Looking in FS companies. While the 2011

Looking into the key findings about
the executive compensation from a 2017 PWC survey

·       Total CEO
compensation in the largest 100 companies has increased markedly over the past
few years. From 2009 to 2016, median total CEO
compensation has increased by 41.2%, 67.0% and 12.1% for SMI, SMIM and small-cap companies, respectively.

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·       CEO
compensation in SMIM companies is catching up with compensation in SMI
companies – but a divergence is seen in compensation of CEOs at
SMIM and small-cap companies.

The overall rise in executive
compensation since 2009 has mostly been driven by non-financial-services (non-FS)
companies rather than FS companies. For example, median CEO compensation in
non-FS SMI companies has increased by roughly
50% since 2009, while it has actually fallen by around 27% in FS companies.

While the 2011 Occupy Wall
Street movement had the larger agenda of protesting against the influence of
corporations in policy making and governance, one of its focal points was the
growing disparity in the distribution of wealth and income across the world.
The spectacular collapse of giants in the world of banking and finance between
2007 and 2009 revived the focused attention on the unduly high executive
compensation paid by these organisations. The central issue in the compensation
debate is what ought to be and what are in practice the determinants of such compensation.
This paper explores these issues in the Indian context with special reference
to the role of corporate performance, corporate ownership, and corporate
governance in optimising CEO compensation in keeping with the shareholders’
interests. The study is based on published compensation data (both yearly
absolutes and year-on-year changes) relating to the 5-year period 2007–2012 for
the top 102 companies in the country.

The evidence suggests
that firm performance measured by accounting, as well as market-based measures,
significantly affects executive compensation. We also test for the presence of
persistence in executive compensation by employing the system generalised
methods of moments (GMM) estimator. We find significant persistence in
executive compensation among the sample firms. Further, we report the absence
of pay–performance relationship among the smaller sample firms and business
group affiliated firms. Thus, our findings cast doubts over the performance-based
executive compensation practices of Indian business group affiliated firms.

The corporate world is
mired in controversies relating to the morality and propriety of the compensation
levels of executives and directors, some of which at least are perceived to be unconscionably
high and disproportionate to performance. Executive compensation in India has been
an emotionally-charged subject at the best of times. Post political
independence—possibly as a legacy of the colonial past and as a fallout of the
left-of-centre political orientation of the governments of the day—there was
general prejudice against and mistrust of private enterprise as well as the
executive management that was seen to be at the helm of corporations. According
to a former president of a major industry chamber, “The general impression …
is that we industrialists are intoxicated with power and wealth, indulge in
its vulgar show, and … our sole aim in life is to amass fortunes for
ourselves regardless of national interests” (Sundar, 2000: 242). A marked gravitation
towards central planning and socialist ideologies soon after independence also militated
against what were seen as extravagant compensation levels in the private
corporate sector. This situation was further compounded by the relatively lower
monetary compensation levels of government bureaucracy that was only too happy
to prescribe restraints against executive remuneration in the private sector
corporations in the name of public interest. Elaborate regulations were
introduced to curtail such perceived excesses, in the process, swinging the
pendulum to ridiculously lower extremes. The fact that such measures could and
did encourage unethical pay and perquisite practices was neither observed nor
bothered about. Unfortunately, some of those practices did (and still do)
continue even after compensation restraints were relaxed. Therefore, it is not
easy to obtain wholly credible compensation data even now from disclosures in
the public domain. This, of course, is not unique to India and can apply to
many countries, some even in the developed category. In addition, many of the
perquisites provided to executive management are valued for personal tax
purposes at arbitrarily prescribed and largely unrealistic monetary levels, which
often bear little relationship to the real costs of such facilities to the
company, and the compensation data required to be disclosed are based on such
valuations. Apart from the private benefits of control that are associated with
such ownership and control situations, published compensation data-based
studies such as the present effort suffer from these inadequacies. The extent
of such distortions in published data remains a matter of speculation and needs
to be borne in view while assessing the limitations of research findings based
on such data.

There are three broad
approaches to determine executive pay in corporations generally and in publicly
traded companies in particular. These are optimal contracting, managerial
power, and public policy approaches. These approaches are briefly discussed in
the following sections.


