India Inc.’s Remuneration Levels Need To Be Reined In

Early signs in 2022 suggest that once again, the growth in remuneration will outpace revenues and profit growth. Compensation levels are increasing, and remuneration disclosure levels are decreasing. Nomination and Remuneration Committees are unable to build tangible contours for compensation, resulting in runaway payments. SEBI needs to mandate that remuneration resolutions come with monetary caps, and make it a majority-of-minority vote.

The remuneration structure, where promoters get a significant upside and bear a limited downside of company performance compared to other executive directors, is a reflection of a feudal mindset that needs desperate change.

The first step of curtailing such behaviour is where a board’s Nomination and Remuneration Committee comes in. It needs to answer if promoters, by definition, contribute significantly more to a company’s success than professionals. Or is it just an ownership right that is being abused?

NRCs have been reticent in driving accountability through remuneration. They allow promoters to have a direct share of profits as commission, which means that promoters will get paid as long as the company is profitable, independent of the quality of profits.

Long-term goals of growth, de-risking of the business, and focusing on non-financial performance metrics are assumed to be on the list of the promoters’ responsibilities, but a tangible measurement of delivery is not required. This limits the incentive mechanism.

This is different for professionals at the helm of companies.

Professionals Vs Owner-Managers

Salil Parekh’s much-discussed remuneration, estimated at Rs 81.88 crore for FY23, is largely driven by stock options which will vest only if he accomplishes a set of predetermined targets, most of which have been disclosed by Infosys Ltd. in its 2022 annual general meeting notice.

These targets include both financial and non-financial performance measures. Such clarity and accountability align pay with performance and therefore, shareholder interest. This is reflected in how shareholders reacted: the resolution passed with a 98.54% majority.

In contrast, JSW Steel Ltd.’s Chairperson and Managing Director Sajjan Jindal’s compensation in FY22 was Rs 134 crore. It is high because it comprises a flat 0.5% commission on profits, over and above a fixed pay.

In other words, he benefited from the upswing in the commodity cycle and not necessarily by driving stronger business metrics. Other executive directors of JSW Steel, however, were not equal participants in the company’s FY22 success.

Salil Parekh’s remuneration, too, would have exceeded Rs 100 crore if he were to get 0.5% of Infosys’ profits as commission–but what then would be his incentive mechanism to create shareholder wealth?

Some promoters have moved to a non-executive capacity yet continue to draw high remuneration. This is not unreasonable, given that they are the ones who remain ultimately responsible for the business.

However, in several instances, these non-executive promoters are paid more than executive directors and other key management personnel, or almost the same remuneration as when they were executive directors.

Suresh Krishna was the managing director of Sundram Fasteners Ltd. till 2018, following which he became a non-executive director. His two daughters now hold executive capacity.

His proposed remuneration comprises up to 1% commission on profits, which IiAS estimates will be Rs 7.36 crore in FY23, equivalent to an executive’s pay. Shareholders, too, raised concern with 47.87% of institutional shareholders not supporting his remuneration–the resolution passed because promoters voted their 49.7% equity.

Having promoters and families run businesses can have its positive aspects. Promoters have a generational view of the business and therefore think of the longer term while professionals may indulge in short-termism.

And while they push for higher compensation for themselves, the NRC should make a distinction between the owner and the manager. They must ask, is this the best CEO that money will buy or will my company CEO get the same salary with another firm? Finally, they need to remind the owner-managers that their wealth is tied to the share price, which is what they need to focus on.

Impact Of Venture Capital And Private Equity

A new breed of controlling shareholders–those that do not have a defined ‘promoter’ under SEBI regulations but are controlled by a founder and some private equity investors–have brought in a new set of remuneration structures.

In the case of startups that have been listed, remuneration levels are driven by restricted stock units (stock options exercisable at face value). Several of these startups are trading below their issue price, but with stock options at face value, founders who are not subject to the same restrictions as ‘promoters’ are in-the-money independent of company performance.

Vijay Shekhar Sharma of One97 Communications Ltd. (Paytm), for example, received a little less than half the stock options granted by the company at face value, pegging the fair value of stock options at over Rs 110 crore. 67% of institutional shareholders voted against the company’s stock option scheme, but the resolution passed because of the support of the private equity investors.

Private equity investors have raised the level of remuneration to different heights. In companies like EPL Ltd. and Sona BLW Precision Forgings Ltd., private equity investors have promised a share of their exit returns to key employees of the company, including the CEO.

There is no quantification at this stage because private equity investors do not know what their returns will be from that particular company, but given that they usually have a three- or five-year post-listing investment horizon, the management is then incentivised to focus primarily on the private equity investors' exit valuation.

Once the private equity investors exit, the management will have made generational wealth. Will they then continue to build a stronger institution or exit and leave someone else holding the can?

Institutional investors have supported such structures because active investors, too, have a three-to-five-year investment horizon. Yet, these remuneration structures create an incentive mechanism that does not support the long-term interest of the company and its stakeholders.

These are just some of the examples we have seen in the early part of 2022: the jury is still out on the rest of the proxy season.

What SEBI Should Do

Disclosure on remuneration levels has slowly deteriorated, despite the investor push-back. Promoters are able to get past the shareholder ire by voting their shares and therefore remain sanguine.

As is often the case, poor behaviour in a few pockets begets regulatory scrutiny. RBI has already set a framework within which remuneration will be paid to bank CEOs, including pushing for clawbacks and malus.

For the rest of corporate India, if remuneration levels are to be tempered, SEBI needs to mandate that every resolution comes with a monetary cap (and includes the fair value of stock options)–NRCs must disclose a cap in absolute terms and seek shareholder approval if they believe a higher remuneration level is warranted. This itself will act as a deterrent.

SEBI also needs to make promoter remuneration a majority-of-minority vote: allowing promoters to vote on their own compensation is a conflict of interest, much like other related party transactions.

For companies that are ‘promoter’-less and controlled by founders and private equity, the regulator needs to find a way of addressing the regulatory loophole and arresting the egregious remuneration structures.

Hetal Dalal is President and Chief Operating Officer at Institutional Investor Advisory Services India Ltd.

The views expressed here are those of the author and do not necessarily represent the views of BQ Prime or its editorial team.