Article Type : Research Article
Authors : Das PK
Keywords : Corporate governance; Directors’ remuneration; Corporate performance; Board; Agency problem
The paper succinctly outlines the
amelioration of corporate governance and directors’ remuneration in India.
Governance is about how an organization is being administered and controlled
while corporate governance is about a system, procedure or tool of harmonizing between administering and controlling
corporate internal affairs and the exigencies of its external shareholders and
stakeholders. An endeavour has been made in the paper to emphasize polemics
about the necessity of disclosure of director’s remuneration, shareholders’
approval on directors’ remuneration, approval of directors’ remuneration by a
committee, segregation of role of the Chairmen and Chief Executive Officers,
etc. Thereupon, it touches on the headway made by India in boosting the
corporate governance practices. The paper also appraises few thrusting germane
and offers recommendations on how the future approaches for the progress of
corporate governance in India with regard to directors’ remuneration shall take
fashion.
Excessive
directors’ remuneration unentangled with performance sprouts problem in
corporate sector in India. Even when a corporate not performing well and its
share value declines constantly, directors’ remuneration still touches skies.
However, the big problem concerning Indian corporate is that there is a huge
gap between the salary of top executives and other employees. Though supporters
explain it to be a result of dearth of talent at top level but even then too
much difference cannot be justified. Drastic differences in pay levels evidence
some tricks in play in the corporate governance (or, CG). Moreover, public
attention on CG acclimates due to high profile corporate failures. Although
directors’ remuneration as a mechanism of CG is viewed resolving agency
problems, it has transformed itself into a CG problem. This paper provides a
brief description of theoretical perspective of directors’ remuneration. The
relationship between executive remuneration and CG has also been highlighted.
Furthermore, whether directors’ remuneration is considered as a problematic
mechanism or a solution has been discussed in details.
Literature
review
This part occasions the
conceptual and theoretical reviews of the subject matter. Various studies
evidence the impact of board size on financial performance of firms. Glowing CG
tool especially board independence supports positive association between financial
performance and remuneration. Board size has major impact on CEO compensation
indicating crucial part of the board size in the directors' remuneration [1].
Opined that shareholders have right to approve or disapprove directors’
remuneration [2]. Examined the implication of ownership concentration on CEO
compensation and firm performance with the help of regression analysis for the
period from 2001 to 2005, and observed negative effect of ownership
concentration on CEO compensation and financial performance [3]. This study
bespeaks the manner where ownership structure can moderate the association
between CEO compensation and performance. Further, Studied on the relationship
between firm performance, CG and executive compensation in 13 companies listed in
2007-2009 on the Indonesian Stock Exchange, and found positive relationship
between executive compensation and ROA [4]. Higher the company profit, higher
the bonus. The study finds also that the mechanism of CG can strengthen the relationship between executive compensation and
performance. Investigated the connection between directors' compensation, CG
and financial performance of 150 companies listed on the Bursa Malaysia for
2008 to 2013 with the help of panel based regression model [5]. The findings show
that company size variable indicates positive and invincibly expressive with ROA. Leverage variable stipulates
negative but significant with financial performance (ROA). The results show
positive and significant relationship between director compensation and company
performance. Studied on the moderating role of CG on the compensation and
performance in South Africa taking a sample of 407 non-financial companies
quoted on the South African Stock Exchange for the period from 2003 to 2012.
The result suggests synchronic association among board characteristics,
executive compensation and firm performance [6]. CEO power and CG technique can
moderate compensation and financial performance. Studied the
cushion effect of CG and dividend policy on CEO compensation and financial
performance of 287 Pakistan listed companies for the years from 2010 to 2014
[7]. The findings signify that family owners confederate
CEO's compensation with working parameters, institutional owners with market
efficiency and company magnitude, and foreign investors with market share. It
also reveals that ideal board size reinforces pay-performance link. On the
other hand, CEO dichotomy and dividend policy modify pay-performance link.
Prescribed in their conflict of interest of distinct beings in executive
remuneration procedure and agency problem [8-19]. Proclaimed close relationship
between directors' remuneration and performance epitomized
that firm financial performance is positively but not strongly correlated with
CEO pay divulged unhealthy relationship between firm performance and CEO
compensation for bilateral subornation of CEOs with
directors. The study of explored coexisting reciprocation between compensation
and financial performance with identical board characteristics also observed
direct relationship between directors’ remuneration and firm performance [20].