Optimal contracting

This approach is based on the agency theory of corporate governance, where the
board’s objective of acting on behalf of the shareholders is to maximise their
wealth. In pursuing this goal, executive pay is negotiated at levels that
dissuade them from pursuing their own material interests through expropriation
of what ought to belong to the shareholders. The optimal contracting approach
builds upon this assumption and postulates that managerial remuneration will
tend to be pegged at levels where the executive will be discouraged from
“plundering” the wealth belonging to the principals, i.e., the shareholders. An
extension of this proposition would concomitantly seek to “align” executive
interests to shareholder interests by converting them into shareholders
themselves—by offering them stocks and options besides attractive cash compensation
both to motivate them to perform better as well as to stop them from going out
looking for greener pastures, i.e., by holding them back with “golden shackles”.
However skilfully the board may seek to design a compensation package to meet
this objective, it is virtually impossible to do this exercise to perfection.
This is because humans differ vastly in terms of their “indifference levels”
towards garnering more wealth for themselves and their “tipping points” at
which they may desert righteous action and embrace less virtuous alternatives;
this is further compounded by the fact that these thresholds are not fixed all
the time but vary depending upon the dynamic circumstances at different points
in one’s life. The effort, therefore, will always be to balance the
compensation costs and expected outcomes. “The optimal contract is therefore
the one that minimizes agency costs (that is, the sum of contracting costs,
monitoring costs and other costs incurred in achieving a certain level of
compliance with the principal’s interest) and the costs of the residual
divergence” (Bebchuk et al., 2002: 10). Although this approach is widely
adopted in theoretical studies and in practice, the probability of serious
errors in this estimation is quite high. This can be inferred from the extent
of overt and covert usurpation of corporate resources by executives that
surfaces in the various cases of corporate distress and misdemeanour from time
to time.



Managerial power approach

While the optimal contracting approach with all its inherent uncertainties is
intuitively very appealing, the bargaining equations between the employers and
the employees can and do vitiate this process in practice. Outstanding talent
at the top management levels is scarce, and hence, commands a premium in a
competitive market.5 The specific requirements of individual corporations (depending
upon their business circumstances and needs) may further exacerbate the situation
and tilt the power balance farther towards the executive than the boards may
have bargained for. This can turn out to be a critical factor in determining
executive compensation, especially in economies with a predominance of dispersed
corporate ownership (such as the U.S.). The process is further impaired by the
fact that the market for CEOs—limited in size as it normally is—tends to feed
upon itself in terms of peer pricing, with compensation consultants (whose earnings
largely depend on the absolute compensation numbers eventually contracted)
fuelling the escalation of executive pay. Striking evidence of such managerial
power is now available. For instance, in a study of over 1500 U.S. companies
between 1992 and 2007, Taylor (2013) showed that CEOs captured about 50% of their
companies’ (lagged) growth in market capitalisation for themselves.
Interestingly, any negative growth in market capitalisation did not affect CEO
pay and had to be borne by the shareholders.

Board compensation committees (generally composed of incumbent or former CEOs
of other corporations) are usually quite supportive of high compensation levels
for this elite group. Not only does this power take its toll while the
executive is incumbent and with more years of employment but it also extracts
its proverbial pound of flesh on retirement or separation. The classic example
of Lee Raymond (the Exxon Mobil CEO) retiring after 40 years of commendable
service, including some 13 years as CEO during 1992–2005 with an excellent
performance record, is a case in point. His retirement package estimated at USD
400 million in 2005 (in addition to approximately USD 686 million during his
tenure as chairperson) ranks as the highest in corporate history (Mouawad,
Immediate cash pay-outs to retiring CEOs in India do not normally reach such
sky-high numbers,
but that is not to say that preferred CEOs do not command handsome benefits
post retirement. The sale of upmarket residences at throwaway prices based on
archaic valuation rules, attractive retainers and consultancies (state-owned
Air India had been in the news for engaging a retired CMD to recruit foreign
pilots for the carrier), and preferred engagement on outsourced contracts for
services or manufacture are some of the often undisclosed and unreported golden
parachutes that companies resort to.

As a result, managerial power tends to be strong enough to successfully demand
excess rent in terms of its pay and perquisites, stemming from the
demand-supply gap of suitable talent, peer pressure, and motivated consultants.
This goal is accomplished because of sympathetic board compensation committees
and relatively weakly-positioned boards, which are under pressure to get the
right candidates to achieve their objectives of sustainable shareholder wealth maximisation
and corporate growth.




