriptive Statistics and Correlations
Table 2 shows the descriptive statistics and a Pearson
correlation matrix. Approximately 14% of the firms in
our sample are led by a nonfamily CEO and nearly
86% of the firms are in the controlling-owner stage.
The mean compensation of the CEO in 2003 is
US$175,619. The average firm in our sample has 2.47
owners. Approximately one third of our sample con-
sists of single-owner firms, one third of firms has two
owners, and one third of the firms has three or more
owners. Our sample firms employ on average 40
employees and have an average return on assets of
0.33.
Although the Pearson correlation matrix (Table 2)
shows no high correlations among the variables, we
checked for the possibility of multicollinearity to ensure
that our results are not affected by it. We use the “ivvif”
command in STATA, which reports variance inflation
factors for the second stage of an instrumental variables
method (Roodman, 2005). The maximum value is 1.26,
which is well below the threshold of 10, above which
multicollinearity might be an issue.
Results and Discussion
Table 3 reports Fuller’s LIML estimations for the
impact of firm performance (ROA) on CEO compensa-
tion, moderated by the investigated ownership and
management characteristics. Robust standard errors are
calculated in order to correct for heteroscedasticity. The
coefficient of determination, R2, is not reported because
it has no real meaning in models using instruments and
it can even be misleading (Wooldridge, 2002). Moreira’s
CLR (Moreira, 2003) is considered to be the test of
choice when checking the validity of a Fuller’s LIML
regression, because it gets around the weak instruments
problem by relying on a conditional approach. Contrary
to the other estimators, Moreira’s CLR critical values
used to yield a correct significance level are not con-
stant, but conditioned (Bascle, 2008; Murray, 2006). By
using this approach, it draws correct inferences, inde-
pendent of the strength of the instruments (Andrews,
Moreira, & Stock, 2007; Bascle, 2008). The discrepan-
cies of Moreira’s CLR estimators and those obtained by
Fuller’s LIML are very reasonable, and thus there is no
indication of a finite-sample bias (Yogo, 2004).
Models 2, 3, and 4 in Table 3 report the interaction
models that are used to test the impact of Owners,
Generation, and Family CEO on the pay-for-
performance relationship. Even though the use of
interaction models is quite common in different dis-
ciplines of research (such as in finance and manage-
ment literature), the interpretation of these models
differs in an important way from linear additive mod-
els (Brambor et al., 2006). In an interactive model,
the effect of an independent variable X on the depen-
dent variable Y is not any single constant. The effect
depends on the coefficients (betas) of the indepen-
dent variable X and of the interaction term XZ, as
well as on the value of the moderating variable Z. For
example, the marginal effect of X in the following
interaction model:
Y = β0 + β1X + β2Z + β3XZ + ε
is
∂
∂=+
Y
XZββ
13
.
So the effect of X on Y depends on the value of the
conditioning variable Z. We cannot infer whether X has
a meaningful conditional effect on Y from the magni-
tude and significance of the coefficient on the interac-
tion term. For certain relevant values of Z (the
moderating variable), the marginal effect of X on Y
can be significant even if the coefficient on the inter-
action term is insignificant. Thus, to correctly inter-
pret these combined effects, the relevant elements of
the variance–covariance matrix can be used to
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12 Family Business Review XX(X)
recalculate the standard errors, which are displayed in
Table 4 and represented graphically in the appendix.
By doing so, we obtain insight into these substantively
meaningful marginal effects. For a more detailed tech-
nical explanation on the calculation and use of mar-
ginal effects, we refer to Brambor et al. (2006) and
Kam and Franzese (2007).
All four models in Table 3 strongly support the
positive impact of performance (ROA) on CEO com-
pensation (Hypothesis 1). This stands in stark contrast
with the results of Ke et al. (1999) and Banghøj et al.
