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ABSTRACT

Corporate Governance in India gained prominence in the wake of liberalization and soon
acquired a mandatory status. The financial crisis in Satyam during 2008 and more
recently the saga of JSW Steels and Kingfisher Airlines exposes the ugliest face of Indian
business. It shows dreary in corporate governance, and also manifests executives self
interest with complete lack of accountability for stakeholders. Firms are headed by CEOs
who were paid too much at the expense of the stakeholders. The paper attempts to study
the existing scenario of executive compensation viz. a viz. firms profitability in India. By
taking cases of few Indian firms, this paper attempts to analyze the relation between
executive compensation and firms profit. It also gives suggestions to justify the need for
strong policy formulation & implementation in the area of executive compensation. In the
era of jet owned and million dollar package receiving executives, the only ray of hope
seen is the emergence & implementation of good corporate governance practices and its
recognition as an important and burning issue to address the India-specific challenges
more efficiently.

INTRODUCTION

Good governance practices shoot from the culture and mind set of the organisation. The
governance is about outdoing sustainable organisations. These are the organisations that
succeed steadily in the market place, achieve a greater share of market prospects and
sustainably drive their top and bottom lines. Corporate Governance is a set of customary
systems and practices to safeguard the dealings of the company. It ensures that
transactions are being managed in a way which ensures accountability, transparency, and
fairness in the widest sense and meet its stakeholders objectives and societal
expectations. Many researchers and observers believe that top-level executive
compensation is not appropriately linked to long-term performance. There are have been
several incidents in which executive pay at companies rose dramatically even though the
companies were doing poorly and the stock prices were sinking. Stock options have been
particularly responsible in this regard. Mangers have been given overly generous
compensation packages with large-sized stock option which has created opportunities for
managers to manipulate company financial statements in order to drive up stock prices,
contributing to the corporate scandals of the post-dotcom era and the current financial
crisis. Besides the insufficient link between compensation and stock prices, the level of
executive compensation is also widely believed to be much higher than that required to
retain and motivate effective top managers.

EXECUTIVE COMPENSATION: THE GOOD SIDE AND THE DARK

SIDE

Managerial compensation in India often has two components--salary and performance-


based commissionas well as retirement and other benefits and perquisites. Based on an
analysis of unbalanced panel data for roughly 300 firms each year, Sonja Fagerns
reports that the average total compensation (salary plus commission) of Indian CEOs has
risen almost three-fold between 1998 and 2004 (from INR 2.1 million to INR 6.4 million
in real terms. During this period, the proportion of profit-based commission has risen
steadily, from 13.4% to 25.6%, and the proportion of CEOs with commission as part of
their pay package has risen from 34% to 51%. CEO pay has thus clearly become more
performance based over the past decade. There is also some evidence that this increasing
performance-pay linkage is associated with the introduction of the corporate governance
code or Clause 49. Meanwhile, executive compensation as a fraction of profits has also
almost doubled from 0.55% to 1.06%. Fagerns also finds that CEOs related to the
founding family or directors are paid more than other CEOs. In a firm fixed effects
model, she finds being related to the founding family can raise CEO pay by as much as
30% while being related to a director can cause an increase of about 10%. There is some
evidence that the presence of directors from lending institutions lowers pay while the
share of non-executive directors on the board connects pay more closely to performance.

CEOs in India are not only responsible for managing operations in India but have also
assumed responsibility for expansion of companys brand overseas and leaving a global
footprint. With the changing scenario and added responsibilities to the role of CEOs in
India, companies have felt the need to have highly talented executives in charge of their
operations. With demand outstripping the supply of this unique talent, the CEO
compensation is being taken to a new height. It should be not long when Indias CEO will
make command the same as their American counterparts.

