Executive pay in family firms: a principal-agent model
A large number of family firms employ non-family executives. This chapter analyzes the optimal compensation contract for non-family executives using principal-agent analysis. It is shown that if the business-owning family is interested in long-term performance but the non-family executive is more interested in short-term performance, the compensation contract should be lowpowered with regard to short-term performance. The level of short-term incentives depends on the measurement error of effort for short-term performance, the executive’s level of risk aversion, and the executive’s responsiveness to short-term incentives. This chapter is connected to Chapter 6 and Chapter 7 by explaining how the compensation contract of a non-family executive should be designed if the business-owning family wants to pursue a long-term strategy. Furthermore, this chapter explains some of the empirical findings about the differences in executive pay between family and non-family firms (Chapter 8).
KeywordsFamily Firm Stock Option Certainty Equivalent Optimal Contract Flexible Labor Market
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