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Are company founders underpaid?Konstantinos Tzioumis aa Compliance Risk Analysis Division, Office of the Comptroller of the Currency ,Washington , DC 20219 , USAPublished online: 20 Apr 2012.

To cite this article: Konstantinos Tzioumis (2013) Are company founders underpaid?, Applied Economics, 45:18, 2527-2536,DOI: 10.1080/00036846.2012.669463

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Applied Economics, 2013, 45, 2527–2536

Are company founders underpaid?

Konstantinos Tzioumis

Compliance Risk Analysis Division, Office of the Comptroller of the Currency,

Washington, DC 20219, USA

E-mail: kostas.tzioumis@occ.treas.gov

This article examines the relation between founder status and CEO compensation in

publicly listed US firms. The results suggest that CEO/founders receive lower cash pay

and total compensation compared to professional managers. In contrast, CEOs who are

relatives of the founders receive similar cash pay and total compensation to that of

professional managers. Different compensation levels also emerge in terms of stock

option awards. The findings underline the importance of distinguishing among these three

CEO types when examining the determinants of executive compensation.

Keywords: founders; executive compensation; stock options; repricing

JEL Classification: G30; J33; M52

I. Introduction

Rarely do the media report on executive compensation without

referring to a CEO who is the company’s founder, portraying

the CEO either favourably as a model of low compensation or

adversely as an entrenched individual commanding excessive

remuneration.1 Aside from these extreme illustrations, it is

commonly understood that founders are different from pro-

fessional managers in terms of entrepreneurial abilities and

firm-specific human capital. Given that the phenomenon of

CEO/founders is widespread in publicly listed firms in the

Unites States, a systematic look at their incentives structure

would improve our understanding on managerial incentives.

This article examines the relation between founder status

and CEO compensation in public firms in the United States. In

particular, it focuses on the issue of CEO compensation when

the CEO is either the founder or a relative of the founder,

using a large panel of the US firms between 1992 and 2001

with data for 2478 CEOs in 1915 companies, a total of 9867

CEO-year observations. After controlling for a number of

CEO and firm characteristics, it is found that founders’

compensation is different in terms of size and mix, compared

to that of professional managers. Nevertheless, whether the

CEO is the founder or a relative of the founder does not affect

the likelihood of stock option repricing. Overall, the article

contributes to the literature on CEO compensation by illumi-

nating the different incentive structures between founders and

their relatives, thus offering a potential explanation for the

mixed evidence on executive compensation in founder- and

family-controlled firms.

The remainder of this article is organized as follows.

Sections II and III present the hypotheses and offer an

overview of the related literature, respectively. Sections IV and

V outline the data design and the empirical methodology,

while the findings are analysed in Section VI. Section VII

summarizes the results and offers conclusions.

II. Hypotheses

When the CEO of a large public firm is either the firm’s

founder or relative of the founder (hereafter the terms

‘CEO/founder’ and ‘CEO/relative’ will be used, respectively,

to describe these cases) there are several important implica-

tions. For instance, CEO/founders usually own a considerable

stake of their firm’s equity, and their families often own an

even larger stake, thus offering advantages in monitoring and

control (Fama and Jensen, 1983). Notably, this effect is not

1 For instance, in Forbes’ 2001 list for the ‘best value’ CEOs, all CEOs in the top 5 were founders or co-founders of their company [namely,W. Buffett (Berkshire Hathaway), K. Adams Jr (Adams Resources and Energy), E. Harari (SanDisk), D. Miller (Biomet), A.West Jr (SEIInvestments)]. On the other hand, the cases of company founders L. Ellison (Oracle), S. McNealy (Sun Microsystems) and H. Silverman(Cendant) were repeatedly used in the press during the 1990s in order to illustrate allegedly exorbitant CEO compensation.

Applied Economics ISSN 0003–6846 print/ISSN 1466–4283 online � 2013 Taylor & Francis 2527http://www.tandfonline.com

http://dx.doi.org/10.1080/00036846.2012.669463

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captured in studies that solely focus on levels of CEO

ownership.2 Moreover, CEO/founders are particularly inter-ested in the conservation of the firm, since they predominantly

hold undiversified portfolios and face increased reputationconcerns (Casson, 1999; Anderson et al., 2003).

Agency theory predicts a negative relationship between riskand performance pay, or alternatively a positive relationship

between risk aversion and performance pay. If wealth is aproxy for absolute risk aversion and founders are wealthier

than professional managers, then one would expect thatCEO/founders receive more stock-based compensation, even

though they would become further undiversified (Becker,2006). Although it is not feasible to collect accurate data on

individual CEO wealth (firm-related and nonfirm-related),

based on anecdotal information it seems plausible thatfounders in publicly listed firms are wealthier than professional

managers. For instance, Conyon (2008) suggests thatCEO/founders’ wealth is about 80% greater than nonfounders

after calculating the value of shares and options for CEOs offirms in the Russell 3000 index during the period 2003–2005,

and adjusting for individual and firm characteristics. Thiswealth gap could also explain why many CEO/founders opt to

receive little salary. For instance, during our sample period(1992–2001) we find many CEO/founders who received a

symbolic salary of $1, such as Thomas Siebel (Siebel Systems),Steve Jobs (Apple), Richard Kinder (Kinder Morgan) and

Richard Manoogian (Masco). Similarly, when focusing at the

lowest quartile of CEO cash pay in our sample, we find 31.9%of all CEOs to be founders, even though they comprise 17.8%

of the overall sample.CEO/founders also enjoy more years at the helm of a firm

compared to professional managers since they are recognized

for their firm-specific human capital and entrepreneurial

activity, thus becoming less mobile in the managerial labourmarket.3 Figures 1 and 2 reflect this sharp tenure differential in

our sample. Compared to professional CEOs, founders have

substantially longer CEO tenure both across time and across

age groups. Moreover, the median tenure for professional

CEOs is surprisingly stable across our sample period and after

controlling for age. These patterns have a direct implication on

the likelihood of exercising stock option awards since stock

options are nontransferable and typically vested after 2–3 years.