According to a recent study conducted by the consulting firm Aon Hewitt, the median
pay for a CEO in India on a purchasing power parity basis was at nearly $3.5 million in
2011 for companies with more than $2 billion in revenues. CEOs compensation in India
has seen a momentous growth over the past few years. As per the same study by Aon
Hewitt, CEO compensation in India has been snowballing at the rate 15 per cent to 18 per
cent in the past few years. According to the data provided by Indias government and
private sector the CEO compensation in India has grown at almost twice the rate of the
countrys per capita income in 2011.The significant increase in CEO compensation in
India has been attributed to the emerging trend of performance-based incentives but the
data does not seem to bear this same conclusion. In United States, fixed pay is 20-25
percent of a CEOs total pay, while in India fixed pay makes up 35-40 percent. Other
factors responsible for the growth of CEO compensation in India are global recovery in
sectors that are prevalent in India. This notion seems to hold some weight as financial and
information technology services are trying to align the pay of CEOs in India with their
global counterparts; however, in other sectors, such as telecom, there is more of a demand
for unique talent that only India can provide.
LITERATURE REVIEW

Liberalization of the Indian economy began in 1991. Since then, India has witnessed
wide-ranging changes in both laws and regulations, and a major positive transformation
of the corporate sector and the corporate governance landscape. Perhaps the single most
important development in the field of corporate governance and investor protection in
India has been the establishment of the Securities and Exchange Board of India in 1992
and its gradual and growing empowerment since then. Established primarily to regulate
and monitor stock trading, it has played a crucial role in establishing the basic minimum
ground rules of corporate conduct in the country. Concerns about corporate governance in
India were, however, largely triggered by a spate of crises in the early 1990s
particularly the Harshad Mehta stock market scam of 1992-- followed by incidents of
companies allotting preferential shares to their promoters at deeply discounted prices, as
well as those of companies simply disappearing with investors money.

These concerns about corporate governance stemming from the corporate scandals,
coupled with a perceived need of opening up the corporate sector to the forces of
competition and globalization, gave rise to several investigations into ways to fix the
corporate governance situation in India. One of the first such endeavours was the
Confederation of Indian Industry Code for Desirable Corporate Governance,
developed by a committee chaired by Rahul Bajaj, a leading industrial magnate. The
committee was in 1996 and submitted its code in April 1998. Later the SEBI constituted
two committees to look into the issue of corporate governance--the first chaired by
Kumar Mangalam Birla, another leading industrial magnate, and the second by Narayana
Murthy, one of the major architects of the Indian IT outsourcing success story. The first
Committee submitted its report in early 2000, and the second three years later. These two
committees have been instrumental in bringing about far reaching changes in corporate
governance in India through the formulation of Clause 49 of Listing Agreements.
Concurrent with these initiatives by the SEBI, the Department of Company Affairs and
the Ministry of Finance of the Government of India also began contemplating
improvements in corporate governance. These efforts included the establishment of a
study group to operationalize the Birla Committee recommendations in 2000, the Naresh
Chandra Committee on Corporate Audit and Governance in 2002, and the Expert
Committee on Corporate Law (J.J. Irani Committee) in late 2004.All of these efforts
were aimed at reforming the existing Companies Act of 1956 that still forms the
backbone of corporate law in India.

CLAUSE 49 OF THE LISTING AGREEMENTS ON EXECUTIVE


COMPENSATION (AS PER SEBI ACT, 1992)

The key mandatory features of Clause 49 regulations deal with the following: (i)
composition & compensation of the board of directors; (ii) the composition and
functioning of the audit committee; (iii) governance and disclosures regarding subsidiary
companies; (iv) disclosures by the company; (vi) CEO/CFO certification of financial
results; (vi) reporting on corporate governance as part of the annual report; and (vii)
certification of compliance of a company with the provisions of Clause 49. It lays down
rules regarding compensation of board members, sets caps on committee memberships
and chairmanships, lays down the minimum number and frequency of board meetings,
and mandates certain disclosures for board members.

An important theoretical perspective on the design of management incentives is provided


by the concept of agency costs, which focuses on conflicts of interest and incentives
among different corporate stakeholders, notably between management and its
shareholders. In the finance literature, this view can be traced to a pioneering paper by
Michael Jensen and William Meckling (1976), which demonstrated the incentives of risk-
neutral top managers with less than 100% ownership of their companies to take actions
that reduce firm value. To illustrate with a simple example, a manager with a 3% stake in
a publicly traded company gets 100% of the benefits from consuming a dollar of perks
but incurs only 3% of the costs. Moreover, the sensitivity of the managers wealth to that
of the shareholdersin this simple example, three dollars for every 100 of shareholder
wealthis typically used as an index of the degree of alignment achieved by the
compensation structure. In an influential paper (that appears earlier in this issue), Jensen
and Murphy (1990) introduced and estimated an empirical measure of pay-performance
sensitivity a measure designed to answer the question: to what extent does executive
compensation vary with shareholder wealth? Their methodology uses regression
(Ordinary Least Squares) estimates of a model that relates a change in total CEO pay to a
change in firm performance. The regression coefficient is taken as an estimate of the pay-
performance sensitivity. Measuring performance in terms of shareholder value, Jensen
and Murphy estimated that, during the period of their study (1974-1986), top executive
pay increased by about $3.25 for every $1000 increase in shareholder wealth. On that
basis, they concluded that executive pay was surprisingly insensitive to shareholder
wealth.