(2010), who did not find any significant relationship
between ROA and CEO compensation for their sam-
ple of 43 private U.S. insurance companies and 125
private Danish companies, respectively. It confirms,
however, results of Barkema and Pennings (1998),
who found a strong positive impact of firm profitabil-
ity on executive compensation (more specifically,
bonus) for a sample of 143 Dutch private firms. Our
results, which are based on a large sample that is rep-
resentative for U.S. private family firms, are also in
line with those of Schulze et al. (2001) and Chrisman
et al. (2007), who find that private family firms make
significant use of agency cost control mechanisms,
such as incentive compensation. In sum, contrary to
the predictions of agency theory, which assumes that
the agency costs in private family firms will approach
zero, our results suggest that these firms do use
explicit management compensation contracts with
objective performance-based measurements as a gov-
ernance mechanism.
Model 2 shows the regression results for Hypothesis 2,
which predicts a weaker influence of firm performance
on CEO compensation as ownership becomes more dis-
persed. Therefore, we include the interaction variable
Owners * ROA. To infer whether the number of own-
ers has a meaningful conditional effect on the pay-for-
performance relationship, we look at the marginal
effects and standard errors. We calculate the marginal
effects by taking into account the relevant elements of
the variance–covariance matrix and recalculate the
standard errors as suggested by Brambor et al. (2006).
With respect to Hypothesis 2, we present the results
of the calculation of these marginal effects in Table 4
(Panel A). A graphical representation can be found in
the appendix.
Panel A in Table 4 and the appendix show that the
positive relationship between ROA and CEO
compensation is only significant if the number of
owners varies from 1 to 2. For 3 or more owners, the
moderating effect becomes nonsignificant. We thus
find support for Hypothesis 2, indicating that concen-
trated ownership leads to a stronger pay-for-perfor-
mance relation in private family firms. This result
implies that, indeed, performance-based pay might be
a more important instrument when agency costs asso-
ciated with self-control and parental altruism are high-
est in private family firms (i.e., when family ownership
is more concentrated).
Hypothesis 3, discussing the moderating influence
of the generational stage, is tested using the interaction
variable Generation * ROA. Analogous to the method
used to interpret the results of Hypothesis 2, we inter-
pret the interaction coefficient by looking at the mar-
ginal effects and recalculating the standard errors
(displayed in Table 4 [Panel B] and graphically in the
appendix). Panel B in Table 4 shows that the coeffi-
cient of the controlling-owner stage is positive and
significant. This result reveals, consistent with our
Hypothesis 3, that the positive relationship between
performance and CEO compensation is only present
in the controlling-owner stage. Our findings thus sug-
gest that the higher agency costs associated with
parental altruism in the controlling-owner stage will
be mitigated by using pay-for-performance contracts.
Hypothesis 4 predicts that the positive pay-for-
performance relation will be weaker for family CEOs,
compared with nonfamily CEOs. After recalculating
the standard errors (Table 4 [Panel C], and graphically
represented in the appendix), we can conclude that for
both a family CEO and a nonfamily CEO, firm perfor-
mance has a significant positive effect on CEO com-
pensation. A test of differences of the beta coefficients
in Panel C indicates that these beta coefficients are sig-
nificantly different (p value of .03). Thus, although for
both family and nonfamily CEOs performance has a
significant positive effect on CEO pay, the pay-for-
performance sensitivity for a family CEO is weaker
than for a nonfamily CEO. This is in line with our
Hypothesis 4, which argues that both private family
firms with a family CEO as well as those with a nonfa-
mily CEO have various motives to offer their CEO
performance-based compensation. Our findings thus
support the hypothesis that the effect of firm perfor-
mance on CEO compensation will be less strong for
family CEOs.
