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How Does the Influence of Founders and Investors Relate to Employee Compensation in Entrepreneurial Firms

Employment in entrepreneurial firms is often associated with non-pecuniary benefits and access to unique technologies. We provide evidence that these work motivators are higher when the founder has more (and outside investors have less) influence over the firm’s decision-making. In particular, we show that the degree of control exerted by venture capital investors helps explain the design of nonCEO employee compensation contracts. Across 18,935 employee compensation contracts from 1,809 U.S. firms, we find that those with more VC / less founder dominance pay their employees higher cash salaries, provide stronger cash and equity incentives, and have more formal pay policies in place. However, the differences in cash pay and incentives only apply to hired-on employees and not to founders. Founders are special in that they receive similar compensation contracts regardless of the company’s degree of founder/VC dominance. Our results are consistent with the argument that investor control changes the nature of hired-on employment in innovative, high-potential small businesses. We thereby shed new light on how innovative small businesses evolve into professionalized companies, the role that venture capitalists play in this evolution, and the determinants of entrepreneurial compensation.