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Pay variation in family firms – Derivation of hypotheses

Pay variation in family firms – Derivation of hypotheses

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Pay variation in family firms – Derivation of hypotheses



3.1.



71



Introduction and theoretical base for hypotheses development



The research objective of this dissertation is to identify drivers and antecedents of vertical and

horizontal pay variation in a family firm context. To understand those triggers in my research

context, we have to first understand what drives pay variation in general and which theoretical

approaches provide information about the source of such pay variation. Therefore, I will use

two theories introduced in detail in the previous chapter, as they provide not only explanatory

potential for both vertical and horizontal pay variations, but also address different degrees

(high / low) on the pay variation scale. Then, to transfer the pay variation analysis to the family

firm context, it is essential also to understand what drives family firms to pursue specific

strategic decisions such as compensation policies and structures. Thus, I apply a theoretical

approach to current family firm research, which more precisely explains specific family firm

behaviors and decision rationales, namely the socioemotional wealth approach.

First, major theoretical concepts help in explaining the sources of pay variation in

family firms. Higher pay variations are often driven by Tournament Theory (TT) and lower pay

variations by Equity Theory approaches; the individual motivational triggers, the functioning,

the risks and benefits connect the respective theoretical approaches to probable family

behavior. Tournament theory, whose motivational trigger can be found in the size of the

available “compensation prize” for managers or employees, is often applied to explain large

pay variations. The larger the compensation for a job or position, the more attractive it

becomes and the more employees will strive to achieve it (Lazear, 1999; Lazear and Rosen,

1981; Wade et al., 2006). This approach works via a relative performance evaluation of each

employee competing for the job (in this “tournament”). Thus, small differences in

performance lead to large compensation differentials (Lee et al., 2008). TT is mostly used to

explain vertical pay variation between jobs or hierarchies (Lambert et al., 1993; Lazear

and Rosen, 1981) as compensation normally rises over-proportionally per organizational level

(Gerhart and Rynes, 2003); however, it is also applied horizontally as resources in the form of

compensation are often restricted and thus zero-sum games may lead to “tournaments” for

the highest bonus (Gupta et al., 2012). The advantages of the model are clear as it leads to

highly motivated, performance-driven employees (Baker et al., 1988; DeVaro, 2006) and also

shows positive correlation to organizational performance despite appearing to be only shortterm (Connelly et al., 2013). The risks, however, though less obvious, are substantial as TT may



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Pay variation in family firms – Derivation of hypotheses



lead to excessive risk-taking, aggressive behavior, and an ongoing contest or competition

between employees (Becker and Huselid, 1992; Siegel and Hambrick, 2005) where low

performers tend to be left behind (Lambert et al., 1993).

Equity Theory, on the other hand, is mostly focused on smaller pay variations (Cowherd

and Levine, 1992), motivating employees on a perceptional level as they feel to be

compensated appropriately and fairly. The approach works via a comparison of performance

/ compensation (input / output) ratios between oneself and other employees where the

assessment is heavily influenced by the transparency and reproducibility of the compensation

decision (Finkelstein et al., 2009; Pfeffer and Davis-Blake, 1992; Pfeffer and Langton, 1993;

Siegel and Hambrick, 2005). Obviously, absolute performance is to be rewarded. Equity

Theory is mostly applied to horizontal pay variation as such input / output ratios are easier to

compare among similar jobs (Festinger, 1954; Kepes et al., 2009; Tremblay et al., 1997);

however, employees tend to compare themselves with upper or top management as

commensurability is also of interest, thus, also explaining vertical variations (Buunk

and Gibbons, 2007; Gupta et al., 2012; Sweeney and McFarlin, 2005). Advantages can be

found in high general employee satisfaction, cooperative behavior and efficient and

harmonious labor relations, whereas risks are connected to lower incentives as large pay

differentiation is difficult to achieve and the fact that ratios are individually perceived as unfair

could lead to dysfunctional behavior by employees (Adams, 1963; Cowherd and Levine, 1992;

Lazear, 1989) or excessive turnover (Bloom and Michel, 2002). Generally, lower pay variations

are more long-term oriented and focused on sustainable business relations improving in

tendency long-term corporate performance (Connelly et al., 2013).