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13
Table 2. Summary Data and Pearson Correlations Between CEO Compensation and Determinants
Variable Mean SD 1 2 3 4 5 6 7 8 9 10
1. CEOcomp 175619.50 169662.10
2. ROA 0.33 1.01 0.048
3. Owners 2.47 3.03 0.230*** −0.031
4. FamilyCEO 0.86 0.34 −0.160*** −0.000 −0.235***
5. Generation 0.14 0.35 0.110** −0.052 0.188*** −0.029
6. Firm size 39.56 43.44 0.475*** −0.011 0.268*** −0.121*** 0.183***
7. Firm age 56.30 10.43 0.058 0.028 0.151*** −0.173*** −0.011 0.056
8. Low credit risk 0.43 0.50 0.038 0.014 0.046 0.050 0.091** −0.021 0.123***
9. Moderate credit risk 0.42 0.49 0.002 −0.038 −0.047 0.034 −0.059 0.002 −0.076*
10. High credit risk 0.15 0.35 −0.056 0.033 0.002 −0.118*** −0.045 0.027 −0.066 −0.361*** −0.356***
11. Sites 2.11 3.50 0.179*** −0.001 0.066 −0.032 0.031 0.293*** −0.045 −0.18 0.021 −0.004
Note. N = 529. All amounts are expressed in U.S. dollars. ROA = return on assets.
*, **, ***Correlation is significant at a probability level below .10, .05, or .01 level, respectively (two-tailed).
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14 Family Business Review XX(X)
The control variable firm size has the expected
positive (significant) effect on the level of CEO
compensation. Firm age does not seem to have a sig-
nificant effect on compensation. Firms with high
credit risk pay their CEOs significantly less than
firms with a low credit risk. Additionally, CEOs
working in the transportation, public utilities, and
retail trade industry earn significantly less than their
colleagues in other industries. A CEO’s job complex-
ity has a positive, but insignificant, effect on the com-
pensation he receives.
Summary and Conclusions
This study addresses the effect of firm performance on
CEO compensation in privately held family-controlled
firms. Its central finding is that firm performance is
positively related to CEO compensation in private
family firms. This finding stands in contrast to predic-
tions of traditional agency theory, which claim that
pay-for-performance is irrelevant in the case of private
family firms because of minimal (or zero) agency
costs. Additionally, our study argues that the relation-
ship between firm performance and CEO compensation
is contingent on ownership and management configura-
tions. We distinguish several types of private family
firms, based on their ownership structure and manage-
ment position. We find that the positive relationship
between firm performance and CEO compensation is
only significant if the number of owners is small. This
result implies that performance-based pay is a more impor-
tant instrument when agency costs associated with self-
control and parental altruism are highest in private family
firms, that is, when family ownership is more concen-
trated. In line with this finding, our results also suggest
that the positive relationship between performance and
Table 3. Regression Results: Fuller’s LIML
Model 1 2 3 4
Constant 10.01641*** (0.9060) 10.3015*** (0.9005) 10.6722*** (1.0923) 10.2791*** (0.9474)
Hypotheses
Firm performance
ROA 0.7217** (0.3550) 0.7774* (0.4555) 0.6476** (0.3396) 1.0945** (0.4856)
Ownership dispersion
Ownersa0.2459 (0.1645)
Owners * ROA −0.3514 (0.5908)
Generation
Generation 0.3193 (0.2300)
Generation * ROA −0.9328 (0.9995)
Family vs. nonfamily CEO
FamilyCEO −0.0807 (0.2235)
FamilyCEO * ROA −0.4587 (0.5079)
Controls
Firm sizea0.4940*** (0.0430) 0.4566*** (0.0516) 0.5124*** (0.0463) 0.4819*** (0.0424)
Firm agea0.0156 (0.2257) −0.0538 (0.2256) −0.1532 (0.2734) −0.0209 (0.2261)
High credit riskb−0.3428** (0.1582) −0.3443** (0.1558) −0.4217** (0.1747) −0.3460** (0.1582)
Moderate credit risk −0.0384 (0.1028) −0.03489 (0.0969) −0.0133 (0.1149) −0.0655 (0.1077)
Sites 0.0167 (0.01141) 0.0169 (0.0108) 0.0117 (0.0112) 0.0178* (0.0108)
Industry dummies Ye s Ye s Ye s Ye s
N529 529 458 529
Model F statistic 15.60 15.40 13.26 14.71
Note. ROA = return on assets. Dependent variable = ln(CEOcomp); Heteroskedasticity-robust standard errors in parentheses; N = 529 for the
Models 1, 2 and 4, and N = 458 for the Model 3 (only firms with a family CEO selected to distinguish between founder and descendant CEOs).