Overall, in light of wealth and tenure differentials, we

expect that CEO/founders receive more incentive-based

(i.e. stock-based) compensation and less cash pay. Our

hypothesis for CEO/founders’ compensation is also supported

by the management literature’s stewardship theory, which

asserts that an executive could be motivated intrinsically

through psychological attachment and organizational citizen-

ship, aside from the typical monetary incentives that are

described in economic theories (Davis et al., 1997; Wasserman,

2006).Compared to the CEO/founders, we expect CEO/relatives

to receive a different compensation structure with less

incentive-based compensation due to their increased entrench-

ment capacity. When CEO succession is drawn from within the

founder’s family, it signals a strong founder grip on the firm.

In turn, this grip could increase CEO entrenchment by

reducing the monitoring capacity of the board and influencing

the board’s agenda and composition. In the absence of critical

evaluation by board members, CEO/relatives are less scruti-

nized about their decisions, often resulting in adverse conse-

quences for the future performance of their firms (Bertrand,

2009). Furthermore, heirs to the CEO position that are drawn

from the founder’s family may be considered inefficient

choices since they are selected from a smaller pool of potential

successors, have experienced a quicker advancement within the

0

5

10

15

1993 1995 1997 1999 2001

Founder

Professional managerM

edia

n C

EO

Ten

ure

Year

Fig. 1. CEO tenure across the sample period

0

5

10

15

<50 50-54 55-59 60-64 >=65

Founder Professional manager

Med

ian

CE

O T

enur

e

Age group

Fig. 2. CEO tenure across age groups (for year 1997)

Notes: Figs 1 and 2 show the median tenure (in years) as CEOacross founders and professional managers. We choose taking themedian tenure of active CEOs, rather than looking at tenure at thepoint of CEO turnover, in order to avoid introducing selectionbias given that CEO/founders are less likely to experienceturnover.

2 For instance, in NACCO Industries, Alfred M. Rankin Jr (CEO and grandson of the firm’s founder) owns approximately 12% of thefirm’s equity, while the rest of the Rankin family collectively owns about 55% (Source: Hoovers Online, 2003).3 Bhide (2000) conducted a survey on entrepreneurship in the US and found that the majority of founders of successful firms had no priorexperience in the industry they were entering. Moreover, he finds that most successful founders (as distinguished from small businessentrepreneurs in general) aspire to create a large, national, or multinational company and intend to do whatever is required to achieve thatobjective. Holmes and Schmitz (1990) have captured these particular functions of founders in a formal theory of entrepreneurship.

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firm, and their placement sometimes follows a clash among

family members over the CEO selection. Moreover, despite the

fact that they enjoy higher confidence from family share-

holders compared to an outsider, CEO/relatives have only

firm-specific knowledge (without the entrepreneurial ability of

the CEO/founder) thus making them less competitive in the

labour market for executives. As a result, it is often considered

that the promotion of founders’ relatives in the CEO position

encourages nepotism, exacerbates agency problems and poten-

tially mitigates competition in the market for corporate

control, thus reducing efficiency and stockholders’ wealth

(Schulze et al., 2001). Overall, we expect relatives of the

founder to receive CEO compensation that is less sensitive to

future firm performance, such as higher levels of cash pay and

lower levels of stock-option compensation.Besides the level of compensation, stock option repricing is

often suggested to be another facet of entrenchment (Chance

et al., 2000; Bebchuk et al., 2002).4 Generally, the rationale

behind repricing is to protect managers’ incentives in the event

of market-wide fall in stock prices. However, the business press

and institutional investors have greatly criticized this practice

as it could potentially reward management for firm-specific

poor performance that is not related to an industry- or market-

wide downturn. Based on their hypothesized entrenchment

capacity, we expect to find a positive relation between

CEO/relatives and the likelihood of repricing. On the other

hand, based on agency considerations, we do not expect

CEO/founders to be associated with a higher likelihood of

repricing.

III. Related Literature

The literature provides mixed results for CEO/founders’

compensation. Two recent studies by Conyon (2008) and He

(2008) find that CEO/founders receive both lower incentive

compensation and lower total compensation. In particular,

Conyon (2008) uses firm data from the Russell 3000 index

during the period 2003–2005, while He (2008) contrasts CEO/

founders and professional CEOs in 1143 newly listed firms that

had an IPO between 1998 and 2002. Unlike these two

aforementioned studies, Rose and Shepard (1997) find insig-

nificant effects on cash pay and total compensation when the

CEO is the firm’s founder. However, their data come from a

period (i.e. 1985–1990) in which stock options were not

widespread as a form of executive compensation. Anderson

and Bizjak (2003) find a significant positive correlation

between founders and CEO stock options, as well as total

compensation. Yet, their definition of CEO/founders does not

distinguish between firm founders and members of the

founding family and their sample of 110 firms over the

period 1985–1998 could be subject to firm survival bias.