OBJECTIVES

The paper attempts to study the existing scenario of executive compensation viz. a viz.
firms profitability by taking few Indian companies as case studies
It closely examines the relation between the top executives compensation and firms
profitability
Lastly, it suggests ways for strong policy formulation & implementation in the area of
executive compensation in Indian context. The authors express support for a number of
reform proposals aimed at improving incentive alignment and fostering stability in the
financial system.

FINDING & ANALYSIS

After banks and non-banking institutions brought the world economy to its knees through
imprudent and indiscriminate lending corporate practices, there is widespread repulsion
at the plus size pay of CEO. A recent case where shareholders denied USD 15 million pay
hike to Citi bank CEO Vikram Pandit. Similarly a revolt over salary increase forced UK
insurer Aviva's CEO Andrew Moss to resign. Some of the other companies which had to
face shareholders anger include the retailer Marks & Spencer, advertising company WPP,
and brewer SAB Miller. In most cases shareholders did not see any link between pay hike
and the performance of the manager. Similar episode has recently happened in India
where all the institutional shareholders voted against a resolution which allowed the
Chairman Naveen Jindal change the remuneration of his team including his own. They
were not against the salary drawn by directors but had objections to Naveen Jindals
package. Also similar episode has happened in Gammon India where resolution was to
pay a minimum remuneration to Abhijit Rajan, promoter & chairman, for 2012/13 &
2013/14 where profits & market value fell over five years while Rajans pay grew nine
times. Dividend also dipped from7.65 crores in 09/10 to 2.73 crores in 11/12. Same thing
have happened in Divis Lab & Sun TV networks. Since September 2011, IIAS (Indian
Investor Advisory Services) have got compliant against 39 compensation related
proposals. (Source: Moneycontrol.com, Why Indians CEO pays need policing) A
study by HR consulting and outsourcing firm Aon Hewitt on executive compensation for
2011/12 shows the median Indian CEO salary was $3.5 million as against $7 million in
the US & about $6 million in Europe & $3.5 million in Australia despite the smaller
Indian companies. With this one can analyse that Indian CEOs have got better earning
than their US counterparts for every dollar of returns & there is no stopping to this as the
gap between Indian and global CEO salaries narrows as wage hikes in the West is in low
single digits with Indian management pay scales rises in double digit. A study by
Business Today jointly with INSEAD-HBR did a study to identify Indias CEOs by
evaluating their performance from 1995-2011 vis a vis their salary. As per the study Mr.
Naveen Jindal, CEO of Jindal Steel & Power along with Mr. A.M.Naik, CEO of Larsen &
Turbo and Mr. Y.C. Deveshwar, CEO of ITC are nearby in performance but with a
substantial difference in their perks like Mr. Jindal (69.7 crores), Mr. Deveshwars (11.76
crores) & Mr. A.M.Naiks (14.18 crores) though market capitalization, net profits and
growth have been on similar graphs for all the three companies.

During 2011-12 when inflation was at its peak, stock markets were crashing and GDP
number shrinking, no known changes were made to pay packets of top corporate leaders.

A study by Economic Times of India showed that during 2011-2012 fiscal years, Indians
top CEO earned 68 times over the employees with increase by 9 times in one year.
Moreover, an average Indian CEO is paid 675 times than that of minimum wage earned
by entry-level graduates. Few of the examples are

Naveen Jindal, MD &VC of JSPL has earned Rs. 69.7 crores, an income 2000 times the
average salary of employees of his company.
Sun TV Network's Chairman & MD Kalanithi Maran and his wife Kavery Maran, who
were already hugely overpaid with salaries of Rs 37.08 crore each in 2009/10 and
2010/11 has increased the salaries to Rs 64.4 crore each in 2011/12. Aditya Birla Group's
Kumar Mangalam Birla (Rs 47.1 crore) & Bharti Airtel's Sunil Mittal (Rs 21.3 crore)
are also in the race.