Thus, as the two theories offer very different approaches to compensation structures,

policies and employee incentives and explain larger or smaller pay variations, understanding

them enables us to draw conclusions about the strategic decision approach of the firm and

their owners (Gerhart and Rynes, 2003). What is important for and what drives such family

firm compensation decisions helps in understanding why firms apply one theoretical

compensation model and not another (Astrachan and Jaskiewicz, 2008; Cruz, Firfiray, and

Gomez-Mejia, 2011). The socioemotional wealth approach provides significant insight

regarding this question by introducing the notion that family firms base their decisions

primarily on a non-economic reference point outside financial goals (Gómez-Mejía et al.,

2007). This notion enables researchers to categorize specific, sometimes illogical, family firm



Pay variation in family firms – Derivation of hypotheses



73



behavior into a comprehensible family firm specific rationale. Berrone et al. (2012)

categorized family firm goals into five FIBER Dimensions (family control, identification of

family members with the firm, binding social ties, emotional attachment and renewal of family

bonds by dynastic succession), providing a structured frame to discuss SEW reference points,

strategies and actions.

Existing research on family firms using these FIBER dimensions shows that maintaining

control over the firm (F) (Gómez-Mejía et al., 2007), fostering image and reputation of the

firm (I) (Carrigan and Buckley, 2008; Micelotta and Raynard, 2011), pursuing welfare of the

community (Brickson, 2007) or kinship ties with family surroundings (Coleman, 1990) (B),

finding belonging and intimacy in family and firm (E) (Kepner, 1983), and striving for long-term

sustainability in family succession (R) (Handler, 1990) are major SEW goals. However,

maintaining or enhancing these aspects cannot be achieved by the family or the firm alone;

other (internal and external) stakeholders and their benevolence are needed as well.

Such a relationship is discussed in the proactive stakeholder engagement approach

(PSE) of Cennamo et al. (2012), stating that it is in the best interest of family firms to include

stakeholder interests because a high degree of SEW per FIBER dimensions is correlates

positively to respective proactive stakeholder activities. As a result, if the positive perception

of stakeholders is an important goal in itself (normative viewpoint) and also a mean for

fostering SEW endowment (instrumental viewpoint), it is also clear that sustainable strategies

or appropriate behavior in line with this positive stakeholder perception goal need to be

pursued. Therefore, compensation strategies that foster SEW would need to be less conflict

and competition driven and more harmonious and cooperative. Eventually, this should lead

to a respective compensation approach affecting pay variation.

Cennamo et al. (2012) sum things up nicely by stating that "Regardless of the primary

logic behind the adoption of PSE, organizational actions that diminish the welfare of

stakeholders also reduce the family principal’s socioemotional endowment, and the opposite

would be true for actions that enhance the welfare of stakeholders. Hence, the drive to build

and preserve SEW would tend to induce family owners (who use SEW as a reference frame)

to consider the needs of stakeholders and favor care-oriented activities." (Cennamo et al.,

2012: p. 1159).



74



3.2.



Pay variation in family firms – Derivation of hypotheses



Normative SEW (FIBER) configuration and vertical / horizontal pay range



Nevertheless, not all SEW dimensions impact compensation and pay variation in the same way

and equally powerfully. Therefore, it is useful to identify which FIBER items may logically

impact pay variation the most and are therefore worth pursuing. It then makes sense to take

a step back and think more broadly about what may influences corporate compensation from

a firm perspective. There are three potential influencing factors apart from the firm and

owners themselves. First, market conditions and requirements influence entry pay through

wage levels, availability and quality of human capital. However, due to their nature they are

largely market given and can hardly be influenced (Althauser and Kalleberg, 1981; Gerhart

and Rynes, 2003; Gupta et al., 2012; Milkovich et al., 2014), reducing their importance for this

thesis. The second and third group, though, may be labeled as internal stakeholders of the

firm – (nonfamily) shareholders, employees, suppliers, customers or business partners

(Clarkson, 1995), and external stakeholders – community, government or media organizations

(Choi and Wang, 2009; Deephouse, 1996). Both of the latter may somehow influence

compensation, which will be discussed in more detail in the following paragraphs.