a. Natural logarithm.
b. Low risk is the suppressed credit risk category; Moreira’s CLR for ROA in Model 1 = [0.10, 2.04] (p value .032).
*, **, ***Denote significance at a probability level below .10, .05, and .01, respectively (two-tailed).
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Michiels et al. 15
CEO compensation is only present in the controlling-
owner stage. Hence, the agency costs associated with
parental altruism appear to be much lower in the later
generational stages. Finally, we find that both family
firms with a family CEO as well as those with a nonfamily
CEO have various motives to offer their CEO perform ance-
based compensation, but that the pay-for-performance
sensitivity is stronger for nonfamily CEOs.
As such, our study makes an important contribution to
the family business literature. It provides additional evi-
dence that private family firms do indeed face agency
costs, because they seem to use performance-based
compensation for their CEOs. Although our article uses
an agency framework to investigate the compensation
decisions in private family firms, other theoretical mod-
els such as socioemotional wealth or distributive justice
theory may offer some additional explanations for the
use of performance-based incentive pay in family firms
as well. For example, family firms may reward their
family managers with performance-base incentive pay,
because it may also increase the justice perceptions of
the nonfamily managers (Barnett & Kellermanns, 2006).
Additionally, our study also indicates that private family
firms cannot be considered as a homogeneous group
when studying compensation behavior, seen the signifi-
cant moderating effects of ownership and management
characteristics. For management consultants and HR
managers, this study also provides some interesting
implications as there is almost no other research avail-
able on the design of CEO compensation contracts in
private family firms. For example, our study confirms
the need to consider the ownership structure and the
CEO family status of the private family firm, in order to
design a CEO compensation package which is in line
with the type of agency problems the firm faces.
There are a number of limitations associated with this
study that should be acknowledged. First, our data are
cross-sectional, so we cannot examine the factors that
are associated with changes of the pay-for-performance
over time. Next, our compensation measure is limited to
reported CEO cash compensation. In some cases, the
manager may also have earned some deferred or stock-
based compensation. Fortunately, implications from
previous work suggest that this limitation should not be
a significant problem, as family firms place much less
weight on stock-based compensation than do public or
nonfamily firms (Achleitner, Rapp, Schaller, & Wolff,
2010; Park, 2002).
Finally, the results of this study lead to some interest-
ing avenues for future research in this domain. Our
understanding about the effects of ownership and man-
agement characteristics on the relationship between per-
formance and CEO compensation would be enhanced if
they were generalized across different countries. Our
results are quite promising and therefore call for larger
and more detailed research.
Table 4. Moderating Effect of the Number of Owners (Panel A),
Generational Stage (Panel B), and Family CEO (Panel C)
Panel A
Number of Owners ∂y/∂ROAaSD t-Statistic
1 0.7774 0.4555 1.7067**
2 0.5338 0.2015 2.6491***
3 0.3913 0.3138 1.2470
4 0.2903 0.4574 0.6346
6 0.1478 0.6807 0.2171
8 0.0467 0.8445 0.0553
10 −0.0317 0.9731 −0.0326
Panel B
∂y/∂ROAbSD t-Statistic
Controlling-owner stage (0) 0.6476 0.3396 1.9070**
Later generational stage (1) −0.2852 1.0634 −0.2682
Panel C
∂y/∂ROAcSD t-Statistic
Nonfamily CEO (0) 1.0945 0.4856 2.2540***
Family CEO (1) 0.6358 0.3392 1.8747**
Note. N = 529 in Panels A and C; N = 458 in Panel B.
a. ∂y/∂ROA = 0.7774 − 0.3514 × In(Owners).
b. ∂y/∂ROA = 0.6476 − 0.9328 × Generational stage.
c . ∂y/∂ROA = 1.0945 − 0.4587 × Family CEO.