Objective of the study
The objective of the study is to highlight the
association between directors’ remuneration and CG
practice particularly in India.
Research question
The
research question raised in addressing the study objective is what impact does CG
has on directors’ remuneration in Indian context.
Research methodology
The
study is descriptive in nature and conducted by variety literatures in terms of
CG
and directors’ remuneration. Descriptive research has been preferred for
developing better profundity of knowledge. Thus, this study purely adopts
secondary data collection strategy, and considers a variety of secondary
sources accessed through the Internet and academic databases viz. literature
reviews, empirical studies, website, books, journals, reports, etc. The work is
designed for a cross-section of those for making the issue easily
understandable and organized into several sections/parts. The inherent
limitation of the study is that as the study is based on published data and
information, and this secondary sources may be lacking in authenticity, the
result inferred there from may not be completely reliable.
Association between corporate governance and directors’
remuneration
Association between CG and
directors’ remuneration can be explained by the agency theory. The theory
concerns the relationship between management and shareholders in which
management works as agent for shareholders’ best interest. Although individual
members work in their narcissism, well-being of every individual depends on the
well-being of other members. Management and shareholders have different outlook
for risk avoidance. Management does its best to improve the financial
performance of company. Shareholders mind to influence executives by designing
incentives to align their interest and directors. Statutory requirements
mandate all listed companies to publish directors’ remuneration report with
their annual financial statement. Stock exchange regulations also require full
remuneration disclosures and policies for executives. This minimizes risk of
excessive remuneration and enhances transparency. Trust and fairness must exist
in the matter of directors’ remuneration.
Agency theory and
executive remuneration
Thus, principal-agent
theory behaves as cornerstone of executive remuneration and governance
practices. Executives obtain company loan with low interest and sometimes even
interest-free. Opined if separation of ownership and control eventuates, agency
problems subsist [21]. Still managers use company’s assets to enhance their
lifestyles and satisfy their claims without regard for shareholders.
Agency problem
Directors
perform the task of managing daily affairs. Their decisions often influence
their personal interest instead of increasing shareholders’ value. Directors
cannot be expected to perform with same diligence in managing other people’s
investment as they manage their own money. Managers and shareholders have
conflicting interest. Agency cost arising there from is must in any
organization where the control is in the hands of agents. Properly structured
remuneration scheme reduces agency cost by aligning executive’s interest with
that of shareholders. But due to improper regulations, executives milk their
discretion and maximize own remuneration against the overall interest of
company. Thus instead of minimizing agency cost, it becomes a tool for further
exploitation.
Executive pay as
positive perspective
High
executive pay often tempts splendours with high performance and acts as
positive perspective in company. Incentives motivate, reward and discipline
executives to take risky projects and achieve increased return in the company.
Explained that optimal cognation motivate narcissistic manager to adopt investment
policies that increase shareholders’ wealth with executives’ remuneration [22].
According to return on assets, earnings per share, return on capital employed,
shareholders’ return and directors’ performance measure performance [23].
However, negative relationship develops where executives behave fraudulently to
materialize high remuneration [24].
Existing regime in India
To ensure
equitable remuneration to executives, the law intervenes to balance the
conflicting interests. Executives’ remuneration is governed by the following:
·
Companies Act, 2013
·
Schedule V of Companies Act, 2013
·
Clause 49 of Listing Agreement, SEBI
Companies
(Appointment and Remuneration of Managerial Personnel) Rules, 20
Key highlights
· Section 197 of the Companies Act, 2013 states maximum
ceiling of 11% of net profit to its managing director, whole time director and
manager. However, excess of the prescribed ceiling must get shareholders’
approval in general meeting. The Act also stipulates ceiling on individual
salary to be 5% of net profits.
· Schedule V of the Companies Act, 2013 details about
disbursement by company in case of no profits or inadequate profits. Any excess
needs Central government’s approval.
· The law also imposes restrictions in other forms of
remuneration e.g. Central Government has restricted a sum of Rs.1 lakh per
meeting on the sitting fees of directors.
· The Company is not empowered to waive recovery of refund
where sanction of remuneration exceeds the prescribed limit without the Central
Government’s permission.
· The law provides for disclosure of remuneration in board
report.
The Central
Government mandates the following disclosures in board report:
· Ratio of remuneration of director to that of median
employee.
· Percentage of increase in CEO remuneration and that of each
director.
· Percentage increase in remuneration of employees.
· Relation between percentage increase in directors’
remuneration and company’s performance.