Gomez-Mejia et al. (2004) base their study on the examination

of 253 family-owned firms during the period 1995–1998 and

find only a moderate negative estimate on CEO cash pay when

the firm’s CEO is a member of the founding family, compared

to professional CEOs. At the same time, they find no

significant effect on the CEO compensation from founder

status. However, their paper studies only firms in which two or

more directors must have a founding family relationship and

in which family members own or control at least 5% of the

voting stock. Thus, due to their sample selection criteria,

Gomez-Mejia et al. (2004) do not take into account high

technology firms (e.g. National Association of Securities

Dealers Automatic Quotation (NASDAQ) firms) that came

into prominence in the 1990s and often had no other family

presence besides the CEO/founder.Unlike these aforementioned papers on the topic of CEO

compensation for founders and their relatives, this study

focuses on listed US firms during a period in which stock

options became a major component of CEO compensation

(i.e. 1990s), deals with a uniquely large sample, and

distinguishes between founders and their relatives (i.e. children

of the founder of the firm, or otherwise family-related to the

founder, such as nephew, grandson, great-grandson, etc.).5

Hence, this study takes into account of even firms where there

is no other family present in the firm besides the CEO, and do

not fit with the description of the traditional ‘family business’,

employed by Gomez-Mejia et al. (2004). By and large, this

article also corresponds to a growing interest on

CEO/founders not only in terms of their compensation, but

also in terms of organizational outcomes (Adams et al., 2005;

Fahlenbrach, 2005; Villalonga and Amit, 2006).

IV. Sample and Data Collection

Data on executive compensation, firm characteristics and CEO

tenure are obtained from the Standard & Poor’s Executive

Compensation database (ExecuComp). Regarding executives’

age and founder’s status, detailed information was manually

collected on executive biography and corporate history from

firms’ annual reports (especially 10-K forms), Dun &

Bradstreet’s Million Dollar Database, Hoovers Online, the

Standard & Poor’s Register of Corporations, Directors, and

Executives, company press releases, and other official sources,

such as litigation documents. In some cases, additional

information was retrieved from the companies’ internet sites

and the business press (in the latter case any finding had to be

corroborated). The reason for such a thorough investigation is

4 Existing empirical evidence on repricing is mixed, thus allowing for speculation concerning managerial influence on the repricing process.Saly (1994), utilizing data from the 1980’s, finds strong evidence that justifies the use of repricing as a re-incentive mechanism after a stock-market crash. In particular, he finds that stock option contracts are renegotiated after a market-wide downturn in stock-prices, such as afterthe market crash of October 1987. However, Chance et al. (2000) suggest that repricing for top executives is usually carried out by firms withgreater agency problems such as relative smaller size and insider-dominated boards. They further suggest that in most cases, repricing can beavoided because after a 2-year period the options would have been in-the-money. Similarly, it has been found that the likelihood of repricingfor top executives is higher in smaller, younger, high technology firms (Carter and Lynch, 2001; Chidambaran and Prabhala, 2003), andfirms with conflict of interest on the board’s compensation committee (Brenner et al., 2000).5 Similar studies examining effects of CEO/founders on compensation have much smaller sample compared to the present study, which has9867 observations. In particular, Rose and Shepard (1997), Anderson and Bizjak (2003) and Gomez-Mejia et al. (2004) have 1493, 1376 and253 observations, respectively.

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that proxy statements are not always straightforward in the

identification of a founder. For instance, they hardly ever

identify relatives of the founder with a different surname(e.g. sons-in-law), and some company proxies with

CEO/founders either do not identify them as such or report

so indirectly (e.g. ‘is a CEO since the day of incorporation’).Also, CEOs in charge of companies as a result of management

buyout or leveraged buyout are not classified as founders.The hypotheses are tested utilizing two independent indica-

tor variables. The first indicator variable (CEO is founder)

takes value 1, if the CEO is the firm’s sole founder or co-

founder, and 0 otherwise. The second indicator variable (CEOis relative of the founder) takes value 1, if the CEO is a relative

of firm’s sole founder or co-founder, and 0 otherwise. For

illustrative purposes, Table 1 presents the distribution, by

industry, of CEO/founders in the sample. More specifically,the great majority of CEOs in the sample (i.e. 79%) have no

founding relation with the firm they serve, and the rest of the

sample consists mostly of sole founders or co-founders (16%),

leaving only a 5% of CEOs as relatives of the founder or oneof the co-founders.

The initial starting pool began with 15 069 observationsincluded in Execucomp for fiscal years from 1992 to 2001 (May

2003 version). All observations related to compensation of

CEOs that entered or left office during a specific fiscal yearwere excluded from this initial pool because they did not

correspond to annual CEO compensation (ca. 13% of the

starting sample, in addition to 7% that has missing date of

appointment). Next, observations of non-US headquarteredfirms were also removed because they may be subject to

different regulatory and corporate governance rules.

