An agency theoretic analysis of the professionalized family firm.(Report)

The professionalized firm must evaluate the performance of managers and provide incentives that will motivate them to achieve the firm's goals. Using the agency theoretic framework we develop propositions on how differences in goals, altruistic tendencies, and strategic time horizons might affect performance evaluation and incentive compensation in family firms that employ both family and nonfamily managers and how these differences would affect the performance of the professionalized family firms relative to that of nonfamily firms.

Introduction

Many entrepreneurial firms involve family members in governance, management, and/or ownership (Chua, Chrisman, & Chang, 2004). Such family involvement may influence the goals pursued (Lee & Rogoff, 1996), the firm's strategic time horizons (Gallo & Vilaseca, 1996; Le Breton-Miller & Miller, 2006; McConaughy & Phillips, 1999; Sirmon & Hitt, 2003), and the altruistic tendencies of owners (Schulze, Lubatkin, & Dino, 2003; Schulze, Lubatkin, Dino, & Buchholtz, 2001). As these entrepreneurial family firms expand, they must by necessity start to employ nonfamily managers because there are only a limited number of able and willing family members. In the process, the family firm faces the challenge of professionalization, which involves changes in the firm's authority relationships, norms of legitimacy, and incentives (Gedajlovic, Lubatkin, & Schulze, 2004).

Of particular concern in this article are the formal performance evaluation and incentive compensation that must be developed in a professionalized firm. Studying performance evaluation and incentive compensation in professionalized family firms, aside from being important in its own right because of the ubiquity of family business (Astrachan & Shanker, 2003), can help us better understand the ways various aspects of firm governance affect one another in professionalized firms.

In this article we use agency theory to examine performance evaluation and incentive compensation in firms with and without family involvement and the implications for firm performance. Agency theory has been used extensively to explain how the working relationship between owners and managers affects firm performance (Eisenhardt, 1989) and the theory provides one of the two leading theoretical explanations for the distinctiveness of family firms (Chrisman, Chua, & Sharma, 2005). Building on the predictions of agency theory regarding incentive compensation, we focus on implementation issues arising from family involvement-induced differences in goals, altruistic tendencies, and strategic time horizons. The propositions point to reasons why professional management might be more difficult in family firms.

This article contributes to the literature by describing how professional management is more complicated and creates unique challenges for family firms. We examine how these challenges are likely to influence the relative policies and performance of family firms versus nonfamily firms using the codified agency theory framework to provide a rigorous discussion of these issues and help pave the way for other, more sophisticated applications. In the process, we explain how seemingly irrational family manager compensation and behaviors are very rational given the self-interest pursuing economic persons assumed in agency theory.

Theoretical Context