Setting the right mix—Analyzing outside directors’ pay mix in public family firms

Journal of Family Business Strategy 6 (2015) 130–140

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Journal of Family Business Strategy journal homepage: www.elsevier.com/locate/jfbs

Setting the right mix—Analyzing outside directors’ pay mix in public family firms Pascal J. Engel a,*, Andreas Hack b,c,1, Franz W. Kellermanns a,d,2 a

WHU Otto Beisheim School of Management, Burgplatz 2, 56179 Vallendar, Germany Universita¨t Bern—Institut fu¨r Organisation und Personal, Engehaldenstrasse 4, 3012 Bern, Switzerland c Universita¨t Witten/Herdecke—Wittener Institut fu¨r Familienunternehmen, Witten, Germany d Department of Management, University of North Carolina—Charlotte, Charlotte, NC 28223-0001, United States b

A R T I C L E I N F O

A B S T R A C T

Article history: Available online 14 May 2015

Outside directors’ pay mix determines if and to which extent a firm’s designated monitor is incentivized by means of performance related (PR) pay. Owning families of public firms, still having substantial influence on the compensation process, need to balance the family’s genuine interest against PR pay and non-family stakeholders’ contrasting preferences in setting the right mix. At first, family and non-family firms show no difference regarding the adoption of PR pay. However, among PR pay adopters, we find family firms to devote greater shares to this pay component, thus sacrificing part of their socioemotional wealth in order to meet stakeholders’ demand. A differentiation between different types of family firms reveals that especially true family firms, i.e. firms managed or owned by at least two family members, account for this particular behavior. ß 2015 Published by Elsevier Ltd.

Keywords: Corporate governance Family firms Socioemotional wealth Pay mix

Introduction Agency theory is concerned with problems stemming from the separation of ownership and control (Berle & Means, 1932). In the classical setting, agency conflicts occur because information asymmetries exist between shareholders and their managers, who have diverging goals (Jensen & Meckling, 1976; Eisenhardt, 1989). Public family firms, often characterized by a dominant family shareholder, are said to be less exposed to this type of agency problem; however, they are often troubled by agency conflicts among shareholders (Claessens, Djankov, Fan, & Lang, 2002; Morck & Yeung, 2003; Shleifer & Vishny, 1986; Villalonga & Amit, 2006). While it is unclear which agency conflict prevails in family firms, scholars agree that a firm’s outside directors are an effective remedy for both types of conflict (Chrisman, Chua, & Litz, 2004; Fama & Jensen, 1983; Jensen & Meckling, 1976; Villalonga & Amit, 2006). In this regard, outside directors’ primary task is to

* Corresponding author. Tel.: +49 261 6509 0. E-mail addresses: [email protected] (P.J. Engel), [email protected] (A. Hack), [email protected] (F.W. Kellermanns). 1 Tel: +41 0 31 631 8058. 2 Tel: +1 704 687 1421. http://dx.doi.org/10.1016/j.jfbs.2015.04.002 1877-8585/ß 2015 Published by Elsevier Ltd.

advocate for shareholders’ rights and claims by diligently monitoring the firm’s managers (Byrd & Hickman, 1992; Fama, 1980). Outside directors, who are hired to mitigate a firm’s agency conflicts, can exacerbate these conflicts and create a new set of agency problems when they pursue different goals to those of the firm’s shareholders. This scenario is likely due to the importance of non-economic goals for family firms (Chrisman et al., 2004; Go´mez-Mejı´a, Hynes, Nunez-Nickel, & Moyano-Fuentes, 2007; Kumar & Sivaramakrishnan, 2008). This circumstance raises the difficult question: how can we align outside directors’ conduct with shareholders’ interests? As it is difficult to monitor outside directors, scholars frequently rely on incentive compensation and especially the use of performance-related (PR) pay (Kumar & Sivaramakrishnan, 2008; Morck, Shleifer, & Vishny, 1988). The family, either a dominant or powerful shareholder, is likely to have substantial discretion in setting outside directors’ pay mix and to be able to determine the pay mix according to their preferences, which may include a focus on non-economic and long-term goals. These kinds of goals generally contradict the adoption of PR-pay (Chrisman, Chua, Pearson, & Barnett, 2012; Claessens et al., 2002; Gerhart & Milkovich, 1990). However, as public family firms are dependent on the capital market, they might also consider non-family stakeholders’ potentially diverging preferences (e.g.,

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adoption of common business practices, focus on economic goals, short-term orientation) regarding the right pay mix. Thus, public family firms have to balance family shareholder preferences with those of non-family shareholders and other stakeholders to set the right mix of outside director compensation. The extant literature includes few studies analyzing outside directors’ pay mix (e.g., Andreas, Rapp, & Wolff, 2012; Ertugrul & Hegde, 2008; Fich & Shivdasani, 2005; Vafeas, 1999), and studies on the same issue in family firms are nonexistent to the best of our knowledge. This absence is remarkable given the public debates. Moreover, academics have observed, ‘‘in the last years an increasing momentum to understand director compensation as a firm-specific governance instrument to produce effective monitoring structures in the best interest of the company’’ (, p. 73). When we look at the literature on the determinants of pay mix in family firms, we find a similar picture: occasional studies mostly focusing on CEO pay mix (e.g., Block, 2011; Chrisman, Sharma, & Taggar, 2007; Go´mez-Mejı´a, Larraza-Kintana, & Makri, 2003; McConaughy, 2000). Building on existing findings, we combine classical agency theory with the more recently introduced perspective of socioemotional wealth (SEW) to shed light on the determinants of outside directors’ pay mix in public family firms and familial influence on that decision. Specifically, we investigate the tension between pressures of SEW to avoid adopting PR pay and external pressures imposed on the firm to adopt such practices. Based on the heterogeneity debate around family firms (e.g., Chua, Chrisman, Steier, & Rau, 2012), we discuss how different types of firms solve this dilemma. First, we assess differences between family and non-family firms and subsequently break down the group of family firms into lone-founder family firms (LFF) and true family firms (TFF). At first, our results reveal, contrary to our expectations, that there is no fundamental difference between family and non-family firms with regard to their likelihood to adopt PR pay for outside directors. In line with prior research (Go´mez-Mejı´a et al., 2003), we interpret this result as evidence of two counterbalancing tendencies: on one hand, a family’s genuine desire to avoid PR pay, in line with their wealth-preserving, risk-averse attitude, and on the other hand, their propensity to include PR pay to incentivize a more risk-taking attitude and thus to meet shareholders’ demands. However, we find that among PR pay adopters, family firms in general and TFF in particular grant higher shares of PR pay than other firms, although this decision is contrary to their genuine interests. We suggest that these family firms are willing to accept a partial loss of their SEW (by granting higher shares of PR pay) to ensure the support from non-family stakeholders they need because it allows the family to maintain control and continue their pursuit of SEW. Our paper contributes to the family business and compensation literature in several ways. First, we are the first study to investigate the pay mix of outside directors in family firms, thus extending the knowledge about family influence on a specific type of compensation contract design. Second, we contribute to a theory of the family firm (Chrisman, Chua, & Sharma, 2005) by expanding the knowledge around the pursuit of SEW. Specifically, we reveal that not all dimensions of a family’s SEW can be pursued and maximized at all times. Instead, as the pursuit of one dimension might have an adverse effect on other dimensions, we find that family firms are willing to sacrifice part of their SEW to ensure permanent pursuit of the family’s SEW. Third, we provide an empirical data point on outside directors’ pay mix in German public family firms and thus providing a basis of comparison for future empirical studies in other countries. This is important as the legal system could affect compensation policies (Bryan, Nash, & Patel, 2010) and research seems to suggest that there could be a convergence in compensation

