Executive reward and retention strategies in family offices

Family offices are known for their desire for confidentiality. One area of particular opacity is the compensation structure of family office executives. There is increasing global demand for well-qualified executives to manage family office activities such as investments, financial and legal matters. However, corresponding growth in the understanding and adoption of reward and retention strategies has not kept up pace.

We believe that a key part of the process should focus on understanding the importance of equilibrium between the parties, i.e. addressing the needs of the family as well as of the executive, with both parties achieving their desired outcomes. How, then, might a family and an executive establish a process that produces the desired outcomes in such a way that identifies and navigates the core tenets of behavioral science? The following three points are vital:

Understand family values and executive motivations

Foremost amongst key behavioral factors is an alignment of "values". When problems occur, it is often due to misalignment and poor communication of values, and both parties making assumptions about each other’s intent with respect to reward and retention. Therefore it is essential that executives understand the family’s values and their views on executive compensation. Similarly, the family needs to understand the executives’ compensation needs and expectations. Executive recruitment firms as well as specialized compensation consultants might be able to provide a fair assessment based on current market trends.

Navigating these issues requires delicate action. Consultants, search executives, and advisors can help by asking candid questions of all parties. It is important to look for how the family embodies its values, e.g. how the family spends money or compensates executives in their family business. Being able to articulate attitudes concerning how much the family is willing to reward the executive for a given commitment and range of outcomes is essential.

Define outcomes

The strategy must be based upon a clear understanding of desired and potential outcomes. While some families have explicit investment expectations, this is neither universal nor does it always cover outcomes in other areas such as family services, finance, or governance. Although this does not necessarily have to involve strategy by management of objectives, some specificity is required to anchor the executive’s year-end performance appraisal.

One essential element that is often overlooked by families is not "what" they expect to be accomplished, but also "how" they expect their executives to achieve the results. Issues around the volatility and distribution of returns and illiquidity, manner and frequency of communication with the principal, executive autonomy, interactions with extended family members, and spending practices can cause greater issues than unfavorable portfolio performance.

Recognize the executive’s interests and passions. While money is the foundation of most reward and retention strategies, families should not overlook other ways in which their family office executives could be rewarded. Families could reward executives by utilizing their resources and networks to offer their executives opportunities that they might not otherwise enjoy.

Examples include those of families providing access to their vacation homes, facilitating membership of corporate and non-profit boards, providing access to family-owned aircraft, or making an annual charitable donation as a way to enrich the relationship further, as well as rewarding and retaining the executive.

Strive for equilibrium

An effective process will strike a balance between the values and interests of the family and the needs and motivations of the family office executives. Skewing the arrangement too far in favor of one party over the other invariably results in dissatisfaction, mistrust, and ultimately, a poor outcome for all parties. The aim, therefore, should be an outcome in which both parties are satisfied, albeit not to the extent that either or both feels aggrieved.

Reward strategies mostly fail at the extremes. For instance, when general market conditions produce exceptional portfolio results that trigger unforeseen levels of Chief Investment Officer (CIO) compensation, it is not uncommon for the family to feel resentment despite the high portfolio returns. Conversely, when executives effectively protect against downside losses during a protracted bear market but nevertheless miss targets and thus receive diminished compensation, they may feel unappreciated. Therefore, best practice would be for families and executives to discuss a wide range of outcomes and their implications.

For more on the subject of family office executive compensation, please read our whitepaper – Executive reward and retention strategies in family offices.