Volume 2 Issue 7 - 2009
HR in the Boardroom | Boards Focus on their CEOs | Paying the Family | Increasing Board Effectiveness 

Compensating Family Members in Family-owned Company

Addressing the Demands of the Younger Generation

Richard Payne 

The challenges

Management structure and compensation

After operating for almost 50 years, ABC Company, a family-owned business based in Hong Kong, had reached a turning point. Family members had run ABC since its inception, but now, third- and fourth-generation descendents of the founder were becoming increasingly reluctant to join management ranks. The problem was that the management structure and the method of compensating family members were no longer working. The result was that many were opting out for more lucrative positions in major multinational companies and financial institutions. Something had to be done.

As long as first and second-generation heirs of the founder ran the company, the management structure and compensation was not an issue. The founder and his direct heirs ran the company in an informal manner and they made all of the important decisions. Family members received as compensation a modest base salary and a miniscule bonus; however, it was the dividends that each received from their shareholding that made the compensation attractive.

Corporate culture with weak accountability

The informal approach extended to accountability as well. The absence of explicit performance expectations and of a structured appraisal process, led to a culture of weak accountability.

ABC could no longer sustain this approach as time passed and third- and fourth-generation descendant entered the business. A “Family Council” replaced the founder as the overseer of the dispersed activities of the now far-flung business. More and more family members took on jobs across the enterprise without a clear set of roles or responsibilities. New businesses were created, but none of them were run with the objective of eventually listing them and of unlocking value for the Family. Such businesses remained small and inconsequential. As for compensation, the company shares (and the associated dividends) became spread thinly among the increasing number of family-member employees. Plus, many family members who owned shares (and received dividends) were not employees. 

Expectations

Expectations were an additional problem. Unlike the first and second generation, who had grown up entirely within the company, the third and fourth generation had worked in major multinational companies (MNC) prior to joining the family business. They came in to the firm expecting to see a competitive compensation package, similar to that of a MNC, comprised of base salary, bonus and long-term incentive. Unfortunately, the modest base salary, minuscule bonus and increasingly unattractive dividend amount did not add up to much. Increasingly many were asking, “Why should I give up my job outside the company to take a job within the family-owned company and settle for compensation that simply is not competitive?”

As a result, the company decided to review their entire compensation philosophy. They fixed on three requirements:

• “We need to pay family executives competitively.” 
• “We need to motivate our senior family executives to achieve higher levels of performance, by providing them with more upside on performance-based reward.” 
• “We need to align the interests of family executives with little or no shareholding with shareholder value creation.”

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The approach and desired outcomes

Aon Consulting devised an approach to address these issues head on.

1. “We need to pay family executives competitively.”

• Determine an appropriate Target Total Compensation positioning for each of the family executives to ensure that their compensation opportunity is competitive.
• Determine an appropriate compensation mix for each family executive.
• Separate compensation from family ownership.

The planned outcome was a policy of Compensation Positioning, Structure and Mix for senior executives, regardless of whether they were family members or not.

2. “We need to motivate our senior family executives to achieve higher levels of performance by providing them with more upside on performance-based reward.”

• Design a short-term incentive plan and link it to appropriate performance metrics in order to motivate family executives.

The planned outcome was a Short-term Incentive Plan Design accompanied by performance metrics for the Group and for its Business Lines.

3. “We need to align the interests of family executives with little / no shareholding with shareholder value creation.”

• Design a long-incentive plan to align all family executives to shareholder value creation.
  The planned outcome was a Long-term Incentive Plan Design.

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The findings and recommendations

Analysis criteria identified

Aon Consulting benchmarked the compensation level and mix for each family executive against executives in peer group companies in Hong Kong. The analysis covered a comparison of their base salaries and bonuses. Plus, it looked at long-term incentives over a period of time in order to give them a sense of where they stood now and historically relative to their peers. The compensation comparison was complemented by a comparison of the performance of ABC’s listed company over the last three years with that of a set of peer-group companies.

The findings

Aon’s finding was that ABC was at the bottom quartile both in terms of compensation and corporate performance – their pay matched their performance. Clearly the issue was how to raise both in tandem, i.e. raise performance to justify higher pay and use higher pay to attract and retain the higher performing family members.

Our recommendations

To address this concern, the Aon Consulting team proposed a compensation structure for all executives (not just members of the family) that combined:

1. A modest base salary increase to bring salaries to the lower end of a competitive range;
2. A substantial enhancement of performance bonus payout; and
3. The introduction of a long-term incentive to replace the dividend as a form of compensation.

These reforms were designed to provide an extra incentive so that aggressive, high-performing individuals could benefit from a significantly higher bonus and new share options. They were also meant to establish a clear allocation of roles and responsibilities among senior executives and bring family member compensation in line with market norms.

Revising the short-term incentive plan

The plan for the short-term incentive plan, i.e. annual bonus, was straightforward. It included details on the calculation for payouts, the metrics that pay should be linked to, which executive would run on which company's performance, and what weightings there should be for each performance metric component.

Redesigning the long-term incentive component

The proposed long-term incentive component was an equally important part of a competitive compensation package, but its design was more complex and challenging. A valuation of the shares in the holding company was problematic: ABC is family-owned and an unlisted entity. The complexity of valuation is compounded by the fact that ABC owns majority shareholding in a listed company as well as 100% ownership in numerous unlisted private entities.

Other proposed solutions

Aon Consulting proposed a two-part solution. For the listed entity, the recommendation was for a share options plan to be put into place that would cover executives working for the listed company. For the unlisted entities, ABC would conduct a valuation exercise to estimate the value of the holding company shareholding. Executives with responsibility for the private entities would have the opportunity to earn performance shares in these entities based on this valuation. As a first step in this process, Aon consultants recommended that ABC create a plan to move the private entities toward an initial public offering (IPO), which would start with an audit of the financial results for the unlisted entities.

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The challenging next steps ahead

The corporate culture

ABC faces significant cultural challenges in implementing these recommendations. The company’s reformers must overcome significant opposition in order to implement the needed changes. The 50-year history of family control of the company appears to have entrenched a culture of “rights” rather than “opportunities” among the senior family executives who comprise the Family Council. It would seem that these family executives believe they have a right to receive a dividend and have the right to a job (if they want it) in the company. For most senior family executives, their primary concern related to the project was how to make base salary competitive. Bonus was a distant second priority.

As the Aon consultant put it, “People who were used to two- or three-months bonus as a maximum bonus payout could now make up to 12 months bonus under certain exceptional circumstances. Instead of looking at this as a serious opportunity to make money, they were clamoring over the base salary increase, which was miniscule in comparison. For them, the incentive opportunity was inconsequential.”

The way forward

Overcoming these entrenched attitudes will be critical to the future success of the company. A clear-cut compensation structure and short-term incentive performance architecture is ready for implementation. The outline for a long-term incentive plan is also complete. If ABC is serious about taking their company to a higher level, they will use the architecture and plan to begin building a performance-driven culture. Strong leadership and effective planning accompanied by experienced and thoughtful advice from external consultants could make it happen. The leadership must now decide whether to rise to the challenge of fulfilling the company’s promise.

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Contact

For more information about Aon Consulting’s capabilities and consulting work and in compensation, please contact Na Boon Chong, Director, South-east Asia Consulting at boon_chong_na@aon-asia.com.

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