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policies across countries (Chizema, 2010)1. Fourth, we provide theoretically derived insights for practitioners with regard to the public perception and potential effects of PR pay adoption and the share of compensation dedicated to this type of pay. Last, we contribute to the debate on family firm heterogeneity (e.g., Chua et al., 2012) by distinguishing between two types of family firms: LFF and TFF.

Theoretical background Outside directors are a powerful mechanism of a firm’s corporate governance (Byrd & Hickman, 1992). On one hand, they monitor executives and offer advice on strategic decisions. On the other hand, they are endowed with the legal authority to decide on executives’ nomination, compensation and potential dismissal (Agarwal, 1981; Byrd & Hickman, 1992; Fama & Jensen, 1983; Weisbach, 1988). Especially for two-tier governance systems, like for example in Germany, outside directors are in contrast to a firm’s executives not entrusted with management. This distinction from a firm’s CEO and management provides outside directors with a degree of independence, enabling them to fulfill their duties without being influenced by the reciprocal dependencies of the managers stemming from their day-to-day business interactions. Thus, outside directors are a vital part of a firm’s checks and balances, established to mitigate its agency problems. Two types of agency problems are of importance to our study: owner–manager and owner–owner agency problems. Stemming from the separation of ownership and management, the first evolves between a manager (agent) and an owner (principal) who delegates some of the firm’s tasks to the former (Berle & Means, 1932; Jensen & Meckling, 1976). If the manager’s goals are not congruent with those of the owner and information asymmetries between these parties exist, the manager’s conduct is likely to undermine the owner’s interests. The second type of agency problem arises from a conflict between different owners, especially between a dominant shareholder and other minority shareholders. When these parties do not share the same goals, existing information asymmetries and a controlling position often enable the dominant shareholder to pursue his goals and to extract private benefits at the expense of the minority shareholders (Shleifer & Vishny, 1997; Villalonga & Amit, 2006). While the owner–manager agency problem can be mitigated by monitoring managers or grant incentive compensation to them, the owner–owner agency problem can only be countered by monitoring the firm’s management, which acts according to the dominant shareholder’s interests. This task is usually carried out by the firm’s outside directors (Cascino, Pugliese, Mussolino, & Sansone, 2010; Chrisman, Kellermanns, Chan, & Liano, 2010; Eisenhardt, 1989; Fama & Jensen, 1983; Jensen & Meckling, 1976).

1 There are two fundamentally different systems how outside directors are embedded into a firm’s corporate governance: a one-tier system and a two-tier system. The one-tier system combines inside and outside directors and their respective tasks under a single board. The one-tier system is applied in the US, the UK and many other important economies around the world. In contrast, the twotier system requires two separate boards, the supervisory board, consisting of outside directors, and the management board, consisting of inside directors. In the two-tier system, the concurrent membership in both boards is legally prohibited. Beyond Germany, the two-tier system has been adopted in a variety of countries such as the Netherlands, Denmark and other central European countries. Conducting a systematic comparison of both systems, Jungmann (2006) concludes that directors are entrusted with a similar set of responsibilities and that both systems, despite existing weaknesses, resemble each other in terms of efficiency. In the same vein, Elston and Goldberg (2003) report that observed conflicts in both systems are quite the same. Due to this high degree of resemblance between the two systems, a systematic distinction seems not to be required in this paper.

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Outside directors who are hired to mitigate these agency problems might, however, also create a set of agency problems. While they should advocate shareholders’ rights and claims through diligent monitoring of the firm’s TMT, thus ensuring an aligned conduct, it is likely that outside directors also have their own agendas (Fama & Jensen, 1983; Kumar & Sivaramakrishnan, 2008). In such cases, the outside director becomes the agent, and an additional layer of the principal-agent problem is created. Thus, although appointed to mitigate agency problems, outside directors might exacerbate them, concurrently creating the need to align their conduct. As directly monitoring the behavior and conduct of outside directors is due to information asymmetries not always feasible, the implementation of incentive contracts to align outside directors’ conduct with shareholders’ interests comes to the fore (Kumar & Sivaramakrishnan, 2008; Morck et al., 1988). Agencybased optimal contracting predicts that based on the outlined relations between shareholders and outside directors, both parties enter negotiations in an attempt to agree on the optimal contract that sets incentives, rewards directors’ monitoring activities and, thus, minimizes agency problems while maximizing shareholders’ wealth (Jensen & Murphy, 1990; Jensen, 1993). The effort and diligence that an outside director puts into his work depends on the compensation he receives for its fulfillment (Brick, Palmon, & Wald, 2006; Linn & Park, 2005). However, there is a distinction between the compensation level and its structure (i.e., the pay mix) with regard to its incentivizing effect. While the compensation level expresses an expectation towards the estimated effort and the shareholders’ appreciation of a given task (Engel, Hack, & Kellermanns, 2013), the PR pay component specifies a direction regarding the effort because it establishes a connection between the task and a specific goal or outcome (Gerhart & Milkovich, 1990). Thus, firms, which usually have substantial discretion in the design of compensation contracts, define their outside directors’ pay mix based on the following general structure of fixed and variable payments (Gerhart & Milkovich, 1990). The annual retainer is a fixed amount of cash granted for outside directors’ regular board service, generally representing the majority of their compensation. The variable pay can be further divided into nonperformance-related and performance-related pay components. Meeting and committee fees are predefined amounts paid for meeting attendance and committee services. While the total amount of this type of payment might vary based on the outside director’s effort, it is non-performance-related in a sense that it is not tied to a specific outcome. The variable performance-related pay component, used to influence the direction of outside directors’ effort, is what we refer to as PR pay and is often linked to financial measures (Block, 2011) (i.e., a bonus payment is triggered by the achievement of an agreed threshold within a stipulated period). On one hand, the compensation literature provides ample evidence that PR pay components in particular are an appropriate and popular remedy for owner–manager agency problems (e.g., Dittmann & Maug, 2007; Jensen & Murphy, 1990; Sanders, 2001; Shleifer & Vishny, 1997), and there are increasing empirical findings that prove its existence with regard to outside director compensation (Elston & Goldberg, 2003; Ertugrul & Hegde, 2008; Fich & Shivdasani, 2005; Linn & Park, 2005). In addition, economic models generally encourage the effective implementation of PR pay components in contracts to increase monitoring incentives and shareholder value (Hermalin & Weisbach, 1998; Maug, 1997; Schondube-Pirchegger & Schondube, 2010). On the other hand, as expressed by Baber, Janakiraman, and Kang (1996; p. 298), the design of ‘‘corporate policies, including the structure of executive compensation, are determined by firm characteristics that govern contracting relationships among parties’’. In this context, scholars

