The complexity that is the field of “remuneration” of owner-managers in family businesses. This can feel like unchartered territory, with no prescriptive methodology on how to navigate it. Many founders of businesses are owner-managers; they are owners of their businesses, whilst they work as managers in their businesses.
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The complexity arises because owner-managers often have conflicting objectives: in one breath they desire a long-term return on investment, and in another they desire short-term job and financial security in the form of fair salaries. Often confronted by frequent reminders by other stakeholders of their status as “owners”, founders often assume an identity that is owner-dominant as opposed to manager-dominant.
In William Shakespeare’s play, King Richard IV Part 2 is quoted to have said “Heavy is the head that wears the crown”. Many owners relate to this sentiment: the crown of headship comes with a cost; a cost of time and money. This often also entails sacrificing their needs as managers, deferring and/or foregoing salaries to free up cash flow to enable operational and capital expenditures to be met.
This mindset though altruistic and well-meaning can be detrimental to the longevity of the business if pursued perpetually, as the owner-manager may become resentful towards this “free-riding business”, particularly where the founder has limited alternative sources of income.
The “Free-Rider problem” is a phenomenon that occurs in social sciences, where a public good has undeniable social benefits to many, however these benefits are either not paid for, or are not paid an amount commensurate to the benefits derived. The consequence of this compensation-benefit mismatch is market failure: where the good is under-produced, overused or degraded. Similarly, where founders are not appropriately remunerated for their day-to-day managerial activities over a long period of time, there may be negative consequences. This can leave the founder frustrated, demotivated and uncommitted.
Free-Riding occurs where rights are not clearly defined and imposed. To avert its negative consequences, founders must be aware of their multiple roles, clearly define them, and enforce their rights. This includes ensuring that their remuneration is delineated and is reflective of market rates.
This culture of clarity and discipline is key particularly for family businesses crossing the generational gap into second generation: where remuneration strategies are ambiguous and/or arbritary, the business may struggle to attract and/or retain the next generation in the business. Furthermore it may cause conflicts in the family. Consider a scenario where all children (those in and outside the business) receive equal amounts from the founder, those in the business may be demoralised.
As best practice, it is critical to separate remuneration according to:
Salary – this should be based on market value;
Bonuses – subject to achieving individual performance goals;
Dividends – returns on investment; and
Gifts – to family members