Moreover, we drop observations for firms that do not separate

actual shares and exercisable options when they report CEO

ownership levels. Finally, after removing firms with incompletedata on independent variables from Execucomp, the resulting

sample that was used for this article has 9867 CEO-year

observations from 1915 companies. The sample is organized in

an unbalanced panel data format and is drawn from a widersample of the US firms that belonged to the S&P 1500

index and other supplemental S&P indices during the period

1992–2001.Besides the level of compensation, this article studies the

relation between founder status and the incidence of stock

option repricing. Executive stock option repricing does notoccur frequently.6 In the initial Execucomp sample there were

214 cases of repricing of CEO stock options for the US firms

between 1992 and 2001. We dropped 31 of these observationsbecause they were related to repricing that happened during

the same fiscal year the executive became CEO or left the CEO

position.7 After corroborating Execucomp’s variable on repri-

cing with the firms’ ‘10-Year Option Repricings’ proxy-statement section, we dropped six observations that had to

do with a single repricing erroneously reported by Execucomp

in two successive fiscal years, resulting in a sample of 177repricing incidents.8 Moreover, due to missing variables in 46

repricing observations in the estimation, the final sample of

companies that repriced CEO stock options in a specific year

comprises 131 cases.9 For the purpose of a control group in therepricing incidence estimation, we select these 131 firms that

decided to reprice the CEO’s stock option contract in a specific

year and we match them with companies from the wider poolof firms in the entire sample that – even though their CEO

holds stock options – did not decide to reprice, have the same

4-digit Standard Industrial Classification (SIC) and operated

Table 1. Founder status by industry

Industry Full sample CEO is founderCEO is relative ofthe founder

CEO is professionalmanager

Mining and Construction (SIC 10–19) 109 (100%) 10 (9.2%) 5 (4.6%) 94 (86.2%)Manufacturing (SIC 20–39) 1117 (100%) 144 (12.9%) 68 (6.1%) 905 (81.0%)Transp., Comm and Utilities (SIC 40–49) 337 (100%) 38 (11.3%) 5 (1.5%) 294 (87.2%)Wholesale and Retail Trade (SIC 50–59) 297 (100%) 69 (23.2%) 24 (8.1%) 204 (68.7%)Financial Services (SIC 60–69) 306 (100%) 40 (13.1%) 12 (3.9%) 254 (83.0%)Services (SIC 70–89) 345 (100%) 101 (29.3%) 12 (3.5%) 232 (67.2%)Other 13 (100%) 1 (7.7%) 0 (0.0%) 12 (92.3%)

Total 2524 (100%) 403 (16.0%) 126 (5.0%) 1995 (79.0%)

Notes: This table shows the findings for founders for the 2524 unique CEO-firm pairs included in the panel of 9867 CEO-years, classified by2-digit SIC industry and founder classification. In the estimation models, two indicator variables are used concerning founder status.The first indicator variable (i.e. ‘CEO is founder’) takes value 1, if the CEO is the firm’s sole founder or co-founder, and 0 otherwise.The second indicator variable (i.e. ‘CEO is relative of the founder) takes value 1, if the CEO is a direct or distant relative or any other familymember of the firm’s sole founder or co-founder (e.g. son, son-in-law, nephew, grandson, great-grandson), and 0 otherwise.

6 In fact, in Brenner et al. (2000) and Yermack (1995), the total sample of executives who had their stock options repriced was less than 2%,just like in the sample utilized in this article.7 These 31 observations are most probably associated with either a promotion award after internal succession (when an executive has heroptions repriced the year she is promoted to CEO) or as an incentive to the CEO to avert him/her from voluntarily exiting the firm (when aCEO has her options repriced but soon after decides to exit the firm). Both these types of repricing incidents are dropped because they arespecial cases, motivated by factors unrelated to the study of managerial entrenchment.8Execucomp’s occasional erroneous reporting of repricing events was first mentioned by Brenner et al. (2000).9 The results from mean comparison tests between the final sample (131 repricing obs.) and the original sample (177 repricing obs.) indicateno differences in any independent or control variable, thus demonstrating that the missing variables in the 46 observations are randomlyomitted.

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the year of repricing occurrence in their competitors. This

approach leads to an overall sample with 825 observations,

with 694 observations for the control group.

V. Empirical Methodology

Level of CEO compensation

Despite the heterogeneity in compensation policies across

firms and industries, executive compensation usually consists

of three basic components: a base salary, an (accounting-

based) annual bonus, and stock options. Since the aim of this

study is to test the association of founder status with the size

and terms of CEO compensation, we interchangeably use cash

pay, value of stock option awards, and total compensation.

Cash pay is the sum of salary and bonus. Stock option value is

defined as the adjusted Black–Scholes value of stock options

awarded to an executive in a given year, while total compen-

sation is defined as the sum of cash pay, benefits, value of

stock-options granted, value of restricted stock granted and

long-term incentive plans.A multitude of control variables are employed. Regarding

CEO characteristics, we include variables on level of CEO

equity ownership, CEO-Chairman duality, CEO age, tenure as

CEO in the firm, and whether the CEO holds an interlocking

position.10 Control variables for firm characteristics involve

firm performance, size and industry, which have all been

widely found to relate to CEO compensation (Murphy, 1999).

Firm performance is measured in both accounting and

financial terms, with returns on assets (ROA) and returns to

shareholders (RET). Moreover, as a proxy for firm size we

utilize firm annual market value (in natural logarithm form).

