No one says the life of the entrepreneur is glamorous, at least in the start-up phase. Financing pressures. Bad diet. Family—what family? And now new research from Harvard Business School professor Noam Wasserman reveals another "founder frustration": below-market pay.

Wasserman's research with 1,200 executives at 500 companies concludes founder pay is on average $30,000 less than that of non-founder executives. (The pay discrepancy disappears as the business matures.) What's the reason for such founder discounts? One reason is that non-founders can increase their compensation by threatening to jump to another company—a card that few founders are willing to play at the negotiation table, says Wasserman.

Wasserman's paper on the subject "Stewards, Agents, and the Founder Discount: Executive Compensation in New Ventures" is scheduled to be published later this year in the Academy of Management Journal. The paper was featured in the Best Paper Proceedings of the 2004 Academy of Management Conference and of the 2003 Babson-Kauffman Research Conference.

Sarah Jane Gilbert: What led you to research the topic of executive compensation in new ventures?

Noam Wasserman: The initial impetus was when I was doing my early field research on founders and heard complaints from them about their inability to increase their compensation compared to their non-founder colleagues, which I found surprising. For instance, a founder complained that his board refused to listen to his argument that he was being underpaid because he could not credibly threaten to leave the company if he didn't get his way, in contrast to a non-founder who could effectively do so.

From an academic perspective, past studies assumed that founders are more powerful than non-founders and thus should be able to command more compensation, but never tried to see if that was true. So I decided to collect data on the executives in new ventures and on the ventures themselves, to see what the real story was. My dataset for this project included 1,238 "C-level" executives from 528 private information technology companies. When I analyzed founder versus non-founder compensation, I found that there is a large "founder discount" (averaging about $30,000 a year), even after controlling for all of the other differences between founders and non-founders. At the same time, the size of the founder discount changes dramatically as the venture evolves. In the early stages of growth, the discount is much bigger, but it largely disappears in later-stage ventures.

The result is even more surprising when compared to executive compensation in large companies. In large companies, the CEO is the highest paid executive and almost always out-earns her direct reports by a significant margin. Also, multiple studies have found that the more equity the CEO holds, the more compensation she commands. However, the patterns are completely different in young companies if there are founders involved. For instance, of 290 founder-CEOs in my sample, 51 percent earned the same or less than a direct report. In other words, fewer than half of founder-CEOs out-earned their subordinates! Also, the more equity held by the executive, the less the executive's compensation. Both of these patterns are the opposite of what we'd expect based on large-company compensation patterns.

Q: Can you explain the difference between stewardship theory and agency theory? How do these theories apply to new venture firms?

A: Agency theory is the standard lens through which academics look at compensation issues. In short, it posits that when hired managers, or "agents," are faced with a conflict between their organization's best interests and their personal best interests, the agents will choose the latter. Therefore, the owners of the organization will have to take steps to increase the chances that their agents will act in the organization's (or owners') interests, and compensation is one of the levers they can use. Agency theory is an extremely useful lens through which to examine situations where there is a divergence between managerial and shareholder interests.

The higher level of intrinsic motivation leads founders to willingly—even eagerly—take lower compensation.

In contrast, stewardship theory posits that some managers—"stewards"—will put the organization's interests first, especially when they identify closely with the organization and are very attached to it. The interests of these "organizationally centered" executives are more likely to be aligned with those of the owners. Stewards identify closely with the organization and thus derive higher satisfaction from behaviors that promote the organization's interests than from self-serving behaviors. Also, intrinsic motivation should be higher in people who create an organization and feel a sense of control over its direction. Hence, there is much less of a clear divergence between managerial and shareholder interests.

It struck me that many founders I had studied are much closer to the steward ideal than to the agents described in agency theory. Stewardship theory is far less known and probably doesn't apply as much to most executives, but it seems to fit founders very well. Executive compensation provides one test of that idea, and new ventures—where founders work alongside non-founders—is a great arena in which to examine it. If founders are typical agents, their compensation should not differ from that of non-founder agents, once we have controlled for a wide variety of potential differences between them (e.g., prior work experience, educational backgrounds, equity holdings). However, if founders are more like stewards and non-founders more like agents, then we should find a significant difference between founder and non-founder compensation.

Q: How does this result in lower founder compensation?

A: There are both voluntary and involuntary reasons why founders would have lower compensation. On the one hand, the higher level of intrinsic motivation leads founders to willingly—even eagerly—take lower compensation. This voluntary side was captured by a VC who maintained, "The Founder CEO benefits from 'soft' compensation, such as greater psychic rewards, that a non-founding CEO will never be able to get." According to this thinking, for a fixed level of total rewards, if founders receive a higher level of psychological rewards, they should be willing to accept a smaller amount of material rewards in cash. There may also be practical reasons: The founders may feel that their cash-poor ventures will gain more from having a lower burn rate than they would gain personally from having higher compensation.

