Compensating Family Members the Right Way

By Prof. Enrique Soriano

 

Compensating family members is a very sensitive topic and can spark conflict from all angles when handled poorly. It can also cause division among family members and non-family executives. In my experience handling family managed businesses in Asia, I have observed that family members tend to either be under-compensated or overcompensated, and rarely are they aligned with the standard salary scale in the outside market.

In a W+B survey three years ago related to how our founder clients compensated their children, we discovered that family members in six out of the ten family firms were compensated below their market salary grade. We also established that there was a major disconnect between the children’s compensation and the positions they were occupying. And of the six family enterprises where the employees/family members were underpaid, half were receiving a paltry amount. The convenient excuse of the parents/business owners was lame. They justified the low salaries of their offspring on the rationale that the children will eventually take over the business and that all of their expenses were covered (from housing, gasoline, food, tuition of the grandchildren, insurance, personal needs all the way to the provisioning of dog food). Why is this happening?

Without science and guidance from experts, what or how you pay family members in the family business creates a multitude of problems. And the problem is exacerbated by the founders’ wrong notion of fairness and equality. Instinctively, the founding parents would opt to follow the family system where the acceptable norms are that family wealth should be distributed either according to need or according to fair principles. When compensating their children, fairness is generally taken to mean equality in pay and benefits regardless of the children’s contribution. When there is no performance, pay and share in the profits continue. This is what we meant by having two sets of employees: an employee who happens to be a relative devoid of any accountability, and another employee who is expected to perform lest he or she becomes a liability. By pursuing a family system of compensating relatives, unbeknownst to him, the founder or business leader has started to cultivate a culture of entitlement. It is dangerous and the word discomfort may not adequately describe all sorts of tension and stress playing in this volatile environment. And here is where it gets more interesting. When it comes to the business circle, compensation and benefits are totally different. Best practices and human resources policies dictate that compensation is based on certain KPI’s (key performance indicators). If the business does not benefit from your service as an employee — even if you are a family member — you can be fired, demoted, transferred, replaced, and retrained. Simply put, it is pay for performance. For the founder, he is torn between treating his child as an employee and tolerating an adult child branded by the organization as a non-performing family member. Mixing both produces a volatile brew.

Noted family business consultant John Ward and his co-author Craig Aronoff offers a good narrative on why this is happening: compensation problems rarely arise during the family business’ first entrepreneurial stage because the parents remain firmly in control and determine all questions of compensation. But during the second stage (sibling partnership stage), problems develop. The causes are predictable: either the parents haven’t taught their children that salaries must be based on credentials, performance, the market environment and the financial condition of the firm or the children do not appreciate the difference between salary for a job performed and dividends for equity as owners.  When science and objectivity are not factored in crafting compensation policies, confusion and misunderstanding can take a toll on everyone.