Table 2 presents the means and SDs of the aforementioned

dependent and independent variables, after pooling the obser-

vations across the 10-year period. Notably, the correlations

among the independent variables are low or moderate

suggesting the absence of multicollinearity (see the

Appendix). All level variables are adjusted to 1992 dollars

using the consumer price index. Finally, year effects have been

added in the estimation models for cash pay, stock options and

total compensation, in order to capture systemic changes.A number of econometric specifications are used. More

specifically, in the study of CEO cash pay and total compen-

sation, we apply panel data estimation with fixed firm-

effects.11 This estimation methodology reduces the problem

of unobserved or omitted variables since it allows to control

for these variables through the inclusion of unobservable fixed

effects as a firm-specific intercept. Overall, the specification for

regression on the level of CEO compensation is the following:

lnðCompensationÞit ¼ �i þ �1Founderþ �2Relativeþ � � xit þ �it

ð1Þ

Table 2. Summary statistics

Full sample CEO is founderCEO is relative of

the founderCEO is professional

manager

Variable Mean SD Mean SD Mean SD Mean SD

Total compensation ($ mil.) 3.55 (11.20) 4.30 (21.33) 2.20 (3.06) 3.49 (7.61)Cash pay ($ mil.) 1.09 (1.61) 0.97 (3.02) 1.02 (0.85) 1.12 (1.09)Stock options ($ mil.) 1.90 (8.85) 2.77 (15.89) 0.93 (2.36) 1.78 (6.58)CEO is chairman (0/1) 0.71 (0.45) 0.74 (0.44) 0.67 (0.47) 0.70 (0.46)CEO is interlocked (0/1) 0.10 (0.30) 0.19 (0.40) 0.19 (0.39) 0.07 (0.26)CEO tenure 8.60 (7.46) 15.41 (9.89) 12.56 (9.26) 6.68 (5.25)CEO age 55.10 (7.45) 54.64 (9.73) 53.03 (9.21) 55.38 (6.60)CEO ownership 0.03 (0.07) 0.08 (0.10) 0.07 (0.09) 0.01 (0.04)Sales ($ bil.) 3.62 (9.19) 1.57 (3.40) 2.39 (3.52) 4.20 (10.29)Return on assets 0.04 (0.10) 0.04 (0.13) 0.06 (0.06) 0.04 (0.09)Return to shareholders 0.22 (0.68) 0.32 (1.02) 0.18 (0.57) 0.19 (0.58)Tobin’s Q 2.13 (2.25) 2.81 (2.72) 1.82 (1.17) 1.99 (2.16)Age that became CEO 47.15 (8.19) 39.98 (9.34) 41.42 (7.74) 49.30 (6.61)

Observations 9867 1756 612 7499

Notes: In 109 firms we observe CEO successions that involve a combination from these three CEO types. Pair-wise tests between these firmsand the 1806 firms that consistently had a specific CEO type illustrate no statistically significant differences (at the 5% level) in terms of firmperformance (i.e. return on assets, return to shareholders), dividend yield, and firm size (i.e. assets, market value and employment).

10 The practice of interlocking CEO and compensation committee structures could influence compensation directly, due to a direct CEOpresence in the compensation committee, or indirectly due to external compensation committee membership exchanges. The relatedindicator variable used in this study refers to any of the following two situations showing conflict of interest in the compensation committeethat firms are obliged to disclose in their proxy’s ‘Compensation committee interlocks and insider participation’ section: (a) The CEO serveson the board committee that makes decisions on executive compensation (i.e. compensation committee); (b) The CEO serves on the boardand/or compensation committee of another company that has an executive officer serving on the board and/or the compensation committeeof the indicated CEO’s company.11As a result, the specifications for cash pay and total compensation do not contain industry effects because fixed-effects estimation dropstime-invariant variables. Panel data random-effects estimation was not employed since the Hausman test rejects the random-effectsassumption that disturbances and explanatory variables are independent. Also, another reason for performing panel data fixed-effectsestimation is that the Breusch–Pagan’s Lagrange multiplier test rejects the classic pooled Ordinary Least Square (OLS) regression model.

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where �i indicates the firm-specific intercepts, x denotes a

vector of CEO, firm characteristics and year effects, and finally

� specifies the residuals. Compensation interchangeably

denotes CEO cash pay and total compensation, all in natural

logarithm form.

In the case of stock options, the traditional estimation

methods are not useful since the data for this dependent

variable are characterized by a positively skewed distribution

of nonzero values and a considerable fraction of zero

outcomes. We follow Cragg’s (1971) two-tier model that is

designed to address the aforementioned data attributes and the

shortcomings of the Tobit model (Lin and Schmidt, 1984;

Stewart, 2009).12 The two-tier model splits the decision over

stock options into two parts allowing for different specifica-

tions13; first a probit on the entire sample estimates the

probability of awarding CEO stock options,

Prð y � 0jxÞ ¼ �ðx�Þ, and then an OLS procedure estimates

the level of CEO stock option compensation conditional on a

positive outcome in the first part (y� ¼ x�þ ", if y � 0).

Notably, y� is assumed to have a truncated normal distribution

with parameters that vary freely from those in the first tier. In

this way, the specification for the first-tier includes all the

variables of the second-tier, as well as variables for firm

riskiness (i.e. 3-year SD of monthly returns) and Tobin’s Q,

since they have been found to influence the adoption and use

of stock option awards.14

Likelihood of stock option repricing

We utilize a binary variable describing a firm’s decision to

reprice CEO stock option grants as dependent variable. This

indicator variable takes value 1, if the CEO had a stock option

contract repriced during the year, and 0 otherwise. The

estimation for the likelihood of repricing utilizes the same set

of control variables as with the estimations for the level of

CEO compensation, except for the firm performance variable.