As internal as well as external stakeholders are of major interest, it makes sense to

refocus on the FIBER-PSE model of Cennamo et al. (2012). The model is based on the

stakeholder management (SM) claim that family firms need to address internal and external

stakeholder to be successful in the short term and even more so in the future (Donaldson

and Preston, 1995; Freeman, 2010; Laplume et al., 2008; Westley and Vredenburg, 1997). It

lies in the nature of stakeholders that they can influence or may be influenced by the (family)

firm and is therefore an important matter to address in general regarding corporate strategy

and compensation policies (Aguilera and Jackson, 2003; Freeman, 2010).

The PSE authors differentiate between the FIBER dimensions by using two criteria.

Firstly, and in line with our previous reasoning, they differentiate by stakeholder type (internal

or external), and, secondly, by the nature of this SEW-stakeholder relationship. The nature of

the SEW-stakeholder relationship is classified as being either normative or instrumental

(Cennamo et al., 2012). Normative motivation implies that by doing the right thing indirect or

intrinsic benefits such as employee or supplier satisfaction accrue (Cameron et al., 2003;

Harrison et al., 2010; Phillips, 1997; Wicks et al., 1994), whereas, by following specific



Pay variation in family firms – Derivation of hypotheses



75



instrumental goals with stakeholder activities, direct economic benefits may be achieved

(Hillman and Keim, 2001; Jones, 1995; Jones and Wicks, 1999; Surroca et al., 2010).

When recapping the FIBER dimensions in Cennamo et al. (2012)’s PSE model (see

Figure 2-1), one thing becomes apparent. By looking at the purely instrumentally motivated

relationships like family control (F) and renewal of family bonds (R), we can see that they

represent aspects of SEW that are mostly oriented towards the management of internal

stakeholders, i.e. potential rival shareholders or ambitious family members. Moreover,

Cennamo et al. (2012) classify this relationship as purely instrumental because those

stakeholder activities serve to maintain control and power in the organization, to ensure

survival of the firm, or to preserve these aspects in the future by handing over the business to

a family successor. In short, they are a prerequisite to achieving SEW goals in the short and

long-term. Thus, due to their nature and orientation, it is difficult to infer any direct influence

or motivation towards compensation as long as pay policies do not endanger SEW (F and R).

However, when looking at the remaining FIBER dimensions of Cennamo et al.’s model,

we find identification of family members with the firm (I), binding social ties (B) and emotional

attachment of family members (E) as SEW values affecting both internal and external

stakeholders to the firm and being described as normative in nature. Regarding those

dimensions, the risk of not satisfying stakeholder demands lies in the failure to live up to one’s

own expectations or family and firm values of what is right or wrong. Further, we have to

recognize that the identification dimension is both normatively and instrumentally motivated,

adding the explicit goal to portray a behavior that fosters image perception. Family firms strive

to accrue positive reputational capital and goodwill which will act like a safety buffer with their

stakeholders, triggering motivation internally and reputation externally (Fombrun, 1996). This

is favorable for family firms since family firms are risk averse (Gómez-Mejía et al., 2007), have

high ownership concentration (Casson, 1999; Gorriz and Fumas, 1996) and have the time to

monetize long-term social capital (Miller et al., 2008; Sirmon and Hitt, 2003; Zellweger

and Astrachan, 2008). Furthermore, identification and emotional attachment are also

connected to values, norms and positive social ties that often go as far as treating key

stakeholders like family that need to be taken care of (Berrone et al., 2010; Brickson, 2005;

Brickson, 2007; Dyer, Jr. and Whetten, 2006). Thus, this may affect strategic decisions or

family firm attitudes towards compensation and pay variation as we can assume that in order

to protect SEW endowment, fostering social community integration, public image and



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Pay variation in family firms – Derivation of hypotheses



reputational perception as well as emotional wellbeing for family members working in the

environment the firm and family provides (Cennamo et al., 2012; Hall and Vredenburg, 2005)

will be targeted.