agree that a firm’s idiosyncratic characteristics strongly affect its compensation contract design and, thus, ultimately determine the adoption of PR pay and the share in total compensation that the firm grants to this type of payment (e.g., Carrasco-Hernandez & Sa´nchez-Marı´n, 2007; Linn & Park, 2005). Following this notion, we believe that family firms in particular often exhibit such idiosyncratic characteristics that need to be considered in contract design and that this distinctiveness will consequently manifest in family firms’ choice of the right pay mix. Hypotheses development One of the idiosyncratic characteristics that unites family firms and constitutes a primary difference to non-family firms is their pursuit of non-economic goals (Chrisman et al., 2004; Go´mezMejı´a, Cruz, Berrone, & De Castro, 2011). Since the beginning of family business research, scholars have encountered objectives that differ from those in publicly held organizations and that influence these firms’ corporate behavior and decision making (Astrachan & Jaskiewicz, 2008; Carney, 2005; Chua, Chrisman, & Sharma, 1999; Demsetz & Lehn, 1985; Go´mez-Mejı´a, NunezNickel, & Gutierrez, 2001; Kets de Vries, 1993). One of the most prevailing goals is the aspiration to perpetuate the family business over generations to preserve the family’s heritage, consisting of norms and values as well as social ties and the family’s sense of belonging (Arregle, Hitt, Sirmon, & Very, 2007; Handler, 1990; Kepner, 1983; Sirmon & Hitt, 2003). This desire shifts a family firm’s time horizon and creates a focus on a long-term perspective (Sirmon & Hitt, 2003). Family firms also exhibit a strong desire, stemming from the often close interrelatedness of the family and the business, to establish and maintain a positive image because the firm is seen as an extension of the family (Berrone, Cruz, & Go´mez-Mejı´a, 2012; Sharma & Manikutty, 2005). Go´mez-Mejı´a et al. (2007) subsumed these non-economic goals, which represent a family’s affective needs intermingled with the family’s business, under the perspective of SEW. Moreover, these authors found support for the notion that the preservation of SEW represents a primary reference point for the family, thus underlining the importance of control and suggesting that a family is willing to take greater business risks if their SEW endowment is at risk (Go´mez-Mejı´a et al., 2007; Go´mez-Mejı´a, Makri, & LarrazaKintana, 2010). The adoption of PR pay in compensation generally fails to effectively reduce the agency problem between family owners and managers as far as non-economic goals are concerned, because such pay primarily promotes economic goals2 (Andreas et al., 2012; Block, 2008b; Chrisman et al., 2004; Jensen & Meckling, 1976). The diverse, non-economic goals that family firms pursue, which we address under the label of SEW, are of great importance to these stakeholders, and some scholars even treat these goals as their primary reference point (e.g., Go´mez-Mejı´a et al., 2007). Yet, the desire to pursue non-economic goals is juxtaposed by a need to pursue economic goals and legitimacy concerns, which are imposed on the firm by non-family stakeholders (Miller, BretonMiller, & Lester, 2013). An emphasis on economic goals, as they are relevant to PR pay, would consequently fail to secure family’s genuine interests. Indeed, agency theory suggests that the closer PR pay components can be tied to performance, the more effective 2 Although PR pay components could also be tied to non-economic goals, there is consensus among scholars that these non-economic goals are difficult to measure and, thus, difficult to link with PR pay (e.g., Block, 2008b). Empirically, we find, among the firms that we investigated in this study and that adopted a PR pay component in their outside directors’ pay mix, that all firms tied this variable compensation to any kind of measurable performance indicator (e.g., dividends paid), thus, underlining the current prevalence of economic measures in conjunction with PR pay components.

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is this kind of compensation (McConaughy, 2000). Following this conjecture, PR pay should be most efficacious if it is linked to a firm’s measurable performance (i.e., to financial performance indicators such as a firm’s stock price) (Gerhart & Rynes, 2003; Gibbons, 1998; Lawler, 1971). Based on a family firm’s disproportional attachment to non-economic goals, we should conclude that, ceteris paribus, PR pay is less effective in family firms based on the following reasoning. First, compensation criteria for PR pay components are difficult to connect with non-economic goals because they are harder to observe and measure than economic goals are (Block, 2008b). Second, if non-economic goals can only partly be connected with compensation criteria, a smaller share of family firms’ goals is covered by the firm’s PR pay, implying a weaker reduction of their agency problems. Although a family firm’s pursuit of non-economic goals provides the foundation for their avoidance of PR pay when compensating their outside directors, it also provides a fundamental counterargument to this line of conduct because PR pay exacerbates the second type of agency problems (Chrisman et al., 2010; Morck et al., 1988). While it already appears difficult for multiple shareholders of a firm to agree on a common set of economic goals, it is likely that this kind of agreement is associated with even more difficulties in family firms, where non-economic goals play a major role (Schulze, Lubatkin, Dino, & Buchholtz, 2001; Villalonga & Amit, 2006). Specifically, family firms often have more influence on the business than over their actual cash-flow rights, thus enhancing their ability to extract private benefits and pursue selfish objectives at the expense of minority shareholders (Villalonga & Amit, 2006; Shleifer & Vishny, 1997). Knowledge of these circumstances, including a family’s pursuit of noneconomic goals and their often influential position, can lead to suspicion from non-family shareholders and other stakeholders such as potential investors (Bertrand & Schoar, 2006; Miller et al., 2013). This suspicion, which can create mistrust among current shareholders, potential investors and the community at large, often entails negative economic and non-economic consequences, such as a higher cost of capital or a reputational loss for the family firm (Berrone, Cruz, Go´mez-Mejı´a, & Larraza-Kintana, 2010; Merton, 1987; Miller et al., 2013). To counterbalance stakeholders’ suspicions, public family firms can engage in trust-building activities by adhering to common business practices that matter to these stakeholders (Berrone et al., 2010; Deephouse, 1996; Miller et al., 2013). In other words, family firms might reduce suspicion and foster trust by conforming to common business norms, thus gaining additional legitimacy with regard to their business practices. As outside directors represent the only remedy for owner–owner related agency problems from a minority shareholder’s perspective (Fama & Jensen, 1983), conformity with regard to outside director compensation should consequently enhance stakeholders’ trust in outside directors’ ability to mitigate a firm’s agency problems. That the adoption of PR pay for outside directors is seen as a common business practice is supported by the fact that the German corporate governance code (GCGC) explicitly recommends the adoption of PR pay components for outside directors and requires the annual publication of a compliance statement, which must include a firm’s justification for non-compliant behavior (Werder, Talaulicar, & Kolat, 2005). Public family firms are often suspected of extracting private benefits and, due to well-known tendencies associated with family firms that are detrimental to non-family shareholders (e.g., altruism or nepotism), they may experience more pressure to adhere to conformist behavior than non-family firms (Kellermanns, Eddleston, & Zellweger, 2012; Miller et al., 2013; Schulze et al., 2001). This finding follows institutional theorists’ view that the legitimacy gained through conformist behavior is especially important for organizations

