Link Governance With Pay

Indian companies are at a unique point in the evolution of their approach and thinking towards compensating boards and executives. In the natural order of things, as organisations grow or plan for significant growth, compensation levels for critical managers who are responsible for driving this growth start rising. So it has been with Indian businesses, which have had, barring the current phase, an almost uniform growth trajectory. This has been reflected in the way companies have remunerated their executives.

A snapshot of the last five years would reveal that executive compensation has grown at a compound annual rate of more than 14 per cent. Indian compensation levels are now beginning to look surprisingly similar to global standards. And if the growth rate in compensation levels remains same across western economies(average of one to two per cent increases) and India, in five to six years Indian executive compensation levels would start exceeding global benchmarks.

The delivery of pay is also becoming increasingly aligned to performance-based structures. The pay mix has moved from being a “cookie cutter” 80:20 mix between fixed and variable to a more evolved mix of fixed pay (about 45-50 per cent), annual incentives (25 per cent) and long-term incentives (25-30 per cent). A more subtle change is the effect of the volatility in Indian equity markets on the earning potential for executives – higher volatility, and thereby risk, providing larger upsides in pay. In effect, what this presents is a very interesting reflection of the fact that compensation for executives in India is very similar in all aspects with western counterparts. However, this presents a distinct reason for investors, regulators and companies to worry because the governance of compensation in India is still very far from the level of maturity that is mandated in western economies.

Aon Hewitt’s research in executive compensation throws up two distinct aspects that should worry. Firstly, the basic tenet of executive pay – that compensation data should have a distinct correlation with business fundamentals – is glaringly absent in India. CXO compensation in India, across sectors and sizes, shows marginal to no correlation with business size or scope.

Secondly, there is significant confusion and opacity in data that are available in the public domain for a large cross section of companies. In our interviews with human resources and compensation managers we have often found them struggling to clearly outline the process of pay decisions at the executive level. Both these factors can perhaps be explained by the structure of the talent market in India where demand for effective CXO talent is believed to far outstrip its availability.

There is also a legacy and structural issue in this. Historically, Indian companies have largely been promoter-driven and the principal-agent relationship has been very different from the primarily shareholderrun organisations in the West. Indian companies have ensured managerial compensation has been strictly in line with the best interests of the promoter group. But they have broadly ensured a certain degree of discipline in managerial remuneration. In fact, companies where the board is largely controlled by the promoter group usually compensates its chief executive officers at an average 60 per cent less than companies where the board is driven by institutional and minority shareholders. The maturity that is forced onto companies through shareholder activism has been very distinctly absent in the Indian context.

Indian regulators have largely played a passive role in ensuring effective governance of compensation – the provisions of the Companies Act on managerial remu- neration have progressively been relaxed and currently exist only as compensation caps as a percentage of profits (the caps are almost irrelevant in large organisations and create confusions for smaller or lossmaking companies). The Securities and Exchange Board of India has allowed companies significant flexibility and through its Clause 49 of the Listing Agreement only requires disclosure of director compensation. Industry-specific regulators have been more active, and the Reserve Bank of India has been more directive in the approach towards managing compensation in Indian private-sector banks.

Over the last three years there have been a range of other “non-mandatory”guidelines that have been issued by the government and industry bodies, such as by the Ministry of Corporate Affairs in 2009 and the Confederation of Indian Industries in 2010. This leaves sufficient room for organisations to manoeuvre both in terms of disclosures as well as the approach towards governing pay decisions.

The current regulatory structure hails from a time when pay structures or quantum for executives were not very different from the rest of the organisation and the world had not gone through a financial crisis largely brought about by misaligned incentives. In this environment, organisations have taken varying approaches towards compensation governance.

While some who are listed on global exchanges have had to comply with their regulators, others have voluntarily ensured high levels of disclosure of pay levels and governance standards. But many leading companies keep their executive compensation structures and approaches sufficiently opaque while disclosing the bare minimum.

There is an urgent need for two changes in the executive salary landscape. Firstly, independent compensation committees need to become mandatory for companies. Secondly, organisations need to be provided more detailed templates for disclosing information on executive pay. The disclosures should start resembling proxy filings that US-listed companies are required to do.

While we have been critical of organisations in their approach towards disclosures and discussions on executive pay, we have seen an increasing maturity in a large number of Indian organisations. What was once a taboo concept with little or no data being shared, we today have companies actively participating in surveys and sharing data. Regulators need to hasten this process of transformation by ensuring all organisations disclose their approach and data on executive pay. Executive compensation conversations always start with a discussion on shareholder value, and it would be unwise for us to forget the fact that ensuring shareholders are completely aware of how pay levels are aligned towards delivering value is in itself a great way of increasing confidence in and attractiveness of a business.

The author is Director, Executive Compensation and Governance, Aon Hewitt