Among the strongest internal stakeholders are managers and employees. Both are

directly affected by compensation policies reflected in horizontal intra TMT pay variation and

vertical TMT-employee pay range and will therefore try to influence firm behavior through

their satisfaction (Festinger, 1954; Tremblay et al., 1997), motivation, performance (Kepes et

al., 2009) and productivity or efficiency (Levine, 1991). This becomes problematical when

considering Equity Theory and its explanation of people’s reactions (Pfeffer and Davis-Blake,

1992; Siegel and Hambrick, 2005), for example, when employees demonstrate harmful

behavior toward the firm through their performance or toward colleagues in order to signal

their perception of unfair input-output ratios (Adams, 1963). Therefore, considering their

needs and managing their perception of the firm regarding fair and reasonable wages would

be in line with SEW preservation.

However, external stakeholders such as the community, suppliers or customers play a

crucial role in the outside-in perception of a firm in general and thus also likely have views on

compensation fairness and appropriateness. How important it is for firms to manage this

outside-in perception can be illustrated by analyzing how stakeholders react to CSR activities.

For example, a paper by Homburg, Stierl, and Bornemann (2013) illustrates how important

corporate



CSR



activities



are



for



strengthening



customer-company



identification



(“philanthropic CSR”) and customers’ trust in the firm (“business practice CSR”). For example,

in the banking industry, customer-centric CSR activities foster identification, satisfaction,

recommendation and repurchase behavior (Pérez and Bosque, Ignacio Rodríguez del, 2015).

A further study by Swimberghe and Wooldridge (2014) underlines the premise that even

though satisfaction may not be strongly influenced, identification and trust will be positively

related to CSR activities. Therefore, it is probable that negative associations with the firm

would also negatively impact relationships with key external stakeholders. This may be

especially true in light of current emotional pay spread fairness debates all over the world in

society and media (Paletta, 2010), and since a negative perception internally or externally may

put the family’s “sense of belonging”, identification with the firm, or their emotional

attachment and acceptance at risk in the community where they live. (Miller and Le BretonMiller, 2005; Westhead et al., 2001). Furthermore, regulatory aspects will come into play as



Pay variation in family firms – Derivation of hypotheses



77



politics intervene in compensation in the form of minimum wages (Federal Government of

Germany, 2014) or introduction of maximum pay ranges (Federal Government of Switzerland,

2014).

According to the inherent logic of the SEW-PSE relationship and the importance of

external as well as internal stakeholders on influencing SEW preservation strategies, I argue

that the normative goal of showing appropriate firm behavior is the means to gain “social

legitimacy”, improve “firm reputation” and enhance the emotional well-being of family

members, thus maximizing SEW endowment by incorporating stakeholder needs (Cennamo

et al., 2012). This will hold true especially regarding pay variation, as external and internal

stakeholders will strongly influence corporate policies through their perception of image and

reputation and related requirements of appropriateness and commensurability. This would

also be in line with family firms striving to demonstrate ethical behavior, often achieved

through role modeling (Adams, Taschian, and Shore, 1996), and the special importance of

fairness and justice rule application in a family firm environment (Baldrige and Schulze, 1999).

Further support can be found in a paper by Barnett and Kellermanns (2006) describing how

moderate family involvement positively affects fairness of HR practices and how the latter

again influence the perception of justice and fairness of non-family employees.

In summary, the endeavor of family firms to acknowledge external as well as internal

stakeholder needs, to follow their value code in doing things because they are right, in

conjunction with the strong desire to maintain a positive self-image and reputation in society

as well as fostering cooperative employee relations to maximize SEW preservation, causes us

to state that the degree of the normative FIBER dimension importance will significantly

influence vertical and horizontal pay range in general. Also, regarding the next hypotheses,

we will focus individually on the effect of the normative FIBER items on pay variation.

Hypothesis 1: Normative SEW endowment is related to pay range.



78



3.2.1.



Pay variation in family firms – Derivation of hypotheses



Identification of family members and vertical / horizontal pay range



The connection between the individual family member, the family and the firm is key to the

dimension identification of family members with the firm (Berrone et al., 2012). However, the

family internal perspective is not enough considering that organizational identity strongly

impacts how internal and external stakeholders are addressed, how their demands are

integrated into family firm actions and how aspects such as values, norms, philosophy drive

firm behavior (Ashforth and Mael, 1996; Brickson, 2005; Brickson, 2007). The identification

dimension is the only dimension that incorporates an instrumental one on the external

stakeholder side and a normative one on the external and internal stakeholder side (Berrone

et al., 2012; Cennamo et al., 2012).

