Compensation should never be based on need – Part 2

By Prof. Enrique Soriano

“There is no longer any justification for the parent/owner to give low salaries based on the rationale that the children will eventually take over the business. This major disconnect between having a formal compensation system that the next generation family member deserves and the parent/owner’s expectations of pay based on individual child’s needs must be resolved immediately. “

A family enterprise can be described as a complicated interaction between three conjoined systems—each system, namely the family, the business, and the ownership system, has distinct characteristics yet is inextricably linked. As conjoined as it may seem, the three systems have different sets of brains but interconnected emotions reinforced with different rules. Graphically, they all intersect at various stages of the family business cycle and conflicts often arise due to overlapping roles. One of the most common sources of conflict is family compensation, specifically the salaries of family members, especially the next generation.

Compensation can be a major source of conflict in family businesses. It is not only a contentious and complex issue but also a forbidden subject during family meetings. Because of its sensitive nature, business owners typically set aside or stall just to enjoy temporary peace. But the longer this subject remains unresolved, the more the danger of witnessing disputes between family members will become imminent and unavoidable. The Managing Director of Pearl Meyer & Partners, David Seitz, highlights a potential red flag when there is an absence of a total compensation strategy, “Family companies often lack a cohesive compensation strategy covering all elements of executive pay: base salary, annual incentive, long-term incentives, and benefits/perquisites. The company leaders may not understand how all of the elements of pay fit together as well as the trade-offs between various elements. Further, while family culture can be a significant competitive advantage, there is a downside to the culture as well. At the extreme, the family company may find itself leaning too much on the culture and goodwill of executives, believing that loyal, long-tenured executives are less concerned about compensation. In some cases, the owners erroneously believe that company culture offsets any competitive shortfalls in compensation.”

On top of the issues pointed out by Seitz is the inherent nature of founders and business leaders being too frugal. Despite the growth of the family wealth, instinctively, the mindset of survival will always prevail. Time and again, business leaders would amplify this narrative to rationalize the low pay, “During my time, when the business was still in the startup phase, compensation was never an issue. I struggled and had to muster everything I’ve got without expecting anything in return just to survive another day.” This parent/founder mindset is carried over to the offspring to leverage their past sacrifices and highlight the series of events to dramatize and reinforce the same as part of the child’s sense of duty to hold on to the torch without expecting anything in return. The interesting survival story is noble, but correlating the anecdote so the child will acquiesce to a lower than industry pay is no longer acceptable.

In my work, I would encourage the family to pursue and embrace a formal compensation model complete with milestones and get everyone, especially the leader, to commit to the change. The plan should include the compensation objectives, pay structure, incentive schemes, performance expectations, and payout periods. It should make the adult children mindful that their compensation is directly correlated to the overall performance of the firm. To lessen the load of the leader, it is highly recommended that a dedicated sub-unit (an ad hoc) or a compensation committee be mandated to formulate the details, including the implementation and monitoring of the plan.