July 24, 2022
By Bertha Masuda
Formulating compensation plans for private family companies can be challenging, especially when family members are in the C-suite and on the board. This article outlines a framework of key principles for thinking through the issues, best practices, and available survey data to enable family company boards to make the best decisions possible.
Early establishment of a governing body (compensation committee or board) and charter with clear definitions of authority and process (an agenda, a calendar, etc.) can keep discussions and pay decisions on a timely cadence. Obtaining agreement on the process and rules of engagement are particularly important when private family company boards and the C-suite are composed of a mix of family members and external hires. There may be different levels of understanding across the leadership team and board, so leaving sufficient time for process and decision-making ensures that everyone has the shared understanding to make and agree on pay decisions. This mitigates rehashing discussions and possibly back-tracking on decisions.
The private family company’s governing body establishes the pay philosophy for the executives and employees. Pay philosophy includes statements about the pay positioning (such as if it is in the 50th percentile or 75th percentile), market benchmarks (such as those related to industry and size range), and pay mix between fixed and variable components.
The pay philosophy at private family companies differs from the philosophy at publicly traded and other privately held companies in several ways:
All privately held companies, including family-owned businesses, should annually benchmark executive compensation to ensure competitiveness just like their publicly traded counterparts. While determining a peer group of companies that is comparable can be challenging, published compensation surveys are available that cover specific industries and privately held company pay practices, including Incentive Pay Practices: Privately Held Companies, published by Compensation Advisory Partners and WorldatWork.
Whether family member executives participate in annual or long-term incentives depends on several factors, including the pay philosophy regarding family members, the affordability of the plan program (overall sharing ratio), and whether it is important for the entire executive team, including family member executives and externally hired executives, to be aligned on the same metrics, goals, and payout timing. According to Family Business Executive Compensation Report, a survey conducted by Compensation Advisory Partners and MLR Media, family and non-family executives often participate in the same short-term and long-term incentive programs.
As is often the case in family situations, communication is key. Family shareholders, whether on the board or not, want transparency around how the compensation plans work, the projected incentive award values, payout dates, and the resulting impact on sharing ratios between management and shareholders of the company’s earnings and value. This information allows shareholders to understand how the compensation plans are aligned with their objectives.
Utilizing a framework of key principles (governance, pay philosophy, incentive plan design, and communication) will enable both family member and independent directors of private family companies to develop an appropriate compensation plan that aligns the interests of executives and shareholders.
Bertha Masuda is a partner at Compensation Advisory Partners.