A central underlying aspect of both normative and instrumental stakeholder

engagement can be found in the actual or perceived inseparability of family, individual family

member and firm behavior leading to the situation that identification among all parties is so

close that the action of any one party is likely to directly cause repercussions on another

(Anderson and Reeb, 2003; Tagiuri and Davis, 1996). And more concretely, any action of the

firm may positively or negatively directly impact social capital such as reputation, image,

status, social wealth and/or acceptance of the individual and/or family (Dyer, Jr. and Whetten,

2006; Kets de Vries, 1993; Zellweger, Eddleston, and Kellermanns, 2010). These negative

repercussions need to be considered when dealing with both internal and external

stakeholders and are amplified by the potential coexistence of the family name with the firm

name (Tagiuri and Davis, 1996). This may even lead to the connection of family reputation

with firm survival (Anderson and Reeb, 2003), or vice versa, firm image to the persistence of

the individual and the family in its established surroundings.

Starting first with the more instrumental aspects, the identification dimension

significantly influences the attitude and actions of the family and by extension the firm on its

external stakeholders such as the community, regulatory or media landscape. Negative

attributions to the family, such as perceived failure as corporate citizen are feared (Adams et

al., 1996; Dyer, Jr. and Whetten, 2006; Kets de Vries, 1993) and need to be avoided at all costs

to preserve SEW (Cennamo et al., 2012). Family members are highly sensitive to such issues

(Micelotta and Raynard, 2011) and their strong connection may cause family members to

experience any harm or public condemnation to this SEW endowment as potentially



Pay variation in family firms – Derivation of hypotheses



79



distressing and troubling (Westhead et al., 2001). This does not imply that family firm owners

have unconditional respect for social issues, but they do view their management as an

essential part of stakeholder management that need to be addressed in operations and

strategy (Cennamo et al., 2012). Thus, concrete PSE activities are carried out with the explicit

goal of lobbying on behalf of the firm and its behavior to generate positive impulses about

firm reputation, additional benefits and SEW endowment (Choi and Wang, 2009; Deephouse,

1996; Deephouse and Jaskiewicz, 2013).

However, not only instrumental aspects cause the dimension identification of family

members to influence pay variation via PSE. The family firm provides not only financial security

for family members but also a place where they can realize their ambitions, build self-esteem

and find individual fulfillment (Kepner, 1983; Westhead et al., 2001). The connection of family

and firm helps not only firm survival but also enables the family to incorporate their values,

beliefs and self-image into the firm. The firm may serve as an extension of the family and

implementing actions towards internal and external stakeholders based on what is believed

to be right, reflects family values (Cennamo et al., 2012; Sharma and Manikutty, 2005;

Westhead et al., 2001). Since these values are so important to the family, they represent an

SEW frame in themselves and just by their implementation, no matter how it is recognized by

external and internal stakeholder. Still, as they are so important, implementation becomes a

paramount and natural part of corporate behavior resulting in the perception of being a

positive part of society (Berrone et al., 2012; Cennamo et al., 2012; Lyman, 1991). From a

normative point of view, the actions fostering SEW endowment by taking stakeholders needs

into account is the right thing for the family to do and must be pursued independently of

immediate or economic gains.

As a result, the striving for a high SEW endowment in terms of identification of family

members with the firm will lead to higher levels of corporate social responsibility and

“community citizenship” influencing key corporate aspects of compensation and pay

distribution (Berrone et al., 2010; Craig and Dibrell, 2006; Dyer, Jr. and Whetten, 2006). From

an external stakeholder viewpoint this would imply that compensation structure within an

organization needs to be appropriate and excessive abuse of employees through low wages

or exorbitant compensation of TMT members would eventually lead to negative social

awareness in the community at large and might cause negative consequences in the media

and among other stakeholders, such as suppliers or customers that may no longer identify the



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Pay variation in family firms – Derivation of hypotheses



non-compliance of the respective firm with their values. Furthermore, a growing public

discussion in the media and society that critically assesses large pay variations will increase

urgency and priority of this matter for family firms. As a consequence, to address external

stakeholder needs and to maximize SEW endowment, applying lower pay variations

horizontally and vertically seems reasonable if identification is a frame of reference for the

family firm.

