Incentivizing the Owner: Why Family Firms offer Pay-for-performance Contracts to their CEOs

We study the managers’ compensation schemes adopted by publicly listed family firms by means of a theoretical model and an empirical analysis. Existing empirical literature finds puzzling evidence about the structure of family CEOs’ pay, which apparently contradicts the fundamental tenets of principal-agent theory under moral hazard. In particular, family CEOs typically exhibit lower expected pay but higher pay-for-performance sensitivity than external managers, despite their large inside ownership. In a theoretical model, we show that the outcome-related compensation structure of family CEOs reduces the CEO’s incentive to divert value from minority shareholders. We test the main hypotheses on a panel of Italian listed family firms (2000-2017), for which we have collected data on CEOs’ parental ties, cash and equity-based components of CEOs’ pay and internal corporate governance mechanisms. The evidence confirms our theoretical predictions.