With the advent of professionally run organizations where the management vests outside of shareholders/owners, compensation of senior executives such as the CEO and CXO tends to be much higher than that of other employees. Their remuneration consists of a mixed bag of components – fixed, variable, as well as short / long-term milestone-driven windfalls, featuring innovative and creative mechanisms like ‘non-compete premiums’.
However, the ingenuity around executive compensation also brings its fair share of controversy such as the recent one surrounding severance packages of outgoing executives in case of a reputed listed company. This incident serves as a reminder that remunerating senior executives involves a balance between rewarding productivity and maintaining good corporate governance. Interests and expectations of shareholders, creditors and other employees must necessarily be considered.
This article aims to provide an overview of the key considerations to be kept in mind while deciding on compensation of senior executives.
Key Considerations - Laws Governing Senior Executive Compensation in India
From the early nineties, salary caps and limits on perquisites for managers stipulated under the Companies Act, 1956 were progressively increased and eventually virtually eliminated, providing companies autonomy in this regard. Presently, Section 197 of the Companies Act, 2013 (Act) prescribes that a public company’s total managerial remuneration must not exceed 11% of its net profits for that year. Excess remuneration can be authorized through a special resolution passed by shareholders in a general meeting, with the approval of the Central Government, provided certain procedures are complied with and a clear justification is given for such increase.
Similarly, listed companies are also obligated to constitute a Nomination and Remuneration Committee (NRC) to maintain standards of good corporate governance. The NRC consists of non-executive directors, with the chairperson and 50% members being independent directors, to frame remuneration policy of the company, which shall be placed before the board for its approval. Listed companies are further required to comply with several disclosure requirements prescribed under the Companies (Appointment and Remuneration of Managerial Personnel) Rules, 2014 (Rules) and the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (LODR). The LODR requires a report on corporate governance, including remuneration figures of directors, to be included in the company’s annual report.
In the current economic climate, transparency and accountability are expected to be at the forefront of any company’s agenda. In furtherance of this, several amendments to regulations have recently been made effective. For instance, ‘upside sharing arrangements’, promising windfalls in case of corporate events, are also being scrutinized from a corporate governance standpoint. In a quest to improve transparency, Regulation 26(6) was recently introduced into the LODR, providing for prior approval of upside sharing arrangements in a meeting of public shareholders, and all interested parties are barred from voting on these matters.
In sum, it can be said that while the legal framework does not regulate the quantum of compensation awarded to senior executives, it provides for a comprehensive disclosure mechanism that companies must comply with to protect the interests of shareholders.
However, it is important to realize that compensation often becomes a personal concern among shareholders and lower and mid-level employees, despite compliance with all legal requirements. In this sphere, legal regulations are subordinated to basic principles of fairness and fiduciary responsibility of executives. In companies exhibiting a strict separation between ownership and control, owners often raise objections to high compensation, arguing for surplus to be distributed as dividend to shareholders, or utilized for expansion of the enterprise. In this light, the most prudent course of action is for companies to fix reasonable compensation in accordance with all legal requirements, ensuring participation of and approval from shareholders at every step. In the long run, such measures will prove helpful in avoiding negative press resulting from shareholder dissatisfaction and internal tussle in the company stemming from excessive executive compensation.