Article: How much is enough?

Benefits & Rewards Consulting

How much is enough?

Despite legal regulations, there really can’t be a bar on the level of executive compensation as it is usually the company that decides how much is too much
How much is enough?
 

It is immensely challenging to determine the right monetary value for the topmost levels, where the competencies required are of a highly abstract nature and expectations not clearly articulated

 

Companies in India actually lay more importance on non-financial goals for their leaders as compared to their counterparts in others parts of Asia

 

Anshit’s day was as hectic and unplanned as many of the days he had been through in the recent past. As the global rewards leader for a gigantic multi-national technology company, he had gottenused to expecting the unexpected each day. Today, however, was going to be more different than he had imagined. The company that Anshit belonged to had been in operation for decades and was known to have been an industry bellwether. As growth slowed, the company’s leadership was under pressure to perform against a different set of metrics and expectations. It had, therefore, started diversifying into related areas, which it had not ventured into earlier and in fact, had consciously stayed out of. The Head of Human Resources had called Anshit later that afternoon and informed him that the company would soon be hiring a chief executive officer for one of its new forays. It would operate as a separate wholly owned subsidiary after inception and once it had been staffed with its initially required management. Anshit’s responsibility was to recommend an appropriate compensation package for the new incumbent – the Chief Executive Officer. Anshit was in a state of deep disquiet: the question he was not able to find an easy answer to was “how much would be enough?”

At a very basic level, compensation is the monetary value one provides in return for certain services. For an economist, it would be a function of the balance between demand and supply of certain skills and competencies. For an accountant, it would be the price business pays for labour. For a human resource practitioner, it would be the financial value required to attract an individual to the active workforce and keep him or her motivated and engaged till such time that the individual’s services are required, usually long-term in most cases.

For most levels across an organization where the number of incumbents is in plural, it is relatively easy to determine what salary levels to pay based on market levels, affordability and the compensation philosophy of the organization. It gets progressively more difficult for the higher levels. At the topmost levels, where the competencies required are of a highly abstract nature and the expectations from a job cannot really be articulated in the form of uniformly understood tasks and activities, it becomes immensely challenging to determine the right monetary value for such positions. Moreover, the impact of the actions of such job holders cannot often be realized in the immediate term. It is, therefore, not a surprise that over the last few years, salary levels for such leadership positions have been on the rise at a rate not commensurate with that of the rest of the levels in the industry. For instance, the salary at the entry level in the top 5 IT companies has remained almost constant between 2010 and 2014 at Rs 25,000 to Rs 28,000 per month. But the salary levels for the CEOs for these very companies have increased from about Rs 20 lakh per month to more than Rs 50 lakh per month over the same period. The more “disruptive” the expectations from such positions, the more “disruptive” the salaries are becoming for the job holders.

Executive compensation is constantly a topic of hot debate. In the recent past, in India we have seen an increasing trend of instances of such disruptive salaries being offered. Flipkart and Infosys are examples of such instances. Experts in the field, leaders of corporate India and shareholders alike have called for greater transparency in terms of how such compensation levels are arrived at and demanded higher fairness keeping the compensation levels of the rest of the levels in mind. Towards this direction, there have been regulatory changes that have been taking place, such as the introduction of the new corporate governance norms under the Clause 49 of the Equity Listing Agreement. But have they been truly effective in bringing about these factors as considerations when compensation packages are determined for key positions?

The Case for Governance & Transparency

The Companies Act stipulates that a whole-time executive director or a managing director can be paid remuneration either by way of a monthly salary or in the form of variable pay as a percentage of net profits with the total pay not exceeding 5 per cent of the net profits. If there is more than one whole-time director, then the cap is 10 per cent of the net profits for all of them put together. For a large profitable organization, this leaves enormous headroom for the board to determine salaries for its members. As an illustration, if we take an organisation with an annual revenue of Rs 2,000 crore and a net profit of 10 per cent, the annual total remuneration for all the whole-time directors put together can be as high as Rs 20 crore.

Apart from the play of numbers, another major pressure point would be the conflict of interest of executives with that of the stakeholders. While executives are expected to act in the interests of the investors and the organization (and hence look at less pay), when it comes to compensating themselves they are likely to over-pay themselves. The increasing number of such instances has led to rising focus on corporate governance and transparency regarding executive pay and how Boards must act and govern themselves. Clause 49 of the Equity Listing Agreement endeavoured to lay down new corporate governance norms for listed companies in India. It lays down norms to be followed on aspects related to rights of the shareholders, disclosure and transparency, board composition, independent directors and aspects of how boards should function. Regulations such as these will help to increase transparency in business.

In a survey conducted by Mercer on governance and transparency of executive compensation in India, respondents felt that:

• More governance and disclosure of executive compensation in Asia is required (59%).

