Who makes more cash compensation, founders or non-founders?
More specifically, taking 2 similar executives (same position-title, similar years of work experience and equity holdings, working in companies that are at the same stage of development), will the executive who was a founder of the company make more or less than the executive who didn’t help found the company?
Academic aside #1: From an academic perspective, past research on executive compensation has looked at executive compensation issues using the lens of agency theory. Agency theory suggests that the interests of opportunistic, self-interested executives (“agents”) will conflict with those of owners (“principals”). However, my field work with founders suggests that they act less like the agents of agency theory and more like “stewards” of their companies. Stewardship theory (e.g., Davis, Schoorman et al. 1997 AMR) suggests that executives’ interests will be aligned with company interests and executives thus be more intrinsically motivated than predicted by agency theory. In this study, I found stewardship theory’s behavioral assumptions invaluable in illuminating the founder issues. New ventures, where founder-stewards work alongside nonfounder-agents, provide us with an excellent arena in which to examine how stewards might be compensated differently from agents.
My dataset for this paper is taken from my 2000, 2001, and 2002 IT start-up surveys (see the CompStudy.com link to the right, or the posting on “A Note on My Research Approach and Data” below) and includes 1,238 executives from 528 private companies.
Overall, the results suggest significant differences between founders and non-founders, with founders making significantly less than non-founders, even after accounting for their different levels of experience, equity holdings, stage of company development, etc. On average, this “founder discount” is about $30,000. However, the founder discount is smaller the larger the company, and is not statistically significant in larger start-ups (here, companies with 150 employees).
The chart below summarizes the founder discount, after controlling for experience, equity, company-stage, etc. The vertical axis is annual cash compensation (salary + bonus, in thousands of dollars), and the horizontal axis is the # of employees in the company.
One implication is that it is possible for private-company CEOs to receive less compensation than their direct subordinates (quite a contrast to public companies in which CEOs are much more powerful, and thus earn far more, than their direct subordinates). Most strikingly, in my dataset, there is a high percentage of founder-CEOs who earn less than the CTOs or CFOs who report to them. Of the 290 CEOs who were founders, 77 (27%) made less than at least one of their direct subordinates and another 69 (24%) were paid the same amount as a direct subordinate.
Is the founder-discount voluntary (i.e., the founder willingly accepts less compensation) or involuntary (i.e., imposed by the board against the founder’s will)?
Two tidbits from the paper capture the two sides of this issue:
- Quote from a VC: “The founder CEO benefits from ‘soft’ compensation, such as greater psychic rewards, that a non-founding CEO will never be able to get.”
- Vignette from a Founder: The founder complained that his board was not taking seriously his threat to leave if he did not get a raise, and observed that a non-founder could more convincingly make this threat.
At its core, founders are more “attached” to the companies they founded, which can increase their “psychic rewards” (if they gain greater intangible rewards, they are probably more willing to take less tangible compensation, especially if doing so can help their companies). However, founder attachment can also act as “psychological handcuffs” that keep them at the company even if they aren’t happy with their cash compensation. Boards can take advantage of this to under-compensate founders.
I haven’t been able to find a way to systematically assess the degree to which the founder-discount is voluntary versus involuntary. I welcome your thoughts on the matter, or on any other relevant issues!
Academic aside #2: I presented an early version of this paper at the 2004 Academy of Management meeting (Business Policy and Strategy division), where it was included in the Best Paper Proceedings. A longer version of the paper just received a conditional acceptance from the Academy of Management Journal.
(Note: In related research, I am also examining various issues on the equity side of entrepreneurial compensation. Posts forthcoming in the coming weeks….)
The “anchoring effect” you highlight is quite an interesting one, Tim, and what I was referring to in my parenthetical comment in the original post (that “they are probably more willing to take less tangible compensation, especially if doing so can help their companies”).An intriguing addition seems to be your linkage between salary and dilution. To delve into it: Is the linkage because lower salaries -> lower burn rate -> don’t need to raise as much outside money -> Founder-CEO keeps more equity? Couldn’t there be a countervailing effect, where a new executive recruit is offered less salary -> he wants more equity to compensate -> <>less<> equity for the Founder-CEO?
salaries of all other key hires tend to be based off the founder ceo salary (even when they are higher). founder ceo then benefits from less dilution on their equity ownership by what is often a few tens of thousands of dollars in salary. Net net, founder can benefit from having their salary be lower.
could be, and would be interested to see a study that maps equity holdings and salaries to see if there is a correlation. while you would expect there would be some inverse relationships, it seems less efficient than that often. there is an equity range for an exec and there there is the “what salary do you need to cover your monthly expenses” that is anchored as you say on the founder salary. there is no efficient market so i would guess that the salaries aren’t moved up significantly. would be interesting to see a study done on $ raised by various companies at various salary levels to see if you could come to some conclusions. I’ve found teams who have lower cost per employee per month averages also tend to be much more frugal and measurement oriented on other expenses and investments they make. would be interesting to see if that held up in the numbers.