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‘‘where constituents (stakeholders) are unfamiliar with the organization or its performance, or expectations are not clear or easily assessed’’ (Ashforth & Gibbs, 1990; p. 178). This pressure will, in turn, affect a family’s concern for a positive reputation, which is a major objective of SEW because often ‘‘the firm is seen as an extension of the family’’ (; p. 262). Thus, the degree to which a family’s business conduct adheres to common practices is likely to positively influence both the family’s and the firm’s reputations (Berrone et al., 2010). Consequently, because we assume a high importance for reputational concerns, we expect to encounter an even higher share of PR pay adopters in family firms than in nonfamily firms with regard to outside directors’ pay mix. To summarize, while PR pay for outside directors may not be an effective measure to protect the family owners non-economic goals, we find a variety of indications that family firms adopt PR pay components in outside directors’ compensation to counterbalance non-family shareholders suspicions and signal legitimacy. This positive effect of PR pay outweighs potential losses of family control. The small portion of the literature that has studied family firms’ compensation pay mix almost exclusively focuses on differences between family and non-family members’ pay mix within family firms, thus allowing no direct comparison with our prediction (e.g., Chrisman et al., 2007; Go´mez-Mejı´a et al., 2003; McConaughy, 2000). Therefore, an empirical investigation of this matter is required, and, based on the arguments above, we predict: Hypothesis 1. Family firms are more likely than non-family firms to include PR pay components in their outside director compensation. When a family firm decides to adopt PR pay components, we expect this to lead to a higher share of PR pay in total compensation. The reason is that non-family shareholders are likely to demand a higher share of PR pay because it aligns outside directors’ risk-taking propensity with their own, thus mitigating their owner–owner agency problems with family shareholders (Go´mez-Mejı´a & Wiseman, 1997). It is well known that non-diversified shareholders such as owning families are rather riskaverse and that non-family shareholders exhibit a higher risktaking propensity as their wealth is usually more diversified (Carney, 2005; Go´mez-Mejı´a & Wiseman, 1997). As a result, nonfamily shareholders are motivated to increase outside directors’ risk-taking attitude to match their own. Indeed, outside directors perceive PR pay as a potential additional gain in wealth as opposed to a potential loss, increasing their risk-taking propensity (Go´mezMejı´a & Wiseman, 1997; Sanders & Hambrick, 2008; Tversky & Wakker, 1995)3. This statement is consistent with behavioral decision theory that suggests that individuals who face a loss would rather engage in risk-averse activities, whereas a preference for risk-taking behavior can be observed when individuals perceive a potential gain (Kahneman & Tversky, 1979). Thus, increasing the risk borne by outside directors might further strengthen their risk-taking attitude and thus align it with that of non-family shareholders. In addition, making greater use of PR pay components in terms of a higher share of total outside director compensation might help public family firms to resolve another source of conflict with nonfamily shareholders: the adjustment of different time horizons (Chua, Chrisman, & Sharma, 2003; Dyer, 1989). Family firms generally imagine longer time horizons than non-family firms do, and this characteristic originates from a desire to maintain the 3 The agency-based compensation literature provides, to some extent, contradictory arguments regarding the alteration of an agent’s risk-taking propensity due to a change in his risk with regard to contingent compensation (See Go´mez-Mejı´a & Wiseman, 1997, for a comprehensive overview).

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family business for future generations (Handler, 1990; James, 1999; Zellweger, Kellermanns, Chrisman, & Chua, 2011). The resulting patient capital leads to strategic decisions that prioritize the firm’s long-term prosperity (Anderson & Reeb, 2003; Sirmon & Hitt, 2003). This long-term orientation contrasts to most nonfamily shareholders’ aspiration for short-term economic performance, thus increasing a family firm’s agency problems (Chua et al., 2003; Jensen & Meckling, 1976). Linking a higher share of outside directors’ compensation to PR pay motivates them to shift their effort towards short-term-oriented performance goals, thus aligning shareholders’ goals in a temporal domain. Although PR pay components can also include long-term incentives, Andreas et al. (2012, p. 73) found that in Germany for the period 2005– 2008, ‘‘performance-based compensation for directors is largely implemented as a short-term incentive rather than a long-term compensation plan’’. Thus, it seems likely that non-family shareholders demand a greater share of compensation to be PR pay. From a family’s perspective, allowing PR pay and then allocating a higher share of compensation to PR pay component than non-family firms will necessitate that the legitimacy concerns will offset any potential loss in SEW. Indeed, while it has been shown that family firms adhere to norms (e.g., Miller et al., 2013), giving up control may not only have negative consequences in terms of SEW. Through additional legitimacy and thus increased reputation, family firms are likely to gain back SEW. Indeed, SEW is multi-faceted and a reduction in one facet (i.e., control) may be mitigated by another (i.e., reputation amongst external stakeholders) (see also Kellermanns et al., 2012). Combining the aforementioned arguments, we expect a higher share of PR pay to be found in family firms. Formally stated: Hypothesis 2. Of all firms adopting PR pay for their outside directors, family firms will exhibit greater shares of PR pay in their outside director compensation than non-family firms. There is increasing consensus among family business scholars that family firms are a heterogeneous group that exhibits at least as much diversity as non-family firms do (Chrisman et al., 2005; Chua et al., 2012; Go´mez-Mejı´a et al., 2007; Sharma, Chrisman, & Chua, 1997). Inspired by prior work by Miller, Le Breton-Miller, Lester, and Cannella (2007), Anderson and Reeb (2003), and Villalonga and Amit (2006), we distinguish between two dichotomous subgroups of family firms: lone-founder family firms (LFF) and true family firms (TFF). This nuance allows us to draw distinctions among family firms and to characterize these different types of family firms in contrast to non-family firms. LFF are unique because their founder is the only family member who is involved in the business as part of the firm’s top management team (TMT) and as a significant shareholder. TFF, in contrast, involve multiple family members in the TMT or as significant shareholders. Prior research has found that differences between these groups of family firms also become evident in their business conduct surfacing, such as in CEO compensation (Combs, Penney, Crook, & Short, 2010) or firm performance (Miller et al., 2007). In line with our arguments that family firms experience substantial pressure to conform to alleviate non-family shareholders’ suspicions regarding private benefits, we expect TFF to be especially prone to this kind of concern. The extant literature provides evidence that family firms show a disproportional rate of failure when they hand over the business from the founder to a subsequent generation (Morck & Yeung, 2003). Capital market participants and especially non-family shareholders, aware of this challenging stage of a firm’s lifecycle, might demand increasingly close scrutiny of business practices in TFF. In this case, unconventional business methods and deviations from