• The Board should be responsible for setting, monitoring, and explaining executive salaries (53%).

• The remuneration committees of Asian corporations are well equipped to make pay determinations (45%).

• Shareholders should have more control over issues such as pay and binding notes on remuneration reports (31%).

In light of the growing scrutiny on executive compensation all over the world, about a quarter of the respondents felt that there was a disproportionate focus on the issue of executive compensation (24%) and only a small percentage of them felt that executive compensation was excessive and should be capped/controlled (10%).

It is indeed a tight-rope walk to strike a balance between freedom and responsibility bestowed on the Board on one hand and the extent of transparency and accountability that should be put in place on its actions on the other. 

The Case for the CEO

“So what?”, one may ask! Is it not a fact that the CEO and the other leaders of an organization actually take on disproportionately higher responsibilities? Aren’t the members of the Board liable as officers of the company for their disclosures and the overall performance of the company? Aren’t they the ones ultimately answerable to the investors, customers, analysts and other stakeholders? The answer to all these questions is a loud emphatic “Yes”. Indeed, the head of the organization can have a far-reaching impact on the overall performance of the organization. Not just does he / she exercise significant control on the broader direction that the organization takes in terms of financial performance, but also influences the culture, values and governance practices of the organization significantly. These can have an even longer-term impact and are extremely difficult to be course corrected or modified on an immediate or short term.

In spite of the seemingly high leeway that Boards derive from the regulations on how high they could fix compensation for the head of the organization, it is not that all caution is thrown to the winds. Increasingly, the head of the organization is compensated with a good balanced mix of fixed pay, short-term incentives (STI) and long-term incentives (LTI). A comparison of the compensation mix of salaries in India for the heads of organizations against their direct reports and the second-level reports showed up the differences quite remarkably.

The CEO and for that matter, the other key leaders of an organization are critical to its destiny. They impact the course an organization, which over time becomes a key part of its history. Therefore, it becomes imperative that the compensation for such leaders is at levels which attract the right incumbents for those positions, motivates them to work towards the enormous expectations of them from various stakeholders, retains them for a long term, and aligns their interests with those of the organization over a long term.

To an extent, corporations have endeavoured to put some checks and balances to executive compensation by using a health mix of fixed pay, short-term incentives and long-term incentives as seen in the comparative chart presented earlier. To align the interests of the leaders with those of the organization and its stakeholders over the long-term and to ensure that they are vested in its growth, a significant proportion of corporations use long-term incentive plans.

In fact, of the companies that offer LTI plans in India, about half offer only a single LTI plan. The remaining half offer two or even more LTI plans often targeted towards different management layers or towards different objectives.

However, there is room for significant improvement on how performance gets reviewed for leaders. It is imperative that management objectives are not just financial or market driven goals but also include a healthy mix of customer- and people-related goals, risk-adjusted measures, and governance metrics.

Here, it has been observed that companies in India actually lay more importance on non-financial goals for their leaders as compared to their counterparts in other parts of Asia.

It, therefore, is not a compensation problem alone. In addition, it is one of setting the goals and objectives for the positions in question, laying down the process for evaluation, defining clear rules for determination of the compensation and its mix, and seeking views and consent from critical stakeholders.

How much is enough?

Unfortunately, there is no easy answer. There is the dichotomy of paying for performance or paying for retention. There is the balance to be struck between paying to attract the absolute best, continuing to compensate them at levels, which motivate and retain them, transparency in the process of doing that, fairness compared to the rest of the organization, and accountability to all the stakeholders of the organization.

Meanwhile, there doesn’t seem to be an end to disruptive salaries being offered in the industry any time soon. In a vibrant growing economy like that of India, something like that happening itself would spell doom. There are new players in the industry with transformational business models who see the horizon golden with opportunities. For them, some of the key executives they hire at the senior levels hold the key to whether their brightest dreams will fructify or not. Flush with investor funds, they are willing to literally pay an arm and a leg for the right hires for those positions.

Anshit’s task never promised to be an easy one; after all, executive compensation is a challenging job! But there are rules that he can work with as guiding principles, which will make his task easier by breaking it down into smaller manageable pieces and a lot more objective. These principles will be able to help Anshit to ensure that his proposed reward package for the new CEO is properly aligned with the company’s overall business objectives, that it measures and rewards the appropriate performance factors, and that it delivers meaningful remuneration to support executive retention.

While he can do his bit as the compensation expert, the effectiveness of the package is not his responsibility alone. It is also the collective responsibility of the Head of Human Resources, key members of the senior management, the Board of Directors and the shareholders. The independent directors should play a key role here and exercise a strong voice.

There is no single answer to the question “How much is enough?” – it changes by the day and, most importantly, it is not a number!

 

 

 

Topics: Benefits & Rewards Consulting, Strategic HR

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