· Fluctuation in market value of shares for listed companies
and for unlisted company’s fluctuation in the net worth of a company.
· Reason for increase in managerial remuneration.
· Disclosure of employees’ name whose remuneration is more
than Rs.60 lakh p.a. and also disclosure of the fact if one becomes a relative
of director or any manager.
· Secretarial audit report should mention whether the
remuneration of executive directors adheres to the Companies Act.
Shareholders “Say on Pay”
Shareholders’ involvement in determining remuneration is
welcome. Certain strict disclosure practices enable them taking informed
decision. In India, excess of remuneration over the ceiling as prescribed in
Section 197 of the Companies Act, 2013 needs shareholders’ approval. Still, this process is merely a formality
with no real benefits for the reason that most of the companies in India are
concentrated ownership. Remuneration is easily approved since the interested party
belongs to majority shareholders. Minority shareholders are least interested.
They know that their voice does not count. In companies where promoters acting
as CEO also vote on their remuneration packages and they being the majority
shareholders, there remains little chance to disregard the approval of their
remuneration. Thus, the entire process of “say on pay” in India becomes
ineffectual. Even though the legislation permits the shareholders for vote, in
practice it has just turned out to be another formality of compliance. However,
shareholders’ vote on pay would be effective subject to the proposal suggested
by SEBI. The Companies Act and CG have taken
different approaches to regulating directors’ remuneration. CG takes more
proactive approach stating that premium listed companies should have
transparent procedure for developing policy on remuneration. CG provides that
company should form a remuneration committee containing only independent
non-executive directors to control excessive executive pay. Shareholders should
be well-equipped about company’s remuneration policy. “Say
on pay” empowers shareholders’ voice and encourages remuneration committee to
challenge directors’ remuneration.
Remuneration
committee devises executives’ remuneration according to their performance. The
committee must be independent and free from any prejudice. According to Section
178 of the Companies Act, 2013, remuneration committee must include three or
more non-executive directors half of whom must be independent. These independent
members protect shareholders’ interest and keep a check on board activities so
that it is not detrimental to the overall interest of company. Howsoever,
committees have not proved much effective. Firstly, committee being of both
executive and non-executive directors, chances of biasness still remain.
Secondly, non-executive directors suffer from agency problem. Thirdly,
independence of these directors is questionable. Often, these directors are
friends or deep relatives of executives. They stay in the company just for the
sake of formality. Fourthly, to legitimize high remuneration, they tend to keep
in terms with the executives allowing big remuneration. Fifthly, most of the
non-executive independent directors being executive directors of other companies
at present or in the past have compassion towards other executives and support
such remuneration. Statutory provision proves insignificant in so far it just
adds to compliance cost with no real benefit.
Impact of
dual role of CEO appointed as Chairperson
Dual role of CEO appointed also as Chairperson in certain
companies is a debatable issue. CEO is responsible to board headed by Chairman.
Board members are responsible to protect investors’ interest. They also
estimate the performance of other executives including CEO. Few opine dual role
ensures unified command and minimizes conflict of interest. However, the
stronger view is that this invites poor CG and undermines the separation of
powers. It also makes the independence of the board questionable. Companies having
separate CEO and Chairperson, level of remuneration is comparatively low as
compared to other companies where there is no such separation. Section 203 of
the Companies Act, 2013 states that one guy cannot hold both the position of
CEO as well as Chairperson barring a few exceptions stated in the Act.
Potential
reforms
Shareholders being owner of a company, the duty of
disclosure rests on them. Top level pay might emerge grave impact for general.
The concept of supply and demand though important, but it only sets the
boundaries wherein the service value bears little relation to real value.
Induction of workers into boardroom arrests excessive directors’ remuneration
and draws extra benefit for the efficiency of firm. More transparency goes
towards tempering public unrest and injustice of large salary. Such
contribution proves valuable in solving the agency issue at the core of CG.
Issues in
India
Excessive
executive remuneration even when corporations are in a state of collapse is one
of the major issues over the world. In India, the situation is not alarming but
this needs to be taken prudently. Recent corporate frauds like Satyam fraud,
Kingfisher’s fraud, etc. have unbosomed the dark side of Indian CG practices.
Behind almost all these frauds, executives’ huge salaries at the expense of
stakeholders are observed. They use tricks to defraud investors and creditors.