common practices might appear particularly suspicious, resulting in damage to the firm’s reputation. The pressure to conform and the family’s desire to maintain a positive reputation might, thus, lead to the adoption of recommended best practices such as PR pay components. In contrast, a LFF has not yet publicly decided to hand the business over to a subsequent generation. This circumstance and the comparably early stage in the firm’s life cycle will result in shorter planning horizons compared to those of TFF (Miller, 1983). One could argue that TFF, involving multiple generations after the founder, have proven they can maintain the business, thus reducing shareholders’ suspicion. While this counterargument might be true, older family firms involving more generations are nevertheless increasingly suspected to engage in managerial entrenchment, family altruism, and nepotism (Bertrand & Schoar, 2006; Claessens et al., 2002; Schulze et al., 2001). Moreover, as a TFF matures, reputational concerns are likely to grow as the firm gradually represents a larger part of the founder’s legacy that is closely connected with the family (Berrone et al., 2012; Go´mezMejı´a et al., 2003). While these arguments suggest a rather constant level of stakeholder suspicion regarding TFF, LFF should experience a substantially lower pressure from stakeholders for two reasons. First, based on their strong emphasis on economic objectives, goal convergence between the founder and nonfamily shareholders is more likely, and agency problems should consequently be less severe (Engel et al., 2013a; Jaskiewicz, Combs, Block, & Danny, 2014; Miller et al., 2007; Wasserman, 2006). In general, founders are exposed to high levels of risk because they are trying to establish a business, which usually requires innovation and the selection of products and services to successfully compete against incumbents (Kellermanns, Eddleston, Barnett, & Pearson, 2008; Miller, 1983). Due to the foundercentered structure of LFF, these organizations are likely to exhibit a risk-taking attitude similar to that in non-family firms. In contrast, TFF, involving multiple generations of the founding family, should display a more risk-averse attitude because they are often poorly diversified and the family’s wealth is closely connected to the firm (Anderson & Reeb, 2003; Miller, Le BretonMiller, & Lester, 2011). Therefore, we expect LLF to perceive less pressure from non-family shareholders to increase their risktaking attitude. Second, founders are recognized as entrepreneurs who are often seen as having a strong economic focus, good business skills, and a high emotional attachment to the desire to successfully build their firms (Miller, 1983; Wasserman, 2006). Thus, we expect the pressure to conform from shareholders in LFF to resemble those of non-family firms rather those of than TFF. In addition, LFF are likely to put more emphasis on short-term performance because they are even more reliant upon the capital market in periods of strong growth, which often coincide with the early life stages of a firm (Miller, 1983; Wasserman, 2006). Thus, we expect comparatively short planning horizons in LFF, reducing the need for an adjustment in the temporal domain. This prediction is consistent with Miller et al. (2013), who find a lower strategic conformity in business practices for LFF, which they associate with founders’ outstanding abilities and a corroborating higher reputation among capital market participants. Based on these arguments, we expect that TFF will come under particular suspicion if they deviate from common business practices and that reputational concerns become more important as a TFF advances in its life cycle. This shift should lead to both a higher propensity among TFF to adopt recommended practices compared to other firms and amongst the adopting firms to a higher share of PR pay in outside director compensation compared to other firms. Accordingly, we hypothesize:

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Hypothesis 3. TFF are more likely to include PR pay components in their outside director compensation than LFF and non-family firms. Hypothesis 4. Of all firms adopting PR pay for their outside directors, TFF will exhibit greater shares of PR pay in their outside director compensation than LFF and non-family firms.

Methods Sample Our sample contains publicly available data from 2009 on 220 companies listed on the Frankfurt stock exchange. The data have been provided by Kienbaum Management Consultants. We excluded all firms from the financial sector from the sample to avoid comparability issues (Ryan & Wiggins, 2004). The remaining 203 companies belong to the German Prime Standard, a stock market tier that is regulated by German law and represents the listing requirement for all major indices (e.g., the German stock index DAX). All companies listed in the German Prime Standard must fulfill specific transparency requirements, such as the application of international accounting standards or the publication of financial reports in local and English language. These standards are matchless in Germany. Relevant information beyond a firm’s annual report is rarely available to the public, and therefore additional data on ownership structures and governance characteristics have been manually collected from Bureau Van Dyck’s (BvD) MARKUS database and Lexis-Nexis database. Moreover, BLOOMBERG served as a source for financial data. Additional information on family background was collected through a broad press research and the use of company websites. Dependent variables Adoption of PR pay/share of PR pay To answer our research question on the pay mix of outside directors in public family firms, we use two dependent variables: (1) the adoption of PR pay, indicating whether a firm offers PR pay components for outside director compensation or not, and (2) the share of PR pay, representing the fraction of PR pay in total outside director compensation. (1) We measure the adoption of PR pay in outside director compensation by means of a dummy variable. This variable is coded ‘‘1’’ if a firm provides a PR pay component and ‘‘0’’ otherwise. We do not differentiate between different types of PR pay. (2) We measure the share of PR pay in total outside director compensation as the sum of all PR pay components paid to all outside directors divided by the total amount of compensation received by the same group. Unlike in the U.S., where PR pay is usually paid in equity-based form (Linn & Park, 2005), outside directors in Germany usually receive their PR pay as cash compensation. Independent variables Family firm In line with many family business scholars, we code a firm as family firm if at least one family member, defined as a founder or descendent by blood or marriage, is involved in the firm’s TMT as either an executive or outside director and if at least one family member is a substantial stockholder with an ownership share of 5% or more (Anderson & Reeb, 2003; Villalonga & Amit, 2006). This

