Micro-management of this sort is pointless in the Indian context but present forms of pay approvals are ineffective
Founder of Finsec Law Advisors
“It is unlikely that the promoter would extract a huge salary as his gains mainly would come from capital appreciation and dividend payouts. Besides, a lower tax incidence on capital appreciation and dividends are deterrents”
It is tempting for the government and regulators to try to curb executive pay; it is surely politically attractive to do so in these days of austerity. The idea of curbing runaway compensation is not new. In fact, our current law has extensive regulations relating to pay, such as deliberations by an independent committee of the board, authorisation by shareholders, various disclosures, maximum percentage caps on commissions for profit-making companies and absolute caps for loss-making ones, government approvals for various acts, minimum period of vesting for employee stock option, to name a few.
No further control on executive pay is warranted for four reasons.
First, Indian firms are not orphaned by their owners. In other words, there is typically a large dominant shareholder known as a promoter who controls the company. Now, this promoter has a financial incentive to keep costs low, and, thus, pay as little as he can to a professional CEO, as little as would get him a high quality CEO. Compare that to the western CEO, who has no one over his head to supervise remuneration. In fact, most western countries do not even require a binding shareholder vote on pay. The agency problem becomes clear as the CEO usually picks his own directors and, thus, members of the remuneration committee, which is a child of the board. Given that for a vast bulk of Indian companies this agency problem does not arise, means we are solving a problem that doesn’t yet exist in the country. Most top promoters give themselves well below 0.5 per cent of net profits as salaries, compared to the law that permits them to take away as much as five per cent of profits.
Second, Indian companies including financial companies are not massively leveraged like their western peers. No wonder, the various crises have not required any governmental bailouts of financial institutions. Thus, the western argument that financial institutions through their CEO take large bets, which, till the bet pays off, results in huge profits for themselves and their top management. When those bets fail, the government must bail out the firm, that is, privatising profits and socialising losses. Given this problem, several western countries have mandated claw-back provisions that take away compensation if there are future losses in a company. Given Indian regulations limits on leveraging, this is not a problem and, again, solving it is, therefore, pointless micro-management.
Third, Indian top honchos’ pay packages are nowhere near as outsized as the western ones. The top US CEO makes over Rs 7,000 crore in a single year (source: Forbes). The top Indian CEO, and there are very few in that bracket (only three), takes home Rs 70 crore by contrast (source: SiliconIndia).
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Fourth, it is unlikely that the promoter would extract a huge salary as his gains mainly would come from capital appreciation and dividend payouts. Besides, a lower tax incidence on capital appreciation (often zero) and dividends (typically 15 per cent payable by the company and tax free in the hands of the shareholder) would ensure that the promoter does not award himself a large salary. In addition, the benefit of a disproportionately outsized salary is likely to depress share prices in the secondary markets so the promoter loses far more in terms of capital appreciation than he gains in terms of a larger salary cheque.
High executive compensation in a market is an outcome caused by limited supply and high and rising demand for top talent. Attractive as it may sound, the government and regulators should restrain an urge to cap executive pay either in all companies or specifically in financial companies. Problems that exist in the West do not exist in India and are unlikely to find a place in India so long as the promoter-shareholder continues to oversee professional CEO and top managers. Increasingly aggressive shareholder scrutiny, especially from institutional investors and proxy advisory firms, has created substantial pressure on executive pay practices. The law should only take action in cases in which a promoter or CEO is seeking to loot the company with strict enforcement action rather than impose absolute restraints on pay packages by way of pointless micro-management.
The writer is also visiting faculty at IIM-A
Chairman & Managing Director, Prime Database
“While general meetings are a farce, board approval is a mere formality since most independent directors play ball with promoters. There are now innumerable cases of promoter-CEOs drawing tens of crores in pay”
A fresh debate has been sparked following a statement by the Securities and Exchange Board of India (Sebi) on the need to take a relook at the executive pay. Sebi has not suggested any cap or formula but has only proposed that such compensation should be entrusted to the “remuneration committee”. This is in contrast to the present practice in which remuneration in most companies is decided by promoters.
In recent times, though shareholders have lost a lot of money, there has not been a corresponding reduction in executive remuneration. Top executives often get an increase in pay regardless of the company’s poor performance, when shareholders would have been happy to see a cut. At such times, the league tables of CEO salaries appear incongruous. Moreover, flaunting big mansions, villas, yachts, aircraft et al does not go down well with minority shareholders.
For a proper debate, however, we need to first differentiate between a promoter-CEO and an outsider-CEO.
Promoter-CEOs constitute the majority since most Indian firms are owned and run by families like personal fiefdoms. The present forms of pay approvals are ineffective. While general meetings are a farce, board approval is a mere formality since most independent directors play ball with promoters. There are now innumerable cases of promoter-CEOs drawing tens of crores in pay. This is a clear enrichment of self at the expense of minority shareholders. There is merit in the argument that their pay be moderated. Promoter-CEOs, in any case, have other sources of remuneration — such as large dividends and greater valuation of their shareholding.
Given our levels of governance, however, any kind of cap would not work since promoter-CEOs would easily find other ways to enrich themselves. How can a regulator verify if purchases of equipment or raw materials have been not over-invoiced? Or that sales have not been under-invoiced? Or that money has not been siphoned out through subsidiaries, especially foreign subsidiaries? How do you stop sons, daughters, wives and sisters from being paid huge sums? Or ensure that almost all personal expenses (weddings, travel, shopping, even household) are not charged to the company? On the other hand, limiting the maximum compensation for non-promoter top management would mean too much government interference, which is uncalled for in the growing competitive environment.
As far as outsider-CEOs are concerned, it is true that for companies of certain sizes and in certain sectors, talent is scarce and high pay may be imperative. The safeguard here is that outlandish pay is unlikely to be the norm since it would not enrich the promoter.
Hence, there is a case for executive remuneration to be closely linked to long-term business performance and sustainability, not short-term goals. Interestingly, there is already an increasing demand that salaries should be divorced from revenues, a relationship that often leads to malpractices for short-term bumper gains.
Sebi has suggested that remuneration committees should be headed by independent directors. This will work, provided we are able to get truly independent directors and, more importantly, there is a requirement for these directors to submit a report to shareholders providing detailed rationale for executive compensation.
The most recent King Code on Corporate Governance deals with remuneration policies and recommends, among other things, that a company’s remuneration policy should be tabled to shareholders for a non-binding advisory vote at the annual meeting. In the UK, there is pending legislation to give shareholders a binding annual vote on companies’ remuneration policies.
The ministry of corporate affairs is also considering the UK prescription, which makes it mandatory for companies to disclose whether the top management was able to meet its targets. Companies also need to publish a comparison between company performance and chief executive pay and data showing the difference between executive pay and staff pay. The UK policy is based on the US Dodd-Frank Act.
The time has also come for proxy advisory services to play a more active role in the form of more research, media stories and recommendations to institutional investors to vote against unfair proposals.
At the end of the day, a better-equipped remuneration committee, more disclosures to shareholders and pressure by shareholder activists can rein in this growing ill.