Public policy approach

This model is based on the principle that executive pay even in the private
sector needs to be aligned to the general levels of compensation for jobs of
similar responsibility elsewhere in the economy, often including the pay levels
of comparable positions in the bureaucracy. This approach is usually justified
on the basis of public policy requirements that call for the reduction of
inequalities in society.7 In this approach, executive pay as disclosed is a
function of the limits and constraints imposed by the state (discussed further
in Section 3). Following independence, India had embarked upon a supposedly
egalitarian drive to contain executive salaries in the private sector at
abysmally low levels. The fact that such arbitrarily determined low-level caps
were inadequate to attract and retain appropriate talent and could thus be an
invitation to unethical, off-the-record, make-up payments appears to have been
ignored or accepted as the cost of implementing the policies of the governments
of the day. The fallout of such restrictive policies is that such compensatory mechanisms
to make up for the shortfall in approved pay may continue partly or wholly even
when such regulatory constraints are relaxed or altogether removed, as is the
case in India after economic liberalisation.

The relationship between
executive pay and firm performance has been one of the most widely studied
questions in the corporate governance literature Over the past two decades, the
academic literature on agency theory and executive compensation has argued that
CEO compensation should be aligned to firm performance  The relation between pay and performance is
derived from agency theory According to agency theory, compensation contracts
should be designed to align the interests of managers (agents) with those of
shareholders (principals). A stronger relationship between executive pay and
performance also results in the selection and retention of more productive managers.
Since these factors are difficult to observe while selecting managers,
providing top executives with performance related compensation can reduce the
adverse selection problems the problem of how best to compensate executives is
a classic application of the principal–agent theory. In such a framework, the
principal (the shareholder) desires the agent (the manager) to maximise shareholder
value, but cannot accurately evaluate the executive’s reaction function. The
goals of the executives may be different from that of the shareholders. For
instance, a manager may be more interested in amassing and defending personal
power rather than pursuing profit maximising strategies

governance and executive
compensation disclosures in India
The thrust for better
corporate governance practices has been an integral part of the Indian
regulatory environment. Indian companies have been largely governed by the
Indian Companies Act, 1956, which provides detailed guidelines on the formation
and functioning of the companies. Although there have been several provisions
under the Companies Act about board structure and composition and managerial
remuneration, the act does not deal with corporate governance directly. The
guidelines for corporate governance and executive compensation in India mainly
come from Securities Exchange Board of India (SEBI) in the form of corporate
governance directives and the Indian Companies Act(s).

of corporate governance practices in India
The Indian Companies Act
1956 contains provisions for managerial and executive remuneration for listed
companies. Section 198 of the act provides for a ceiling on the overall remuneration
payable to managerial personnel. It mandates that the total remuneration
payable to executive personnel of a public company or subsidiary private
company should not exceed 11% of the net profits of the company in a financial
year. It also prohibits payment of remuneration (except sitting fees) in a year
when the company has incurred severe losses or has garnered inadequate profits.
Section 309 supplements the provisions contained in Section 198 and states that
the remuneration of all whole-time or managing directors taken together shall
not exceed 10% of the net profits of the company in a financial year except
with prior approval from the Government of India. These requirements made the
management of the companies accountable and provided regulations to control
executive compensation. However, the failure in the effective implementation of
corporate governance provisions led to the collapse of certain well-established
firms like Satyam Computer Services Ltd (2009), similar to the cases reported
across the globe such as Xerox, Enron, and World Com. These failures
highlighted the need for better laws and regulations to oversee the corporate
governance practices including executive compensation.