More specifically, instead of the annual RET as a control

variable, we employ the 3-year RET in order to capture

possible effects from poor financial performance over a longer

period. Also, instead of ROA as a control variable, we utilize

the 3-year SD of monthly returns in order to measure firm

riskiness in managerial contracts (Aggarwal and Samwick,

1999).Concerning the estimation of the determinants of the firm

decision to reprice the CEO stock options, this study employs

logit estimation and utilizes Execucomp, like in Brenner et al.

(2000). However, a significant difference is that while Brenner

et al. (2000) study resetting at an option-contract level for top

executives, in this study we focus solely on the CEO and the

level of estimation is the CEO-year level. In this way, we avoid

biases from over-inclusion of repricing observations and

narrow the focus on whether the decision for resetting of

CEO stock options is linked to agency problems. The

econometric specification for the logit estimation examining

the likelihood of repricing for CEO stock options is as follows:

PrðREPRICE ¼ 1jxitÞ ¼ F a0 þ �xitð Þ ð2Þ

where �0 indicates the intercept term, and xit is a vector of

variables concerning CEO and firm characteristics.

VI. Results

Level of CEO compensation

Table 3 presents the regression results for CEO cash pay, stock

options and total compensation. For CEOs who founded the

firms, we observe a substantial reduction in the level of cash

pay and total compensation. More specifically, founder

status – on average – is associated with a decrease in CEO

cash pay by 23% and a decrease in total compensation by

16%, compared to professional managers.15 At the same time,

CEO/founders receive substantially higher levels of stock

option compensation, conditional on being rewarded with

stock options. CEOs who are the relatives of the founder,

however, appear to receive no different cash pay and total

compensation than that of professional managers, even though

there is evidence for lower stock option compensation.

Notably, the estimates for cash pay and stock options are

not additive in the effect for total compensation because there

are no stock option awards in 27% of the CEO-year

observations in our sample, and because 16% of total

compensation consists of benefits, restricted stock grants and

long-term incentive plans. Our findings on CEO/founders are

consistent with those of Conyon (2008) and He (2008)

regarding total compensation, but not for stock options,

since both these studies do not correct for selectivity bias in

awarding stock options, especially given that CEO/founders

(and CEO/relatives) are less likely to be awarded stock options

(see Fig. 3).Regarding the value of stock options, the contrasting

estimate between founders and their relatives could be attrib-

uted to the fact that usually firms with CEO/founders are in

their early stages of development with high growth opportu-

nities, thus making stock options a more appealing form of

compensation. At the same time, CEO/relatives receive signif-

icantly fewer stock options since they typically lead older

firms, with less growth opportunities, whose control was kept

within the family. In particular, the mean Tobin’s Q ratio for

the firms with CEO/founders and CEO/relatives is 2.8 and 1.8,

respectively. Also, the mean firm age (as a publicly-listed

12 Previous research has dealt with the selection problem arising from the logarithmic transformation in various ways. Yermack (1995) andAnderson and Bizjak (2003) employ the Tobit method, while Core and Guay (1999, 2001) apply Heckman estimation with the inverse Millsratio. However, both practices have attracted criticism. For instance, Tobit assumes a single decision behind stock option grants, andHeckman’s sample selection perceives the missing outcomes as unobservable rather than the result of logarithmic transformation. Notably,the findings from two-part estimation are robust with alternative estimation methodologies such as the Tobit and Heckman estimations.Results are available from the author upon request.13 This is important since the determinants of the decision to adopt CEO stock options are not necessarily the same with the determinants ofthe level of CEO stock-option compensation (Tzioumis, 2008).14 Tobin’s Q is calculated using the methodology outlined by Gompers et al. (2003).15 The effects are found by calculating (e� � 1), where � is the respective estimate.

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entity) for the firms with CEO/founders and CEO/relatives is

12.8 and 28.2 years, respectively.16 Overall, the aforemen-

tioned findings are consistent with our hypotheses that a

founder is a unique type of CEO with lower monitoring costs,

higher wealth and longer tenure.There are some interesting findings from the other CEO

characteristics. CEO duality is found to significantly increase

CEO cash pay, stock options and total compensation, thus

compensating for job complexity. CEO tenure is also positively

related to cash pay, effectively reflecting returns from firm-

specific human capital accumulation. The results also confirm

previous empirical evidence for a substantially positive relation

between firm size and CEO compensation (Murphy, 1999).

Perhaps surprising, we find that CEO’s connection with the

compensation committee via compensation committee inter-

locks or insider participation consistently has insignificant

association with CEO compensation. The findings on CEO

interlocking are consistent with Kevin Murphy’s (1999) insight

when he writes: ‘based on my own observation and extensive

discussions with executives, board members, and

Table 3. Regression analysis for determinants of CEO compensation

Total compensationa Cash paya Stock options valueb

CEO is founder �0.17** �0.26*** 0.42***(2.45) (6.38) (4.91)

CEO is relative of the founder �0.03 �0.01 �0.33***(0.31) (0.08) (2.72)

CEO is chairman 0.09*** 0.03** 0.13**(3.64) (2.25) (2.55)

CEO is interlocked 0.03 �0.01 0.10(0.99) (0.01) (1.21)

CEO tenure 0.01*** 0.01*** 0.01(3.48) (6.87) (0.90)

CEO age �0.01*** �0.01 �0.02***(3.85) (1.02) (5.67)