Various remuneration schemes of directors in Indian companies focus basically
three key issues viz i) Absence of close association between remuneration and
performance. ii) Glaring difference in the remuneration level of executives and
median employees. iii) Paying much more to CEOs in comparison to non-CEOs.
Influence of
ownership structure
Agency problems are common torment in the countries
having separation of control and ownership. In India, maximum companies have
concentrated ownership. Majority shareholders have a say in the management; but
this does not mitigate problem. In concentrated ownership, regulations
demand more stringent to protect minority shareholders’ interest not just
against the executives but also against majority shareholders. Minority
shareholders whilst having voting power are customarily passive as they know
that their individual vote does not matter much. Dominant shareholders easily
take mass decisions even at the expense of minority shareholders. One such
decision is high executive remuneration not based on performance. Dominant
shareholders holding executive positions earn much more from their salary than
what they earn from dividends. In many countries, there is no clause for
mandatory remuneration committee. In India recently, Section 178 of the
Companies Act, 2013 has mandated this provision for all the listed companies.
Performance
and remuneration
Appropriate executive remuneration serves as an incentive to
attract talented executives for strengthening shareholders’ value. Contrarily,
perception of remuneration for performance appears righteous
but
realistically it is not so. Board and the remuneration committee should shed
light on the determinants to measure performance. There is no straight jacket
formula for evaluating performance-based remuneration. Evaluation criteria must
meet explicit methodology. Design favoured must appropriately align executives’
interest with that of shareholders. Indian Companies Act, 2013 has strived to
associate remuneration with performance by arranging maximum ceiling formulated
on net worth and anything beyond this requires shareholders’ approval; also
apropos inadequate profits no pay more than the amount prescribed in Schedule V
shall be conferred without the Central Government’s approval. However,
provisions are not truly draconian. Shareholders’ vote to enhance
remuneration is easy in a family owned company. Executives’ remuneration keeps
growing even when the company’s performance is unhealthy. There is gap left
either in the implementation of law or in law itself. However the problem is
not merely legally-based but also reluctant etiquette of companies. Strengthening ggip is not simply the responsibility of
administration but the corporation itself instances initiative to further this
intention. Healthy governance practices always keep company healthy.
Excessive
directors’ remuneration non associated with performance is a pressing concern
in Indian corporate. Sometimes even though the companies malfunction and share
value declines constantly, directors’ remuneration still touches skies.
However, the big problem is that there is a huge gap between the salary of top
executives and other employees. Though proponents explain it following the
outcome of mediocrity at lofty but even then much asymmetry is untenable.
Yawning gulf in income ladder evidences few tricks in play in the governance.
Problem is not with how remuneration is decided but who decides remuneration.
Indian regime over this issue fairly endeavours to associate executive
remuneration with performance and has provided detailed provision to determine
remuneration but all these have been hopeless majorly because of the absence of
actual independence in determination of remuneration. Shareholders say on pay
and the remuneration committee is just another compliance for the companies
with no real outcomes.
Law does
have responsibility to enhance sound governance practices. Institutional
investors must utilize their voting power efficiently. Consultancy companies’
participation hereof is also crucial. They effectively serve as a counter
against ill practices besides grotesque remuneration. Companies must heed that
stewardship is always win-win. Awarding mitzvah leads to growth
of company climatically as it buoys to further the mission of company. Company would grow with the growth of its
employees. Thus the problem is not with high executive remuneration but
remuneration not adequately linked to performance and to cosily tame this
problem all the participants must discharge their posture felicitously. Calls
for immediate legislations and reforms are dire need to find out possible
solution for arresting this devastating situation.
Potential
crisis of executive remuneration cannot be well-groomed to employability
as CG
mechanism. Directors are never happy with their remuneration; they want more. Proponents assert parroting executives deserve
such rewards. Proper management and CG code can benefit both principal and
agent without eroding any principal-agent concept and company’s financial
status. Edacity is in human’s DNA acting without
reckoning its consequences. Most financial scandals make employees workless,
pensions off and ensuingly, someday employees shed tears. Initially,
directors’ remuneration eyes spring
but
a sudden
ebbs and the aftereffect follows methodically.
Company management produces big swing in
directors’ remuneration because of convergence of various factors necessitating
re-examination of the structure and make-up of remuneration. Convergence
aspects are mainstream towards transparency, accountability and cohesion
between remuneration and performance, and increasing accountability of the
board of directors for CG and
sustainable value creation.
The paper is devoted to ALMIGHTY
GOD who bestows HIS blessings in all walks of my life.
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