From an internal stakeholder point of view, it is justifiable to assume that the longterm orientation (Miller et al., 2008; Sirmon and Hitt, 2003; Zellweger and Astrachan, 2008),

ownership concentration (Casson, 1999; Gorriz and Fumas, 1996) and risk aversion (GómezMejía et al., 2007) of a family firm, will lead it to acknowledge demands for employee

satisfaction, and to trigger motivation to improve willingness to cooperate and to contribute

to the enhancement of the firm (Carrigan and Buckley, 2008; Teal et al., 2003).

Thus, family firms are likely to choose a more Equity theoretic compensation approach

with lower pay variations that suits their nature better and leads long-term to greater success

(Connelly et al., 2013). This takes precedence over short-term motivational triggers such as

compensation tournaments (Frank and Cook, 1995) which could cause negative feelings

toward the family and the firm on all levels, or might undermine firm culture through

disruptive pay structures. Furthermore, risks related to Tournament structures, such as

aggressive management behavior and risk-taking or a continuously competitive atmosphere

(Becker and Huselid, 1992; Siegel and Hambrick, 2005) in which employees may even start to

sabotage their peers (Adams, 1963) would risk family members’ ability to identify with the

firm and should thus be avoided. Therefore, I hypothesize that family firms placing importance

on identification of family members as point of reference will show lower vertical and

horizontal pay variation.

Hypothesis 2a: The degree of identification of family members with the firm is negatively

related to vertical pay range.

Hypothesis 2b: The degree of identification of family members with the firm is negatively

related to horizontal pay range.



Pay variation in family firms – Derivation of hypotheses



3.2.2.



81



Binding social ties and vertical / horizontal pay range



Binding social ties describe the “embeddedness” of the family firm in its social, community

and economic environment in order to create an atmosphere of benevolence and to accrue

positive social capital (Cennamo et al., 2012; Rowley, 1997). These social ties may exist with

internal and external stakeholders and are of major importance for a family firm in

maintaining its SEW endowment as they are generally reciprocal in nature (Berrone et al.,

2012). This interdependency in the relationship is independent of financial utilities (Choi

and Wang, 2009; Mattingly, 2004) and causes family firms and owners to keep the living

conditions and welfare of these relational counterparts in mind and improve them if possible

(Brickson, 2005; Brickson, 2007). This may go as far as creating a sense of kinship standing

security, relational trust and other normative social benefits connected to such relationships

(Coleman, 1990; Ouchi, 1980; Uzzi, 1997).

Family firms tend to be deeply embedded in the surrounding community and

environment creating a sense of belonging and mutual identity that is often also shared by

non-family employees (Berrone et al., 2010; Miller and Breton-Miller, 2005; Miller et al., 2009;

Uhlaner, 2006). In fact, research shows that pursuing this SEW dimension, for example,

through community work, may even result in negative financial implications for the firm (Choi

and Wang, 2009; Mattingly, 2004). Nevertheless, benefits arising from these bonds also create

social capital representing a value that can help to improve long-term employee as well as

customer and supplier relationships (Sirmon and Hitt, 2003; Uhlaner, 2006). A positive

engagement may create feelings of solidarity, cohesion and intimacy not only within the family

but also extending to other stakeholders and often employees in particular (Cruz, GomezMejia, and Becerra, 2010). Evidence from prior research indicates that these ties within the

family cause firms to support family members in positions no matter their individual

performance (de Ia Cruz Déniz Déniz and Cabrera Suárez, 2005; Gomez-Mejia et al., 2001) but

outside the family they may protect employees by preventing restructuring (Stavrou, Kassinis,

and Filotheou, 2007), even though it may be economically advisable, enhancing quality of life

of employees (Stavrou and Swiercz, 1998), providing stable employment (Stavrou et al., 2007),

reducing hiring rather than dismissing employees (Bassanini et al., 2013) or providing “caring

contracts” with their workforce (Cruz et al., 2010).



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