CEO ownership �1.11*** �0.77*** 0.01(3.74) (4.43) (0.02)

Sales (ln) 0.27*** 0.16*** 0.41***(14.18) (14.00) (23.99)

Return on assets 0.88*** 0.82*** �0.09(9.30) (14.80) (0.40)

Return to shareholders 0.07*** 0.09*** 0.14***(6.77) (14.72) (6.28)

Firm effects Yes Yes NoIndustry effects (2-digit SIC) No No YesYear effects Yes Yes Yes

Observations 9867 9867 9867R2 overall (within) 0.32 (0.21) 0.40 (0.17) –

Notes: The values of the dependent variables are windsorized at the 1% level in order to reduce the influence of extreme outliers. Constantterms are included in the estimations but not reported. Regarding CEO type, the omitted dummy is ‘CEO is professional manager’.a The dependent variables are in natural logarithm form. The absolute values of t-statistics from panel-data fixed-effects estimation appearin parentheses.b Coefficients are marginal effects from Cragg’s (1971) estimation using the robust estimator of variance with firm clustering. The dependentvariable (i.e. Black–Scholes value of the stock options) is transformed using the inverse hyperbolic sine function (Burbidge et al., 1988) thatis very similar to the logarithmic function for positive numbers, in order to avoid converting zero values into missing. The specification forthe first-tier includes all those of the second-tier, as well as two variables for firm riskiness (i.e. 3-year SD of monthly returns) and Tobin’s Q.The values of z-statistics appear in parentheses.** and *** indicate statistical significance at the 5 and 1% levels, respectively.

30%

40%

50%

60%

70%

80%

90%

1993 1995 1997 1999 2001

FounderProfessional managerRelative of the founder

% a

war

ded

stoc

k op

tions

Year

Fig. 3. Percentage of CEOs receiving stock options across the

sample period

16 Following Pastor and Veronesi (2003), we calculate firm age using the date that each firm appears either in the Compustat dataset or theCRSP files as the date of origin. Also, the respective firm age for firms with a professional manager as the CEO is 29.6 years.

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compensation consultants, we tend to dismiss the cynical

scenario of entrenched compensation committees rubber-

stamping increasingly lucrative pay programs with a wink

and a nod’. These results on interlocking are consistent with

previous empirical evidence by Hallock (1997) and Core et al.

(1999) who found very little, if any, evidence that CEOs in

firms with interlocked boards earn higher pay or total

compensation.

The results in Table 3 also illustrate the strong negative link

between age and stock option compensation, in contrast to

previous evidence by Eaton and Rosen (1983), Lewellen et al.

(1987) and Yermack (1995) who find either positive or

insignificant association. This finding can be attributed to

the nature of stock options, which cannot be exercised for a

considerable time period, hence suggesting that older CEOs

may not prefer this type of compensation as they are at greater

risk of losing their unexercised stock options in the event of

early retirement or forced turnover. In fact, the negative

relation of CEO age with the level of stock option compen-

sation is more evident when one employs an indicator variable

for CEO age, rather than a continuous measure. For instance,

the estimate of a dummy variable indicating whether the CEO

is over 58, and thus nears retirement age, is �0.24 instead

of �0.02 for the continuous variable for CEO age (in years).Finally, as a robustness check for potential endogeneity, we

treat CEO/founder status as an endogenous variable. In

particular, we utilize a treatment effects model (Maddala,

1983) with the age that the executive became CEO, as well as

its square term, as instrumental variables for CEO/founder

status. Table 2 illustrates that the mean age for the founders

and professional managers becoming CEOs is 40 and 49,

respectively. Moreover, using probit estimation, these two

explanatory variables correctly classify 85% of founders and

professional managers who serve in the CEO position, using a

cutoff point of 0.5 for the predicted probability. At the same

time these two variables are not expected to be correlated with

compensation measures due to the concave effect of firm-

specific human capital accumulation on compensation (Willis,

1986).17 The estimates for CEO/founders presented in Table 4

are consistent with those in Table 3, illustrating a similarly

negative and statistically significant association of founder

status with cash pay and total compensation.

Likelihood of stock option repricing

As discussed in Section I, one of the main purposes of this

article is to test the full extent of possible entrenchment aspects

for CEO/relatives. For this reason, apart from the size of CEO

compensation, we also examine the relation between founder/

relative status and the likelihood for repricing of CEO stock

option contracts. Table 5 shows that CEO characteristics

uniformly have insignificant estimates for the likelihood for a

repricing decision, while share volatility and 3-year return to

shareholders are factors related to repricing. These findings

confirm the hypothesis that founders do not increase the

likelihood of repricing, but do not support the hypothesis

that relatives have higher likelihood for repricing.

More specifically, we find that consistently poor performance

and increased share volatility enhance the likelihood of stock

option repricing. Firm size is not significant, likely due to

smaller firms’ association with high volatility (Chance et al.,

2000).18 The aforementioned findings are consistent with the

notion that repricing occurs in order to re-align CEO

incentives in highly volatile environments, and contrast

Brenner et al.’s (2000) perception that conflicts of interest on

the board’s compensation committee influence repricing.

