Structure of the compensation package and the quantum of pay being delivered are the two critical points of executive compensation
Compensation levels will only go up in future – it is the natural course of things
While it is true that pay delivery and governance across the world was being driven by the pursuit of growth and overlooking the risks inherent in such growth, this misalignment of pay was more prominent in certain industries and countries and was never a global phenomenon.
Executive compensation as a subject has always been fairly opaque and inscrutable in India and in most parts of Asia. Organizations have rarely, if ever, been open to sharing executive compensation data outside of whatever is mandated by regulators. Valid and reliable executive compensation data, however, has always been a critical requirement for organizations. Much of this article is based on the results of Aon Hewitt’s Executive Compensation survey conducted in more than 60 leading organizations spread across industries.
Compensation for the set of employees who, theoretically, have the highest impact on the definition and implementation of an organization’s strategy is usually classified as executive compensation. Typically, this represents the top two layers within an organization’s management hierarchy. The two critical areas of discourse around executive compensation have been the structure of the compensation package and the quantum of pay being delivered to these executives (many times with a specific focus on how it compares with pay at other levels in the organization).
In the eye of the storm
There has virtually been an explosion in the volume of analysis that executive compensation has been subjected to in the last few years. This is partially on account of the increasingly larger paychecks that have been awarded at executive levels and also due to the consistent linkage drawn between executive compensation and the recession.
Evidence of discussion around executive compensation can be traced back to the days of Plato when he suggested that a community’s highest wage should not exceed five times its lowest. By the early years of the 20th century, the banking community had pushed up this number to at least 20 times. The first evidence of public scrutiny of executive compensation was seen in the post First World War era, when railroad companies were nationalized in the US – in the process exposing huge compensation that was being paid to senior executives. The Great Depression and its aftermath drove the creation of the Securities and Exchange Commission in the US which wrote the guidelines on disclosure of executive pay, which today form the basis of all disclosure norms the world over.
The early traces of discussion on executive compensation in India can be found in Kautilya’s Arthashastra where the governance of compensation decisions for top officials and avoidance of greed at that level is prescribed. With its socialist underpinnings, most of the post-independence era saw companies in India place moderate premiums on top professional jobs. With oppressive tax structures, benefits and perquisites were often more important than the actual pay. Since the early 1990s, the concept of differentiated executive compensation became more prominent and over the last 5–7 years the focus and discussion around executive compensation has become a prominent part of the business management and governance landscape.
The most commonly asked question about executive compensation revolves around its role in the economic downturn, and while the general belief is that it was one of the key reasons for organizations to indulge in risky behavior, it is difficult to name it as the chief culprit for all that went wrong. While it is true that pay delivery and governance across the world was being driven by the pursuit of growth (in the process overlooking the risks inherent in such growth), this misalignment of pay was more prominent in certain industries and countries and was never a global phenomenon.
The late recognition of the role of executive compensation in India is probably one of the key reasons why Indian companies could not be blamed for misaligned pay levels in the last couple of years.
Current perspective on executive compensation in India
A moderately free economy, competitive organizations, rapid economic growth, and a constant need for talent to manage key roles, has led to a significant change in thinking about executive pay in India. The country has undergone a rapid transition from an era of moderate differentiation in compensation in the socialistic economy model, to a huge disparity in compensation (even prompting the Prime Minister to comment on this) across levels in an organization. A quick analysis of our data shows that the ratio of the total salary paid to a graduate entering the corporate world to the CEO’s total pay is about 156 times while it is 63 times the compensation paid to an entry level manager.
Pay levels in India
The study shows interesting trends on total pay levels across the executive population in India. Pay for professional CEOs in India is very frequently above the USD 1 million range per year. Indian pay levels broadly follows the same pattern as the US and other Western economies where CEO pay is usually a multiple of about 5 times the CXO levels.
Variation in pay levels by industry
There are two schools of argument on benchmarking of pay at the CXO levels - the first and more traditional argument suggests that regardless of level, pay benchmarking is best conducted within industry definitions. The more modern argument suggests that at senior levels the skill sets required are broadly the same and are usually independent of the industry but more dependent on size and complexity of the business. The data from our study seems to support the second argument more on account of the insignificant differentiation visible in pay data across different industry clusters.
The width in CEO pay across four broad clusters – BFSI, technology, manufacturing and others (primarily services industries and consumer goods) ranges from 50% to 65% on fixed and total pay respectively. The data gap for the CXO population is even narrower and ranges from 35% to 45% on the two anchors of pay.
An interesting discussion in executive compensation deals with how compensation is divided across fixed and variable elements of pay. This mix of pay often indicates the nature of performance orientation that an organization wishes to drive in its executive pay philosophy while also dictating the extent of risk appetite that the compensation structure is driving.
Across most of the Western world, pay mix is very aggressively tilted towards long-term compensation – in the US long term-incentives usually constitute 65% of total CEO compensation and only about 12% is delivered through fixed pay. Even within the CXO population, long-term incentives tend to be in the range of 50% - 55% of compensation and fixed pay usually does not exceed 30% of total. There has been significant debate on whether this level of incentive alignment is necessarily healthy for the organization and most global regulators seem to be of the view that while long-term incentives are not necessarily the problem, the way metrics are defined in these plan structures could lead to unwanted behaviors within the executive team.
India is significantly different, with not more than 25–30% of total pay being delivered through long-term incentives and fixed pay forming close to 50% of the total compensation for the CEO. While the Indian model on the face of it does not necessarily promote risky behavior, what the right mix of compensation should be at these levels still remains an area of debate and research.
In the Indian context, it is also interesting to find that there exist a wide range of organizations – perfectly modern and competitive in their outlook – that have consciously or otherwise chosen to not incorporate long-term incentives into their compensation structure. The success of some of these organizations sometimes raises the interesting question of whether such incentives really are an important tool for organizations to drive managers to work for long-term success of businesses!
Nature of long-term incentive vehicles
The vehicle or mix of vehicles that organizations use to deliver long-term incentives has been constantly changing in the last few years. This change is driven on account of a variety of reasons – stock market performance, increasing dilution levels, accounting requirements, etc. Our research globally shows a strong move towards performance share plans (share grants to executives at zero cost subject to performance conditions being met) and away from the more traditional vehicles such as ESOPs. The trend in our opinion reflects the need within organizations to move away from plans based on entitlement, to ones that reward performance.
Indian companies are also making the transition to such performance-based structures, although the change is much slower. Indian companies typically rely on a single plan structure to deliver long-term incentives, while globally organizations tend to rely on a basket of vehicles – usually two or more. This portfolio approach stems from the belief that different vehicles reward different kinds of performance and therefore drive different behaviors.
Gazing at the crystal ball
Around the time the world was realizing the extent of the economic mess a Chinese leader commented about Western practices and said “The teachers have some problems.” Our models for economic and business management have traditionally been structured around the capitalistic model promoted by the West. Compensation models have also been based on similar underpinnings. This world order has changed, and in our role as compensation consultants, we have seen this transition as companies increasingly want to know less about Western data or structures and more about how leading local companies are thinking about pay.
Compensation levels will only go up in future – it is the natural course of things; however what needs to be closely watched and managed is the way organizations decide on the means to deliver that compensation to their executives. So long as that process is managed honestly and is in line with the fundamentals of the business, executive compensation will remain a critical driver of managers’ commitment to long-term business success.
Anandorup Ghose, Solution Lead, Executive Compensation & Governance, South Asia & Middle East - Aon Hewitt