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variable is coded ‘‘1’’ if the firm is a family firm by our definition and ‘‘0’’ otherwise. Our sample contains 92 family firms. Lone-founder family firm (LFF) Inspired by the work of Miller et al. (2007), we code a firm as LFF if the founder(s) is (are) the only family member(s) currently involved in the family business. Involvement is defined, in accordance with our discussion above, as being a member of the firm’s TMT and a substantial stockholder (5%). In total, 40 firms are coded as LFF. True family firm (TFF) We code a firm as TFF if at least two family members are involved either as members of the firm’s TMT or as substantial stockholders (5%). In this context, it is of no importance whether the members of the family are involved contemporaneously or over different generations. We only considered individuals as founders and thus eliminated other forms of founders, such as leveraged management buyouts or institutional investors. By our definition, the family firm subsample can completely be divided into these dichotomous categories: LFF and TFF. Our sample contains 52 TFF. Control variables In accordance with the limited number of studies on the pay mix of outside directors or the pay mix in family firms, we include several control variables in our analyses that seem influence the determination of a firm’s pay mix (e.g., Andreas et al., 2012; Fich & Shivdasani, 2005; Vafeas, 1999). Firm size is widely acknowledged to be one of the most important predictors for compensation levels (Gabaix & Landier, 2008; Tosi, Werner, Katz, & Go´mez-Mejı´a, 2000). Large firms often exhibit a higher need for external capital and are thus especially prone to meet stakeholders’ demands for conformist behavior (Wan-Hussin, 2009). We measure firm size as natural logarithm of a firm’s annual sales. Following Andreas et al. (2012), we control for both accounting-based and market-based firm performance indicators. Despite the seemingly comprehensive explanation that PR pay components are often linked to these specific performance measures, prior studies show mixed results that typically fail to report a significant relationship (e.g., Ertugrul & Hegde, 2008; Vafeas, 1999). We measure accounting-based performance as return on equity (ROE) and include dividend yield, calculated as the ratio of dividends paid to year-end stock price, as market-based performance measure (e.g., Fich & Shivdasani, 2005). As is common in the literature, both types of performance measures are time lagged by one year (e.g., Ryan & Wiggins, 2004). Following prior studies (e.g., Andreas et al., 2012; Minnick & Zhao, 2009), we control for a firm’s risk by measuring the stock price volatility, calculated as the standard deviation of (360) day-to-day logarithmic historical price changes. A firm’s investment opportunities have also been argued to influence outside directors pay mix because higher investment opportunities require a higher risk-taking propensity to be seized (Bryan & Klein, 2004; Linn & Park, 2005; Smith & Watts, 1992). As the share of PR pay increases outside directors’ risk-taking attitudes, we also expect a positive relationship, and we measure a firm’s investment opportunities in accordance with prior research as a ratio of the sum of market value of equity and book value of debt to book value of total assets (e.g., Fich & Shivdasani, 2005; Linn & Park, 2005). To reduce high levels of skewness and kurtosis, we calculate a natural logarithm of the investment opportunities variable. Certain ownership characteristics besides a family ownership have proven to be of importance in pay mix determination (e.g., Ertugrul & Hegde, 2008; Vafeas, 1999). In particular, management

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board ownership (MB ownership) and the existence of blockholders (non-family blockholder) are factors that might substitute for outside directors’ monitoring activities and therefore reduce the need for high compensation levels and PR pay components (Cronqvist & Fahlenbrach, 2009; Go´mez-Mejı´a et al., 2003). However, prior research yields ambiguous results. Andreas et al. (2012) find a negative relationship between institutional investors and the adoption of PR pay. Similarly, Go´mez-Mejı´a et al. (2003) find that the existence of institutional blockholders is negatively associated with long-term PR pay in CEO compensation. In contrast, Fich and Shivdasani (2005) document a positive relationship between blockholders and the adoption of a stockoption plan. To capture the influence of blockholders, we control for the share of the biggest non-family shareholder. We further control for firm age, which is measured as the natural logarithm of years since a firm’s foundation, and industry affiliation (e.g., Ryan & Wiggins, 2004). Industry affiliation is measured with a dummy variable that is coded ‘‘1’’ if the firm operates in the manufacturing industry and ‘‘0’’ otherwise (e.g., Go´mez-Mejı´a et al., 2003). Results Table 1 shows descriptive data and provides the results of a univariate analysis that includes mean comparisons between family and non-family firms, as well as TFF and LFF. About twothirds of the 203 firms in our sample have adopted a PR pay component in their outside director compensation, accounting for approximately 18% of total compensation. A first comparison of our dependent variables between family and non-family firms indicates no significant difference. However, no controls are considered yet. As expected, family and non-family firms differ significantly in their ownership structures. While family firms exhibit a superior share of MB ownership (26% vs. 2%; p < .001), non-family firms place a larger percentage of their shares in the hands of blockholders (28% vs. 9%; p < .001). With respect to the subsample comparison, we find significant differences regarding both dependent variables. TFF exhibit a significantly higher percentage of PR pay adopters than LFF do (73% vs. 48%; p < .01), and they allocate a greater share of total compensation to PR pay than LFF do (24% vs. 13%; p < .05). These figures provide a first indication for our conjecture regarding the distinctiveness of different types of family firms. With regard to the overall

structure of our data, we find that the allocation of different types of firms in our sample resembles those of prior studies involving public family firms (e.g., Miller et al., 2007). The reported shares of PR pay adopters also appear reasonable in the light of the data reported by Andreas et al. (2012), who find an average PR pay adoption rate of 61% for public German firms in the period 2005–2008. Table 2 reports the correlations of all variables used in our regression. To test for multicollinearity, we calculated variance inflation factors (VIF; maximum 1.8) and conditional indices (CI; maximum 19.8) for all independent variables. Both VIF and CI values are below the commonly accepted thresholds. Therefore, we assume no multicollinearity concerns (Myers, 1990). To analyze a firm’s likelihood to adopt PR pay components in outside director compensation, we conduct a binary logistic regression because our dependent variable is dichotomous. The analyses regarding the share of PR pay in total outside director compensation are conducted by means of an ordinary least square (OLS) regression. Table 3 contains the results of both regressions, comprising six models in total. Models M1–M3 show the results of the logistic regression, and Models M4–M6 exhibit those of the OLS regression. Regarding the controls in our logistic regression, only firm size shows a positive and significant relationship with a firm’s likelihood to adopt PR pay. This finding is consistent with prior empirical findings and emphasizes the general importance of size with regard to compensation matters (e.g., Ertugrul & Hegde, 2008; Minnick & Zhao, 2009). None of the remaining control variables yields significant results. Ownership in the hands of members of the management board (MB ownership) seems to have a negative impact on a firm’s probability to adopt PR pay, but fails to have significant coefficients. Blockholders, however, are negatively related to the adoption of PR pay, and this finding supports the results reported by Go´mez-Mejı´a et al. (2003) and Andreas et al. (2012). In this context, it seems that blockholders indeed serve as a substitute for monitoring and thus reduce the need to offer incentivizing PR pay to outside directors (e.g., Cronqvist & Fahlenbrach, 2009). We will discuss the influence of blockholders in greater detail below. Turning to the results of our OLS regression, we also find firm size to show a highly significant and positive relation to the share of PR pay in total outside director compensation. As predicted by prior research, a firm’s investment opportunities are positively

Table 1 Descriptive data and test of means for total sample and subgroups. Variables

PR paya PR pay share Firm size [M s] ROEt1 Dividend yieldt1 Firm age Industrya Risk Investment opportunities MB ownership Non-family blockholder # Firms % Of total a

Dummy variable. p < .10. * p < .05. ** p < .01. *** p < .001. y

(A) All firms

(B) Family firms

(C) Non-family firms

(B) vs. (C)

