The Substitute Effect of Monitoring Mechanisms and Performance-Based Executive Compensation in Family Firms: Evidence from an Emerging Market

Abstract

Family owners and foreign institutional investors have played a vital role in shaping the development of corporate compensation practices in Asian emerging markets. However, family owners and foreign institutional investors may differ in their use of incentive plans for top management as a result of different levels of monitoring costs. This study investigates the substitute effect of monitoring mechanisms and incentive-based compensation on agency mitigation issues between managers and shareholders for family firms in the Taiwanese electronics industry over the period from 2005 to 2009. Our results show that compared to non-family firms, family firms are less likely to use incentive-based compensation for top management. This is consistent with family owners’ direct monitoring and superior information advantages over non-family shareholders. Furthermore, we find that greater foreign institutional ownership in family firms is more likely to be correlated with greater use of performance-based compensation contracts for top management. We also find that compared to small family firms, large family firms are more likely to use incentive-based executive compensation to mitigate agency problems.