Reactions to 2 parts of your post, Tim:1. Study-wise, sounds like what might be called a “burn rate” study: Is there a systematic linkage between a company’s approach to compensation (low vs. high cash comp for its executives), its non-comp burn rate, and the amount of capital it raises each round (taking into account the amount of time between rounds)? Based on your post, we’d hypothesize positive linkages between these factors, with low-comp (high-comp) companies also having low (high) non-comp burn rates and smaller (bigger) rounds. To take the flip side: Is it also possible that we could find <>inverse<> relationships, where low spending on one thing enables higher spending on the other? I like the concept; we’ll have to develop it further. Feel free to post any other ideas/refinements (e.g., other factors that would affect these choices, other ways that they might affect company outcomes/performance) and we’ll see how far we can get in defining it. (I already have the data to test most of this.)2. In the “Entrepreneurial Compensation” paper described in the original post, I tested the comp-versus-equity relationship, and it’s a strong negative relationship: executives with higher equity percentages have lower cash comp, and vice versa. (This “tradeoff pattern” is contrary to the pattern found in many public-company studies, which have found high-equity executives to have higher cash comp.) Anecdotally, Bill Holodnak of J. Robert Scott (the exec-search firm with whom I collaborate on my data collection) backs this up with stories of clients who use a well-defined set of cash/equity tradeoffs when they’re looking at potential executive hires (and even use those tradeoffs to get a better feel for the executive’s risk preferences).
I reckon a new type of theory would address the issue of startup founders. Setting up Agency and Stewardship in a cage match begins to tap into the nature of this new perspective. I like your opposing sliding scale of the two theories, however.I just wonder whether founders are a priori stewards. If they were, you would have seen an insignificant effect I reckon - regardless of equity stake, founders would accept less cash compensation. I hope that made sense.A founder with a great deal of equity may not be a true steward. Operating under the necessary assumption of opportunity, they see the equity as a realizable currency for compensation. The hired exectuive, holding perhaps less of this assumption, needs a little more grease for the wheel. Plus, as you know, this equity retained can hurt the firm - you probably see a negative relationship between founder’s equity and company valuation. This is a constructed market of interdependent incentives.Good luck with the work.
Anecdotally, I definitely accepted a founder discount when I started my company. I was young and naive, and thought that doing so would “show the VCs that I believed in my idea.”I’ve talked with a lot of fellow founders, and almost all of them relate the same experience.In retrospect, I think the practice of the founder discount is a bad idea. Founders should pay themselves market rates so that a company can’t disguise poor performance through below-market wages.This is something that is primarily an outdaed social more, like being in the office during certain hours even though you work remotely via email and cell phone on nights and weekends.
I don’t know. I read this online piece and the published paper. Its hard for me to determine whether this is a Founder Discount, or a non-Founder Premium. Seems to rely upon how you want to spin it. Founders are either stewards that do more for less, or Hired Guns require a little financial coaxing to believe in the assumptions of the startup.Glad to see some larger, data-based searches into these questions however.
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Just saw an interesting dialogue about this post at < HREF="http://hitchhiker.blogsome.com/2020/04/17/entreperneur-compensation/" REL="nofollow">Hitchhiker’s Guide to 650<>:<>Comment from Jeremy:<>…I know a few founders who explicitly took lower comp so that they could use that as a negotiating lever for new hires (”that’s more than I make as the CEO!!”), for instance.<>Will's response:<>Hi Jeremy. . . I was being a little facetious
. . . I personally took a lot less as a founder than my non-founder peers (over 50% less) . . . as a way to set the tone for the company. . . but as the company grew the gap narrowed. . . if I was to do it again, I’ll do a 25% discount rather than 50% . . .
Thanks for the feedback, Anthony … though I’m hesitant whenever people try to sell the “novice/dilettante” short — the most interesting questions sometimes come from those with the freshest perspectives! Feel free to chip in with any other observations or queries.
This is very interesting stuff with a great comment section, Noam. Especially for the novice/diletantes among us, like me! Thanks for the information on the “Founder’s Discount” and the lively forum for discussion. This is really what a blog and Web 2.0 is all about!
The Stewardship vs. Agent model seems a very useful approach for founders to think about their personal motivations. In a company I started and grew, whether or not non-founders were stewards became a criterion for whether they were part of the core executive team, although I didn’t think about in those terms initially. If individuals were willing to put their self interest aside and make decisions based on the good of the business, then they could be trusted with critical responsibilities without detailed review. If individuals, when faced with decisions that affected them personally could not set that aside, then they could not be delegated the final decisions. And in some cases could not even be used for formulating recommendations if they couldn’t or wouldn’t see and make explicit their biases. It was simply too much work to try to decipher how the biases had embedded themselves into the recommendations. These biases evidence themselves in issues as central as “where do we allocate our limited resources for the next hire”, to less central but still important decisions such as “what health insurance plan do we subscribe to” or “the location of our new facility”.
This is always an interesting analysis. Each category of CEO always feels as if the other is getting a “better deal”-CEOs on one coast think it’s likely better on the other, and founders and non-founders often feel the other has a better package. Similarly, early-stage CEOs are often jealous of the “rich cash packages” that they seem to hear about in later stage companies, and late-stage CEOs always feel that early-stage CEOs get so much more meaningful an equity position than they as “hired guns” seem to be able to garner.
I think that salaries should be based on equality, always rescuing the right of a founder to reap greater benefits … that's my comment, thank you very much for letting me comment!
salaries however other key hires might be based trip founder ceo salary . MD then advantages from less dilution on their equity ownership by what is known as a few hundreds of thousands of dollars in salary. Net net, founder can usually benefit from having their salary be lower
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