(D) TFF

(E) LFF

Mean

SD

Mean

SD

Mean

SD

t-Statistics

Mean

SD

.66 .18 4.891 .00 .10 61.07 .58 .61 1.48 .13 .19 203 100%

.47 .24 14.520 .56 1.05 56.20 .49 .19 .99 .23 .20

.62 .19 1.936 .01 .19 54.42 .57 .60 1.56 .26 .09 92 45%

.49 .26 8.365 .73 1.55 58.41 .50 .16 .98 .26 .10

.69 .16 7.341 .01 .03 66.59 .59 .62 1.42 .02 .28 111 55%

.46 .23 17.774 .17 .03 53.95 .49 .21 .99 .11 .24

1.102 .943 2.845** .148 1.013 1.528y .420 .423 1.009 7.942*** 7.260*** – –

.73 .24 3.241 .05 .03 79.79 .73 .56 1.36 .22 .09 52 25%

.45 .25 10.989 .46 .03 67.23 .45 .14 .57 .28 .10

Mean

(D) vs. (E) SD

.48 .13 239 .08 .40 21.45 .35 .67 1.81 .31 .10 40 20%

t-Statistics .51 .25

374 .98 2.36 8.75 .48 .16 1.31 .22 .09

2.526** 2.008* 1.968* .744 .968 6.189*** 3.867*** 3.378*** 2.027* 1.637y .225 – –

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Table 2 Correlations, means and standard deviations of variables used in regressions.

1 2 3 4 5 6 7 8 9 10 11 12 13 14 a ** *

Variables

Mean

SD

1

2

3

4

5

6

7

8

9

10

11

12

13

Performance-related pay PR pay share Firm sizea ROEt1 Dividend yieldt1 Firm agea Industry Risk Investment opportunitiesa MB ownership Non-family blockholder Family firm TFF LFF

.660 .175 5.9898 .0014 .1018 3.711 .581 .610 .272 .129 .190 .453 .256 .197

.474 .244 2.378 .557 1.046 .905 .494 .185 .434 .226 .203 .499 .437 .398

.517** .400** .104 .053 .298** .108 .029 .116 .171* .120 .078 .088 .194**

.369** .129 .049 .262** .050 .053 .158* .097 .077 .067 .155* .086

.152* .031 .511** .101 .152* .218** .205** .004 .143* .097 .286**

.054 .147* .080 .163* .002 .032 .035 .011 .050 .069

.012 .059 .068 .049 .009 .021 .078 .038 .140*

.378** .180* .210** .139* .130 .117 .230** .400**

.100 .062 .058 .034 .030 .178* .232**

.045 .038 .018 .029 .167* .147*

.053 .075 .079 .039 .141*

.209** .513** .233** .386**

.432** .284** .229**

.645** .544**

.291**

Natural Logarithm; n = 203. Significant at the .01 level. Significant at the .05 level. All Correlations are two-tailed.

associated with the share of PR pay. In other words, an outside director’s risk-taking attitude is stimulated so that he will seize a firm’s opportunities (e.g., Smith & Watts, 1992). In contrast to our logistic regression results, both ownership structure variables (MB ownership, non-family blockholder) yield no significant relationships with regard to the share of PR pay. Hypothesis 1 predicts a higher likelihood to adopt PR pay components in outside directors’ compensation for family firms.

However, Model 2 (M2) shows a negative and insignificant regression coefficient (.302; ns.). Therefore, Hypothesis 1 is not supported. Hypothesis 2 suggests that family firms devote a greater share of total outside director compensation to PR pay components. Model 5 (M5) shows a positive and significant relationship between family firm status and share of PR pay (.161; p < .05), thus supporting Hypothesis 2.

Table 3 Regression results. Dependent variable

Logistic regression

OLS tegression

PR pay

Controls

Firm size

a

ROEt1 Dividend yieldt1 Firm agea Industry Risk Investment opportunitiesa

Ownership structure

Firm types

2 Log likelihood/F Pseudo R2/Adj. R2 DR2

Share of PR pay

M1

Model

M2 ***

.386 (.097) .182 (.273) 1.198 (5.562) .299 (.241) .153 (.357) .963 (1.002) .092 (.389)

***

.346 (.100) .233 (.278) 1.910 (5.729) .425 (.259) .065 (.364) .885 (1.035) .106 (.393)

Management board ownership

–

Non-family blockholder

–

Family firm

–

TFF

–

–

LFF

–

–

219.088*** .254 –

M3

1.128 (.833) 2.348* (.937) .302 (.442)

21.470*** .301 .047

M4 ***

M5

M6

.347 (4.609) .063 (.980) .012 (.19) .165* (2.027) .064 (.91) .044 (.683) .273*** (4.112)

.338 (4.414) .071 (1.101) .024 (.38) .177* (2.170) .069 (.99) .053 (.822) .265*** (4.012)

.336*** (4.386) .071 (1.102) .019 (.30) .168* (1.984) .074 (1.05) .058 (.881) .267*** (4.030)

1.099 (.841) 2.311* (.936) –

–

.116 (1.55) .037 (.52) .161* (2.004)

.111 (1.48) .036 (.51) –

.182 (.510) .439 (.526)

–

–

–

–

7.749*** .190 –

6.135*** .203 .013

.343 (.100) .233 (.278) 1.852 (5.740) .396 (.266) .036 (.370) .957 (1.043) .084 (.394)

21.237*** .302 .048

***

– –

***

.157* (2.014) .102 (1.210) 5.577*** .200 .010

Logistic Regression: Table contains unstandardized regression coefficients. Standard errors are in parentheses. All tests are two-tailed. OLS Regression: Table contains standardized regression coefficients. T-statistics are in parentheses. All tests are two-tailed. a Natural logarithm. n = 203. * p < .05. ** p < .01. *** p < .001.

