CEO salaries: A question of pay

September 08, 2021 4:50 AM

Large CXO-pays at firms with poor corporate governance puts upward pressure on pays at firms with good governance, thus creating inequity for managers in the latter

Governance is about equity, balance and fairness, and the gatekeepers need to hold themselves demonstrably independent and uphold their moral compass.Governance is about equity, balance and fairness, and the gatekeepers need to hold themselves demonstrably independent and uphold their moral compass.

By Kshama Kaushik & Kaushik Dutta

India is witnessing significant activism from institutional, minority and proxy advisors around approving promoter and CEO remuneration. Since laws for approving remuneration of a CEO and directors above a threshold set by the government need two-thirds of shareholder votes in a general meeting, getting a majority of the minority shareholders voting for the resolution to increase pay becomes crucial. The recent rejection of increased pay for the CEO of Eicher Motors by minority shareholders in the face of the worsening financial position of the company is more than a wake-up call for votaries of extremely high CEO/promoter pays.

A CEO’s or promoter-director’s pay is not just an emblematic issue. Excessive pay distorts labour markets, apart from creating inequity. If a CEO, for instance, is earning `25 crore a year, then it is likely that other high-level executives will also be getting paid in crores. Many highly-paid individuals whose pay gets enhanced to keep parity with the CEO remuneration may not have the talent to command such salaries; this creates entrenchment in the company and lower returns on human capital at higher management levels.

In the US, where the debate on excessive CEO pay emanates, CEOs have always been paid richly, and the ratio of CEO-pay to typical worker-pay is up from 20-to-1 or 30-to-1 in the 1960s and 1970s, to 200-to-1 or 300-to-1 in recent years.

In India, for the Nifty 50, the slope of earnings between a CEO and an average shop floor worker was estimated at 249 times—what an average shop floor worker would earn in a year, the CEO would have earned on the first day. Additionally, if the CEO is a member of the promoter group, then other pay-outs of ownership through dividend and increased share price also accrue to her/him. This is typical when there is no gap between owners and managers and high pay to the owner-CEO creates high multiple income streams from the company, to which other investors have limited access.

Accountability matrix: The Companies Act of 2013 requires that a nomination and remuneration committee, which needs to have half the members as independent directors, articulates a policy for appointment and remuneration of directors and key management personnel. Such a policy needs an effective oversight by members so that equity and fairness in implementation is achieved. The reasoning for pay increase, benchmarks used for evaluation including linkages to key performance indicators, e.g. profits or cash generation, should be recorded in the minutes and included in the explanatory statement to the resolutions seeking pay revisions of a CEO. This helps minority shareholders appreciate the reasoning and decide on their voting strategy.

SEBI or corporate affairs ministry may provide guidance on reporting requirements for corporations for calculating CEO-to-worker pay ratios to make these consistent over time and across firms; this will make these ratios far more useful to government, regulators and the public.

Signs of weakening corporate governance: The Economic Policy Institute of the US notes that “research has demonstrated that CEOs are rewarded for luck and that weak corporate governance—boards of directors more concerned with hanging onto their own positions than with advocating for the best interests of shareholders—fails to restrain CEO pay by subjecting it to serious competition.” These statements echo the sentiments of many market watchers in India, too.

The fact that boards and their committees quickly put together an alternative proposal of a lower pay for a CEO, whose original pay proposal was rejected by minority shareholders, show weakening of governance and lack of conviction in the board processes in which the same directors participated. Rules need to evolve on what should be the cooling-off period before a rejected pay proposal of a CEO can be reintroduced to shareholders for approval—much like the new rules of election of independent directors, who could not get the required minority votes.

The outcome of good corporate governance is plagued by external factors—costs or benefits faced by actors not directly involved in corporate governance decisions. The activist shareholder groups that spend resources to usher in better governance share the benefits with those who are not participatory. Hence, the cry for better governance is only taken up by activist groups who often have their own consideration regarding their investments in a company. The excess pay for CEOs at firms with poor corporate governance tends to put upward pressure on pay for CEOs at firms whose shareholders actually spend resources on good corporate governance, thus creating inequity for managers in a well-governed firm.

Governance is about equity, balance and fairness, and the gatekeepers need to hold themselves demonstrably independent and uphold their moral compass.

Authors are founders of Thought Arbitrage Research Institute

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