originally published by SMS Journals Press Releases

Few topics in organization studies have received as much attention from scholars as CEO compensation. Two key questions are why some CEOs are paid more than others and to what extent is CEO pay sensitive to realized firm performance.

A new study published in the Strategic Management Journal (SMJ) examines whether CEO compensation and its responsiveness to realized firm performance in Indian family firms is influenced by whether the CEO is a professional or drawn from the controlling family. The research was conducted by Guoli Chen and Balagopal Vissa, INSEAD, Singapore, and Raveendra Chittoor, University of Victoria Peter B. Gustavson School of Business.

Their study using data from a sample of 277 publicly listed Indian family firms during 2004-2013 suggests family CEOs get paid more than professional CEOs. This pattern is stronger in superior-performing firms that are named after the controlling family (eponymous firms).  Furthermore, family CEOs’ high compensation is unaffected by poor firm performance and is disproportionately boosted by superior firm performance.

These results suggest that poor corporate governance allows some family-controlled Indian firms to use CEO compensation as a mechanism to tunnel corporate resources in ways that hurt minority shareholders.

Prior research on CEO compensation, set mainly in the United States, has examined a variety of explanatory factors including organizational characteristics such as firm size and performance, CEO characteristics such as political ideology, and human capital situational characteristics such as information processing demand and corporate turnaround contexts, and social comparison processes.

In addition, scholars have extensively examined the effect of corporate governance on CEO compensation, given that publicly listed firms are rife with agency problems between shareholders and managers since ownership is separated from control.  In large publicly listed firms in the United States, widely dispersed ownership coupled with managerial entrenchment create agency problems that result in higher CEO compensation and lower pay sensitivity to realized firm performance.

Prior research — Gomez-Mejia, Larraza-Kintana and Makri (2003) — proposed that the effect of such agency problems on CEO compensation would be reversed in the case of family-controlled firms because of greater alignment of interests between the shareholders and family CEOs. They provide empirical support for their arguments using US data, where family CEOs of family-controlled firms received lower total compensation compared to professional CEOs.

“Despite the advancement of research on this topic we do not know to what extent these conceptual models on CEO compensation design generalize to family firms in emerging economies, which have different formal and informal institutions,” write the authors.  “Indeed, prior scholarship suggests that in emerging economies, wealthy families are typically the largest shareholders and exercise management control over many large, publicly listed firms.

“Scholars have found that principal-principal (P-P) conflicts between controlling and non-controlling shareholders are endemic in these settings because wealthy families may take advantage of their controlling shareholder position to exploit minority shareholders by channeling corporate resources in ways that advantage the controlling family – which scholars refer to as tunneling behavior.  However, we know less about how P-P conflicts might influence CEO compensation in emerging economy firms controlled by families.”

Using a principal-principal agency theory lens, the researchers built a framework on how CEO compensation as well as CEO pay-performance sensitivity in family-controlled firms in emerging economy contexts is regulated by whether the CEO is drawn from the controlling family.  Patterns in CEO compensation data from 277 large Indian family-controlled firms and 395 CEOs comprising 402 unique CEO-firm positions during 2004 to 2013 largely supports their theory that the controlling family’s dominance over the focal firm’s board of directors is reflected in CEO compensation design.

“Family CEOs receive higher compensation than professional CEOs,” write the authors.  “This pay-gap in favor of family CEOs is unaffected by poor firm performance and is disproportionately boosted by superior firm performance. This pattern in the data is consistent with a double standards approach, whereby boards of directors hold family CEOs to a more lenient performance standard compared to their professional counterparts.

“Supplementary analyses on CEO compensation patterns across superior-performing eponymous firms (firms named after the controlling family) versus superior-performing non-eponymous firms lend additional support to our hypothesized mechanism.  Overall, our findings suggest that in some family firms’ CEO compensation practices appear to be pathways for tunneling corporate resources.”

The SMJ is published by the Strategic Management Society (SMS), which is comprised of 3,000 academics, business practitioners, and consultants from 80 countries and focuses on the development and dissemination of insights on the strategic management process, as well as on fostering contacts and interchanges around the world.

Read the full article here: https://onlinelibrary.wiley.com/doi/10.1002/smj.3263