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The remaining Hypotheses 3 and 4 are based on a further differentiation between types of family firms. The results for Hypothesis 3 are reported in Model 3 (M3). We predict a higher likelihood for TFF to adopt PR pay components compared to LFF and non-family firms. The regression coefficient, however, is negative and insignificant (.182; ns.). The coefficient for LFF shows a greater but also insignificant value (.439; ns.). Although this finding, in accordance with our prediction, indicates an even lower probability for LFF to adopt PR pay than TFF, both types of family firms seem to be less likely than non-family firms to adopt PR pay components. Thus, Hypothesis 3 is not supported. Model 6 (M6) contains the results of Hypothesis 4, where we postulate that only TFF will allocate a higher share of total outside director compensation to PR pay. We receive a positive and significant regression coefficient (.157; p < .05), thus supporting Hypothesis 4. To summarize our results, while we cannot find support for our predictions regarding the likelihood of adopting PR pay, our predictions with regard to the share of PR pay in total outside director compensation are supported. Discussion We elaborate the determinants of outside directors’ pay mix in public family firms based on agency theory, and our incorporation of SEW enabled us to account for a family firm’s specific goal set in general and the importance of individual, non-economic goals in particular. Thus, we were able not only to highlight the wellknown severance of owner–owner related agency problems in public family firms but also to derive conclusions about the intentions of the parties involved in this conflict: notably, the family, non-family shareholders and other stakeholders. Outside directors’ foremost task is monitoring the firm’s management, and as such they often represent (non-family) minority shareholders’ only remedy for the illustrated agency problem. This, in turn, lays the groundwork to explain why the intentions of all involved parties are likely to determine outside directors’ pay mix and specifically the adoption and the share of PR pay. Specifically public family firms face the challenge of conflicting demands that stem from their desire to preserve the family’s SEW, on one hand, and non-family shareholders’ and other stakeholders’ demand on the other. In particular, because non-family shareholders and other stakeholders know about a family’s pursuit of SEW, their business practices are regarded with increased suspicion (Bertrand & Schoar, 2006). We suggest that family firms and specifically TFF will sacrifice their tendency to avoid PR pay to signal conformist behavior vis-a`-vis shareholders and stakeholders through their outside directors’ pay mix—a matter directly connected with the owner–owner agency problem and thus a relevant parameter to alleviate stakeholders’ suspicion (Deephouse, 1996; Miller et al., 2013). Our results indicate that the relationship between family involvement and PR payoff outside directors is complicated. Hypotheses 1 suggested that family firms would be more likely to adopt PR pay for outside directors than non-family firms, this hypothesis was not supported. Yet, while the overall adoption level did not differ between family and non-family firms, Hypothesis 2 argued that of the adopting firms, family firms would exhibit great shares of PR pay in their outside director compensation than nonfamily firms. This hypothesis was supported. The above described results are mirrored in Hypothesis 3 and 4, where we investigate more fine-grained differences between types of firms. Hypothesis 3 suggests that TFF are more likely than LFF or non-family firms to include PR pay components for their outside directors. This hypothesis was not supported. However, supporting Hypothesis 4, we showed that TFF have higher shares of PR pay for

their outside directors than LFF and non-family firms. This suggests that family firms and especially TFF who adopt PR pay will experience substantial pressure from non-family shareholders to increase the share of PR pay and align outside directors’ risk-taking attitudes and temporal orientations with their own. We suggest that this is salient for two reasons. First, a family firm’s and especially a public family firm’s reputation is closely linked with family image and thus of paramount importance (Berrone et al., 2012). A non-conformist behavior, such as avoiding the adoption of PR pay despite its recommendation by the German Corporate Governance Codex, would damage this image. Recently published articles emphasizing the importance of reputational concerns corroborate this line of thought (e.g., Berrone et al., 2010, 2012; Go´mez-Mejı´a et al., 2003). Second, and related to the first argument, family firms might ensure the required support from capital market participants, such as new investors, by showing a conformist behavior and thereby securing the family’s ability to permanently pursue SEW. The non-significant results in Hypothesis 1 and 3 reflect the enduring struggle between the families, on one hand, and nonfamily shareholders and other stakeholders on the other hand. This explanation follows Go´mez-Mejı´a et al. (2003) findings, investigating CEO compensation in public family firms, who suggest that family firms have to address counterbalancing preferences for compensation contracts that stipulate a wealth preserving, risk averse conduct and those that incentivize a more risk-taking attitude to meet shareholders’ demands. These opposing influences could therefore explain our insignificant result. We also need to briefly mention the significant negative effect of non-family blockholders, a control variable, which was observed for the likelihood of adoption of PR pay for outside board members. Although the variable was not significant for the degree of PR pay amongst all adopting firms, the finding is counter-intuitive. We therefore conducted the regression again using the individual subsamples and found, in line with general predictions, that blockholders have a positive relationship with the adoption of PR pay in the TFF subsample. Our study contributes to the family business and compensation literature in several ways. First, we are the first study to investigate the pay mix of outside directors in family firms. Thus, we broaden the existing knowledge about family influence on a specific type of compensation contract design while accounting for the distinct goals sets and intentions of the parties involved in this process. Second, we enrich the empirical resources of the family business literature by providing data on outside directors’ pay mix in German public family firms. Third, we provide theoretically derived insights for practitioners with regard to the public perception and potential effects of PR pay adoption, as well as the share of compensation dedicated to it. Fourth, we contribute to the heterogeneity debate of family firms (e.g., Chua et al., 2012) by distinguishing between two specific types of family firms—LFF and TFF. Limitations and implications for future research Several limitations should be noted and considered when interpreting our results. All firms in our sample are listed in the Prime Standard stock market tier of the Frankfurt Stock Exchange, which includes many of the largest, most successful and globally diversified firms in Germany. We share this circumstance with a multitude of studies focusing on the US market, which study firms from Fortune’s list or the S&P index. Therefore, the family and nonfamily firms from our sample have to be regarded as highly professional firms that have learned to play by the rules of modern capital markets. This note is especially important because we expect the business conduct of these public family firms to

P.J. Engel et al. / Journal of Family Business Strategy 6 (2015) 130–140

substantially deviate from that of private family firms. While this fact might not apply to all business decisions, we assume it will affect a family’s decision in setting outside directors’ pay mix. In this context, a comparison of private and public family firms could generate valuable insights as to the degree to which non-family shareholders in public family firms can influence a family’s preferred conduct. In addition, country specific characteristics, such as the recommendations of the GCGC, and legal rules, such as the prohibition of stock options for outside directors, are likely to influence perceptions of conformist behavior. Consequently, these characteristics represent a vital differentiating factor that has to be considered when comparing our results with those from other countries. However, a cross-country comparison of our analysis could extend our knowledge on the actual effects of those country specific characteristics, thus helping scholars to disentangle the role of family-induced, specific conduct from those of other determinants. Our data are cross-sectional, and although this circumstance does not limit the explanatory power of our results, replicating our analyses based on a longitudinal dataset could provide valuable insights as to how a change in ownership structure would impact outside directors’ pay mix over time. Moreover, we encountered a variety of adjacent topics during this study that we consider worth exploring. We encourage future research to investigate the effects of outside directors’ pay mix on a variety of firm specifics, such as corporate performance, CEO and board member tenure, support from capital market participants, and the average tenure of nonfamily shareholders in family firms. In addition, little is known about the effects of pay mix on outside directors’ conduct. In this regard, a further differentiation between types of PR pay, such as short-term and long-term incentives and their respective potential impact on outside directors’ motivation, would provide a fruitful avenue for future research. Last but not least, the separation between LFF and TFF led us to conclude that the differences in outside directors’ pay mix shown in our study are primarily attributable to TFF, whereas the pay mix in LFF resembles that of a non-family firm. This and other results indicating differences between distinct types of family firms such as firm performance (Miller et al., 2007), CEO compensation (Combs et al., 2010), R&D spending (Block, 2008a,b), monitoring need (Engel et al., 2013a), value creation (Villalonga & Amit, 2006), and voluntary disclosure (Engel, Hack, & Kellermanns, 2013b) support the current heterogeneity debate on family firms. Therefore, we encourage scholars to investigate the different types of family firms and their particular influences on a variety of business practices.

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