*, **, ***Denote significance at a probability level below .10, .05, and
.01, respectively (one-tailed).
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16 Family Business Review XX(X)
Appendix
Graphical representation of the moderating effects of the number of owners (Graph 1),
generational stage (Graph 2), and family CEO (Graph 3)
Note. *, **, ***denote significance at a probability level below .10, .05, and .01, respectively (two-tailed).
Declaration of Conflicting Interests
The author(s) declared no potential conflicts of inter-
est with respect to the research, authorship, and/or
publication of this article.
Funding
The author(s) received no financial support for the
research, authorship, and/or publication of this article.
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Michiels et al. 17
Notes
1. In the context of private family firms, establishing a
compensation policy is a difficult and sensitive mat-
ter because of the institutional overlap of family and
business, which makes the development of a com-
pensation policy even more complex than it already
is in nonfamily firms. For example, deciding on the
level and type of compensation contract of family
members versus nonfamily members, and within the
group of family members, can be a very sensitive
matter. We refer to Lansberg (1983) and Aronoff and
Ward (1993) for a more elaborate discussion on this
topic.
2. The composition of a CEO’s pay package tends to be
less sophisticated in privately held firms compared
with publicly held firms, for example, because they
generally make no use of stock options or other
sophisticated financial instruments (Bitler et al.,
2005).
3. In contrast with both subchapter S- and C-corporations,
proprietorships and partnerships do not offer limited
liability and easy transferability of ownership inter-
est. We also exclude subchapter S-corporations
because of differences in tax treatment.
4. More specifically, the database contains executive
compensation that is reported on IRS form on Form
1120(A) Line 12 (C-corporations). Additionally, the
IRS requires corporations to include an estimate of
any stock-based compensation as well, and this line
should thus reflect “all” compensation paid to the
CEO (Cavalluzzo & Sankaraguruswamy, 2000).
Our cash compensation measure is thus one figure
that comprises base salary, bonus, and stock-based
compensation.
5. The SSBF database contains six credit risk catego-
ries, based on the Dun & Bradstreet credit score. As
some categories contain few cases, we reestimated
the regressions using four categories (in which we
combined Categories 1 and 2, and 5 and 6) and using
three categories (high-moderate-low). Regardless of
the categorization used (6, 4, or 3 categories), the
results stay the same.
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Michiels et al. 21
Bios
Anneleen Michiels is a PhD candidate at the Research Center
for Entrepreneurship and Innovation (KIZOK) at Hasselt
University in Belgium. Her research interests include executive
compensation, dividends and governance issues in the context
of family-controlled firms.
Wim Voordeckers is a professor of entrepreneurial finance
and governance and director of the Research Center for
Entrepreneurship and Innovation (KIZOK) at Hasselt
University. His primary research interests include financing
constraints, collateral and relationship lending, agency issues,
and board behavior in family firms.
Nadine Lybaert is a professor of accountancy at the Faculty
of Business Economics at Hasselt University and guest profes-
sor at the University of Antwerp in Belgium. She is associated
with the Research Center for Entrepreneurship and Innovation
(KIZOK) at Hasselt University. Her research focuses on the
intersection of accounting topics and family firms.
Tensie Steijvers is a postdoctoral research fellow at Research
Foundation Flanders (FWO) and assistant professor at the
Research Center for Entrepreneurship and Innovation (KIZOK)
at Hasselt University in Belgium. Her primary research inter-
ests include family enterprise research focusing on several
accounting, finance, and corporate governance aspects.
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