VII. Discussion

During the last two decades, the topic of executive compen-

sation has increasingly garnered a great deal of attention from

media, organized labour, politicians and academics. In this

article, we examine whether being a founder or a relative of the

founder affects the incentive structure of CEO compensation

Table 4. Treatment-effect model for determinants of CEO

compensation

Total compensation Cash pay

CEO is founder �0.16*** �0.19***(3.44) (5.93)

CEO is chairman 0.19*** 0.11***(9.27) (8.70)

CEO is interlocked �0.09*** �0.11***(2.65) (4.79)

CEO tenure 0.01*** 0.01***(8.56) (11.61)

CEO age �0.01*** 0.00(8.21) (1.53)

CEO ownership �2.93*** �1.89***(13.56) (10.98)

Sales (ln) 0.36*** 0.28***(50.43) (56.13)

Return on assets 0.15 0.35***(1.42) (4.77)

Return to shareholders 0.15*** 0.09***(7.91) (8.05)

Industry effects (2-digit SIC) Yes YesYear effects Yes Yes

Observations 9255 9255

Notes: The sample includes only founders and professionalmanagers. The dependent variables are in natural logarithmform. The absolute values of z-statistics from the treatment effectsmodel with robust errors appear in parentheses. Constant termsare included in the estimations but not reported. Regarding CEOtype, the omitted dummy is ‘CEO is professional manager’.Finally, the values of the dependent variables are windsorized atthe 1% level in order to reduce the influence of extreme outliers.*** Indicates statistical significance at the 1% level.

17According to the human capital theory, this concavity corresponds to the decline in the fraction of earnings capacity invested in on-the-job training during the working life of an individual, which eventually reaches zero value at the end of the individual’s career. Indeed, theinclusion of a square term for ‘CEO Tenure’ in the fixed-effects panel data estimations for ‘Cash Pay’ and ‘Total Compensation’ yieldssignificant and negative coefficients, thus indicating declining returns from tenure as CEO in a firm.18 Indeed, in the sample utilized in the logit estimation, the Pearson correlation between firm size and share volatility is –0.53.

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after controlling for a number of CEO and firm characteristics.

The results suggest that CEO/founders compared to profes-

sional managers: (a) receive lower total compensation levels,

(b) receive a compensation mix that contains less cash pay and

more stock options, and (c) do not influence the likelihood of

stock-option repricing.

Interestingly, the finding on lower cash pay of

CEO/founders in public US firms is consistent with

Wasserman’s (2006) finding for lower cash pay of founders

in private technology companies, thus providing strong

support for his suggestion that agency theory and stewardship

theory are complementary. Furthermore, even though stew-

ardship theory is applicable to small, private firms, the findings

in this study could imply that even in large, public firms

founders closely identify with their organizations, and that the

CEO’s utility function reflects both monetary and nonmone-

tary elements (Lazear, 2005).In contrast, we find that CEOs who are relatives of the

founders, ceteris paribus, enjoy higher total compensation

compared to CEO/founders. These results offer evidence for

heirs’ entrenchment utilized to extract private benefits, and

they are consistent with recent findings by Perez-Gonzales

(2006) who illustrated the substantial costs of nepotism in

terms of firm underperformance.By focusing on the compensation level and the likelihood of

repricing (that are often covered by mass media), this article

investigates the presence of overt patterns in rent extraction.

Future research could investigate whether founders or their

relatives covertly influence their compensation as CEO

through other avenues, such as appropriately timing their

stock options exercise based on inside information, altering the

performance measures in the incentive contract and decreasing

their turnover likelihood, even in the presence of poor

performance, thus allowing them to enjoy a longer compen-

sation horizon. Finally, it would be equally interesting for

future research on the topic of CEO/founders to focus on large

private US firms that attract less monitoring by institutional

investors and media, thus allowing for greater managerial

discretion.

Acknowledgements

This research has been benefitted from the helpful comments

of three anonymous referees, the editor (Mark Taylor), Stijn

Claessens, Robert Cull, David De Meza, Asli Demirguc-Kunt,

Rafael Gomez, Morley Gunderson, Luc Laeven and

Gerasimos Lianos. A substantial part of this article was

completed while the author was at the London School of

Economics. The opinions expressed in this article are those of

the author alone, and do not necessarily reflect the views of the

Office of the Comptroller of the Currency or the Department

of the Treasury.

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Appendix

Table A1. Correlation matrix

[1] [2] [3] [4] [5] [6] [7] [8] [9] [10]

[1] CEO is founder �0.12 0.03 0.14 0.38 �0.04 0.43 �0.25 0.06 0.01[2] CEO is relative of the founder �0.12 �0.02 0.07 0.12 �0.06 0.19 0.02 0.03 0.00[3] CEO is chairman 0.03 �0.02 0.01 0.22 0.26 0.05 0.27 �0.02 �0.01[4] CEO is interlocked 0.14 0.07 0.01 0.14 0.05 0.14 �0.07 0.03 0.00[5] CEO tenure 0.42 0.14 0.19 0.14 0.29 0.45 �0.05 0.06 0.01[6] CEO age �0.03 �0.07 0.26 0.06 0.38 0.05 0.20 0.00 �0.02[7] CEO ownership 0.39 0.16 0.09 0.16 0.39 0.08 �0.35 0.11 0.01[8] Sales (ln) �0.24 0.02 0.26 �0.07 �0.04 0.18 �0.15 �0.04 0.01[9] Return on assets �0.01 0.04 0.02 0.03 0.07 0.05 0.09 0.19 0.21[10] Return to shareholders 0.07 �0.01 �0.02 0.00 0.01 �0.08 0.04 �0.09 0.12

Note: Pearson and Spearman correlation coefficients are reported below and above the diagonal respectively.

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