Remuneration of family members in family businesses: challenges and possible solutions.

How to remunerate family shareholders active at different levels of the family business? In its regular contacts with the Belgian family business community, GUBERNA found that many family businesses ask themselves this question. For example, some ask to what extent family shareholders should be compensated for a directorship if they already receive a dividend as shareholders, or a salary as managers of the company. The answers often vary according to the size and maturity of the company. In this article, we take a look at the compensation practices of family members in family businesses, identify the main challenges and suggest some best practices for family businesses and their boards.

In practice, family members can play or combine different roles in the family business, and different compensation practices exist for each of these roles. 

• Each family member's “basic” role is usually that of a shareholder, for which he or she receives no specific remuneration. However, as a shareholder, one usually receives a dividend as a reward for the capital invested in the company and for the financial risks assumed. Here, we can refer to GUBERNA’s article on dividends in family companies.
• In addition, family members often have an executive role in the company. There is a clear tendency to compensate family members in the same way as non-family members in the same position, based on objective criteria. For example, a study by Michiels et al (2012) shows that there is a positive relationship between the financial performance of the family business and the use of performance compensation, including for family members who are active in the business. A similar trend can be observed with regard to the selection for a position within the family firm: the same procedure is applied for family and non-family candidates, based on well-defined criteria; the family candidate is preferred only when competencies are considered equal. Such practices are more relevant and prevalent for higher positions in the company's hierarchy.
• Finally, the family member may also play a role as a director of the company. In small first- or second-generation family companies, this role is usually not remunerated as such. This changes when outside directors join the board: while in an initial phase only outside directors often receive a remuneration for their mandate, in more mature companies it is common for outside and family directors to receive the same fixed remuneration, whether or not combined with a presence fee. Our onw GUBERNA study on the governance practices of candidates for the Family Business Award of Excellence (3rd generation or more) shows that more than 9 out of 10 family-owned companies compensate directors for their mandate. Since all directors (family and non-family) have the same mandate and responsibility, it is common for them to be all compensated in the same way. Nevertheless, in mature and internationally active family companies, given the complexity and challenges facing the company, the board may wish to recruit directors with an international and highly specialised profile. Typically, these profiles are expensive on the international market. The company will then have to choose between an equal increase in remuneration for all directors (which could lead to tensions between family shareholders who sit on the board and those who do not, see below), or a differentiated level of remuneration, with the risk of creating a two-speed board.

The above findings are even more evident in listed family firms, as good governance requirements are stricter and more tightly controlled there. However, the trend towards professionalisation and equal treatment of family and non-family members can also be observed in unlisted family companies.

Remuneration of family shareholders is a major challenge for family businesses for several reasons. First, it is about avoiding tensions and conflicts: as family members may be active at different levels of the family business, often together with non-family members, it is easy to imagine that compensation practices are a source of diverging perceptions on fairness and merit. This can lead to tensions between family members and non-family members, and between active and inactive family members. A second reason is that compensation is now considered a tool of choice to align the various parties involved with the company's interest. It is seen as a lever for achieving the company's long-term strategy. In short, remuneration goes to the heart of good governance.

In this context, what are the good reimbursement practices that can address the above challenges? While there is no single recipe ("there is no one size fits all"), there are some best practices worth mentioning.

• Family businesses usually have great freedom in terms of compensation, as there exist few legal or extra-legal rules on the subject. Nevertheless, it is advisable to develop a coherent compensation policy.
• The remuneration policy for family members active at the different levels of the company can be formalised in a family charter, as for example recommended by the Belgian “Buysse III Code”, the reference code for unlisted companies. In any case, the policy should also be communicated to all relevant persons, in order to achieve transparency and clarity for everyone. The level of remuneration should preferably be explicitly linked to the education, skills and experience required for each position (director or executive). On the other hand, the main issue is to anticipate and provide “in tempore non suspecto” ground rules that must be respected before problematic situations arise. Without predetermined ground rules, solutions to specific situations can be quickly perceived as personal and arbitrary.
• Remuneration policies should also take non-family members into account. In this context, the principle of equity ("fairness") is crucial: ensuring that both family members and non-family members feel they are treated fairly. To achieve this, family businesses need to strike a balance between meritocracy and legitimacy.
• At board level, remuneration of family members (on top of dividends) is not mandatory, but is recommended to make them accountable, enhance the credibility of the position, and avoid misunderstandings about their rights and duties related to the position. Before that, it is good practice to work with a job description for board members and link remuneration to expectations in terms of attendance, personal investment, preparation, professional development, etc. 
• The creation of a remuneration committee at board level can contribute to the objectivity of the choice regarding evaluation and remuneration of family members, and even selection if the remuneration committee and the nomination committee are combined. Article 5.31 of the Buysse Code III states: “In family businesses, it may be useful for the remuneration committee to have the power to make recommendations regarding all family members working in the family business, including outside the board and management, and to follow up on this.” This role will be strengthened if the remuneration committee is predominantly composed of independent/external directors.
• It is important to avoid excessive formalism. Remuneration rules should not inhibit entrepreneurship and the voluntary and spontaneous initiatives that characterise family businesses.

In conclusion, we found that family firms compensate family members differently depending on the role they play at different levels of the company. These compensation practices need to align different interests to achieve the company's strategy and create sustainable value, while promoting a stable and sustainable shareholder base. Although companies are not obligated to provide a remuneration to a family shareholder who is active in the family business as a director, in addition to the dividend, it is advisable to provide for a remuneration for family directors. This avoids misunderstandings about their rights, duties and responsibilities related to the position and increases the credibility of their position. Preferably, the practices should be formalised in a clear and transparent remuneration policy.

To continue the debate, GUBERNA and Hudson launched a platform dedicated to the remuneration committee, with a focus on family businesses. The platform will cover various topics such as the role of the remuneration committee, its functioning and new trends in remuneration. Are you interested in contributing to this platform? Do not hesitate to contact us!