In 1991, the Indian
Government enacted a series of reforms aimed at general economic
liberalisation. The Securities and Exchange Board of India has been established
as per the SEBI act in 1992 to nurture, monitor and regulate the growth of
capital markets in India. The focus on better corporate governance practices
has become essential mainly due to the opening up of the economy which led to
increased competition and also increased requirement of external capital. The
first major initiative to have structured corporate governance norms was
undertaken by the Confederation of Indian Industry (CII), India’s largest
industry and business association. The Confederation of Indian Industry
suggested the first voluntary code of corporate governance in 1998 while
drawing on the parlance of the Anglo-Saxon model of corporate governance. It
suggested the payment of executive compensation, not exceeding 1% of net
profits (if the company has a managing director), or 3% (if there is no
managing director) to non-executive directors for offering their professional
advice. It also supported the idea of offering stock options to the executives.
The second major corporate governance initiative was undertaken by SEBI by
setting up a committee headed by Kumar Mangala Birla2 (1999), to promote and improve the standards of corporate
governance practices. The committee suggested separate disclosures relating to
executive compensation in the form of remuneration package (salary, benefits,
bonus etc.), fixed and performance linked incentives, and stock options. The
Securities and Exchange Board of India accepted the recommendations of the
Birla Committee in 2002 and made it a statutory requirement under clause 49 of
the Listing Agreement of the stock exchanges. Further, SEBI appointed the
Naresh Chandra Committee (2002) and the Narayan Murthy Committee (2004) to
examine various corporate governance issues. These committees offered crucial recommendations
related to corporate governance issues such as audit committee, related party
disclosures, risk management policy, and the like. However, there were no major
changes to the recommendations of the Birla Committee with respect to executive
compensation disclosures.

As we examine the
relationship between pay and performance, we consider consolidated executive
compensation as the proxy for pay. We consider both accounting measures as well
as market performance measures to represent firm performance (we use return on
equity (ROE) and ROA as the accounting-based measures of firm performance.
Tobin’s Q and annual stock return (RET) are considered as the market-based
measures of firm performance. Annual stock return is a forward-looking measure
and reflects investors’ future expectations. Further, we consider firm specific
variables such as size, leverage, and risk as they could influence the
pay–performance relationship. The description of the variables is provided

and Compensation
1. The proportion of
non-executive independent directors on the board positively influenced the
level of compensation. This is similar to the inferences drawn by Cosh and
Hughes (1997) and Core et al. (1999). This possibly provides support to the
theory of executive (read “promoter”) capture of the independent directors;
further, it exposes the institution of independent directors in general, and
questions its real value in promoting good governance and investor protection.
This would also support the measures already discussed for “enabling” the
institution of independent directors to better discharge their assigned responsibilities,
by facilitating more “independence in directors” rather than simply seeking more
“independent directors”.

2. The observed positive influence of greater board independence, besides
supporting the “capture theory” as discussed above, may also be a function of
the fact that most nonexecutive independent directors are drawn from a pool of
present or past CEOs. They may have understandable empathy towards incumbent
CEOs and, thus, behaviourally support higher levels of CEO compensation. A more
charitable view, given that the study period was affected by the global
economic downturn, would be that independent directors (in the interests of the
shareholders) used enhanced compensation to retain and motivate their CEOs
towards better performance under such exogenous adversities.

3. The separation of the chairperson’s position from that of the CEO or the MD
(i.e., ensuring
duality) significantly negatively influenced the level of compensation. This is
in line with the
theoretical precepts that seek a clear separation between the executive
responsibilities for operations and the supervisory responsibilities involving
monitoring and evaluation of executive performance. There may be a case for
regulatory intervention mandating such separation.

4. There is another dimension to compensation levels and board independence. It
offers a legitimate endorsement of the increases by theoretically objective,
external independent directors, and thus, opens up a defensible avenue to
pursue escalating CEO compensation packages. Until now—thanks to the apathy of
absentee shareholders (including institutional investors) and bolstered by
substantial promoter holdings—CEO compensation proposals had little chance of being
rejected at shareholders’ meetings. However, this complacency may not survive
for long with the legislative proposals pending parliamentary approval reining
in interested shareholders’ voting rights such that a promoter CEO’s
compensation proposals will require a super-majority approval by non-promoter
shareholders in future.

5. The irrelevance of
compensation committees as an influencing and optimising governance mechanism
with regard to CEO compensation is quite revealing and runs counter to the recognition
of their importance in most geographies. The extent to which this important
role of the committee has been compromised in the Indian context by promoter
capture and composition fallouts as discussed above is a subject for further
research. In this light, the legislative mandate on compensation committees
appears to be of little consequence until the contributing deficiencies are
remedied; till then, the chances are that the mandate may end up inflicting
more compliance costs on the companies without any material governance benefits.
There is an important caveat to these findings and conclusions, however. There
are major changes in the legislative and regulatory framework on the anvil.
Once implemented, and subject to their rigorous enforcement, the regulatory
scenario in the country will undergo a radical transformation. Some of these
provisions (particularly relevant to CEO compensation), such as reining in
interested shareholders’ voting rights on related-party transactions at
shareholders’ meetings, have already been mentioned in this paper. In this
emerging governance