On the other hand, the higher level of psychological attachment introduces an involuntary element, wherein founders are forced to take lower compensation. This attachment acts as "psychological handcuffs" that bind the founder more tightly to the venture than a non-founder would be psychologically tied to it. Hence, the complaints from founders that their boards would laugh at any threats to leave if the founders don't get a raise.

Both of these factors change as the venture grows. As more people are hired and the founder begins sharing control with non-founders, and as the venture develops and formalizes systems and processes that make it less dependent on the founder, founder attachment and intrinsic motivation should decrease. Thus, the founder discount diminishes as the venture grows.

Q: What implications does this have for entrepreneurs ready to start a new venture?

A: One big implication is that founders have to realize that one of their biggest strengths—their drive to build the venture and to do everything it needs to succeed—can also be a weakness when it comes to benefiting financially from their hard work. The fact that founders are so attached to their ventures is wonderful, but can also be used against the founders, as was the case with the founder who complained about his board's resistance to increasing his pay. The other is the more general recognition, both by founders and by new-venture boards, of how founder attachment and motivation are likely to change as the venture grows, and that adjustments will have to be made because of those changes.

Beyond the founder-CEO specifically, there may be an interesting ripple effect for the rest of the management team. In many companies, when the founder-CEO's compensation is below market, it may also depress the compensation of the other team members. An investor who serves on the board of several communications-industry companies told of a founder who believed he should sacrifice increased salary for the good of his company: "One of the founder-CEOs I work with is paid way under market, but when I approached him with an offer to bring the issue up in a board meeting to get him bumped a bit, he declined, citing the ripple effect it could have on the company's compensation program. If his salary is capped, it is easier to keep other personnel costs under control."

Q: What are you working on now?

A: I'm continuing to do work on other "founder frustration" areas, including founder-CEO succession. However, in follow-on work to the compensation project, I am trying to deepen our knowledge of both the financial and the nonfinancial motivations and benefits for entrepreneurs. Although the compensation study controlled for differences in equity holdings, the major financial gains for many entrepreneurs come from their equity holdings in their ventures, and equity holdings deserve to be studied more deeply. Therefore, in related projects, I'm focusing on three aspects of the equity landscape.

When the founder-CEO's compensation is below market, it may also depress the compensation of the other team members.

First, in a financial complement to the "psychological handcuffs" from the compensation paper, I am using equity-vesting terms to examine the "golden handcuffs" used by boards to try to lock in executives in new ventures, and am again finding a distinct difference both in founder versus non-founder vesting terms and in other factors that cause vesting differences.

Second is my "Splitting the Pie" project. One of the biggest factors driving founders' equity stakes is the initial equity split within the founding team. The typical approach to splitting is exemplified by the founders of Zipcar, a case we teach in our first-year entrepreneurship course. The Zipcar founders, who barely knew each other before founding the company, split the equity simply, shaking hands over a 50-50 split. One founder joined Zipcar full-time as its CEO and went on to become the driving force behind the company. The other founder kept her other job and contributed far less to the company, but still owned the same amount of equity in the company. The founder-CEO now says, "That was a really stupid handshake because who knows what skill sets and what milestones and what achievements are going to be valuable as you move ahead. That first handshake caused a huge amount of angst over the next year and a half."

On the other hand, in my "Ockham" case, which we teach as a counter case to Zipcar, the three founders (who had long been coworkers) split the initial equity unequally based on different contributions, and also crafted a founder's agreement where founders who did not participate in the company full-time would surrender their equity. These two cases sparked my interest in how the past relationships of the founders (e.g., prior friends or coworkers versus strangers) might affect their approach to splitting the equity (both the equality of the split and the timing of the split) and how the split might affect both the founding-team's stability and the company's growth.

The third project is "Rich versus King," a more comprehensive look at a fundamental tradeoff faced by founders. Beyond the financial factors examined above, a major nonfinancial motivation for many entrepreneurs is the ability to leave their stamp on their ventures by being able to control the venture, implement their idea, and realize their vision. The entrepreneurial ideal is to be able both to gain financially (be "Rich") and to control the venture (be "King"). However, this study examines how the control motive conflicts with the financial profit motive that also drives many founders. In order to build a valuable venture, founders almost always have to attract other resource providers—co-founders and non-founding hires on the human resources side, investors on the financial resources side—to the venture. To attract them, the founder has to give up things of value, most prominently equity stakes and decision-making control. Thus, founders are faced with having to trade off financial gains (from building a valuable venture) versus control. In quantitative analyses of 454 start-ups, I show that there is a significant Rich versus King tradeoff, and explore ways in which some entrepreneurs increase the chances that they will end up in the Rich and King (or, "rich and regal") category.

As these projects evolve, I post updates to my research blog, where I also welcome feedback on those results and on new research ideas.