The Impact of Incentive Compensation on Labor Productivity in Family and Nonfamily Firms

Abstract

Family and nonfamily firms both must align owner and employee interests. However, family firms may experience lower labor productivity because of adverse selection problems from labor market sorting and attenuation. Incentive compensation reduces alignment of interest problems in family and nonfamily firms. Importantly, incentive compensation signals to potential employees that performance will be rewarded, which should improve the relative labor productivity in family firms by reducing adverse selection. Analysis of matched data on 216,768 firms supports our hypotheses, implying that incentive compensation has a broader impact on firm performance than commonly recognized in the family firm or human resource literatures.

Are Family Firms Good Employers?

“…This prediction is rooted in established agency arguments suggesting that labor productivity is at least partially a function of both moral hazards, such as misaligned interests between owners and managers, and adverse selection, such as from hiring from a suboptimal talent pool (Akerlof, 1970;Eisenhardt, 1989;Jensen & Meckling, 1976). In conjunction with recent arguments from the family business (Chrisman et al, 2017;Cucculelli, Mannarino, Pupo, & Ricotta, 2014) and finance (Barth et al, 2005;Burkart, Panunzi, & Shleifer, 2003) literatures, we suggest that these problems are particularly severe in family firms. Moral hazards are rampant given the diverging interests of family owners and their nonfamily employees (Chua, Chrisman, & Bergiel, 2009;Schulze et al, 2001).…”

“…Second, we extend agency and stewardship theory to employment practices, and in so doing, contextualize these theories in a manner that enhances their utility in research about both private firms and family firms. Third, our paper adds to the growing literature about how family control shapes firm conduct in general and employment practice in particular (e.g., Chrisman, Devaraj, & Patel, 2017). Answering this question is important because family firms employ 60 percent of the global workforce.…”

“…Starting from this dataset, we follow Chang and Shim (2015) and others (Boivie, Graffin, Oliver, & Withers, 2016;Chrisman et al, 2017) and use a propensity-based matched pair design as the principal method in tests of our hypotheses. Propensity score matching lowers the influence of unobserved heterogeneity, lowers chances of Type 1 error, and provides more conservative estimates than regressions (Dehejia & Wahba, 2002).…”

“…Relatedly, reduced voice and violations of procedural justice are associated with higher levels of voluntary turnover (Shaw, Gupta, & Delery, 2005). Family favoritism also compromises standards of professional practice and may make it difficult for family firms to retain talented employees (Chrisman et al, 2017;Pérez-González, 2006). Nyberg (2010) and others (Trevor, Gerhart, & Boudreau, 1997;Vroom, 1964) argue employees are more likely to leave when there is an unclear line of sight between performance and rewards and perceptions of unfairness.…”

“…Lastly, earlier research about the influence of family on firm governance has proven largely noncumulative due to conceptual, empirical, and methodological heterogeneity across studies (Neubaum et al, 2017;Zahra, Hayton, Neubaum, Dibrell, & Craig, 2008). By probing a large sample of detailed financial and employment data from a large number of private firms from a single country over a significant period of time, we overcome limitations of earlier studies and add to the growing literature about whether, when, and under what conditions family firms might engage in stewardship behavior (Chrisman et al, 2017;Gómez-Mejía et al, 2003, 2001Le Breton-Miller et al, 2011;Sraer & Thesmar, 2007).…”