On the other hand

Mukesh Ambani decided to forgo nearly Rs 24 crores from his annual pay last fiscal as
chief of Reliance Industries Ltd (RIL), keeping his salary capped at Rs 15 crores for the
fourth year in a row as against his eligibility of Rs 38.82 crores as per the shareholders'
approval.
Munjal, in comparison, received a commission of 1.24 per cent of net profit in addition to
a fixed salary of Rs 2.4 crores;
Birla 0.9 per cent of profit from Ultratech and 0.58 per cent from Hindalco Industries

Wipro's Azim Premji and Reliance Group's Anil Ambani have also taken cuts in their
compensation when faced with a tough business environment. A look at the salary viz.
viz. profitability will clearly through light on the corporate India status.
EXECUTIVE COMPENSATION AND FIRMS PROFITABILITY

(TABLE 1)

2009-10 (in Rs. Cr.) 2010-11 (in Rs. Cr.)

Pay (salary, Pay (salary,


Company CEO benefit, Net benefit, Increase in Increase in
Net Profit
commission, Profit commission, pay (%) profit (%)
sitting fees) sitting fees)

Jindal Steel Naveen


48.9808 3,634.56 69.751 3,804.01 38% 5%
& Power Jindal
Sunil
Bharti Airtel Bharti 23.49 8976.8 27.51 6046.7 17% -33%
Mittal

Nitin
HUL 3.1893 2156.63 7.916 2296.05 148% 6%
Paranjpe

H.M.
Tata Steel 3.01 -2120.84 4.15 8856.05 38% 518%
Nerurkar

(Source: Business Today/ Cover Story/Nov, 25, 2012 (Swimming in it)

Further a look at the compensation of non- executive directors is an eye opener as the
minimum compensation offered to the non-executive chairman was Rs 16,000 and the
maximum was Rs 13 crores showing no equivalence in their earning capacities and value
for time. Increase income disparities between executives and ordinary workers result in
executives imagining themselves as boss and this perception of power leads them to ill-
treat workers. Moreover a comparison over region wise fixed pay, annual incentives &
long term incentives will narrate the true picture of Indians CEO. (See Table 2)

REGIONAL MIX (BREAKUP OF CEO INCOMES ACROSS THE GLOBE)

TABLE 2

Country Fixed Pay Annual Incentives Long Term


Incentives

India 46% 23% 31%

Asia 45% 25% 30%

Euro Zone 35% 30% 35%

America 15% 20% 65%


Source: Business Today Survey jointly with INSEAD-HBR,

CONCLUSION

Indians investors normally do not make any blast on pay structure of the CEOs.
Moreover, the structure defining compensation is not well organized leading to gaps for
the businessmen to exploit. Also, studies shows a depressing correlation between CEO
pays versus profitability. On comparing companies between similar industries, companies
having higher pay for top notch had
lower revenue/ profitability for investors as they make worse acquisition decisions
leading to weaker accountability for poor performance than other CEOs. Cases also
depicted that despite of weak economic factors like recession etc, compensation have
increased. Hence, the improvement in pay maybe attributed to luck instead of better
decisions and performance.

RECOMMENDATIONS

Today we are standing at the crossroads of economic change, the aspirations of the
masses are growing and however, their means remain limited. At the same time a group
of select few is financially rewarded far beyond its needs & such a trend is neither
sustainable nor justifiable. Not only does it increase social disparity, conspicuous
consumption, its impact on the socio-economy is far reaching. India needs a proposition
on executive pay like UK which makes it mandatory for companies to disclose whether
the top management was able to meet its targets.
The following immediate measures need to be taken such as

Compensation of the CEO should be based on three factors (see Fig. 1)

1fairness 2transparency 3accountability


Fair play in CEO's versus employees compensation is very important as in case of one of
the leading IT company Infosys, where the CEO'S salary is about 20-22 times that of the
salary of the lowest professional. Full transparency to the shareholders regarding each
aspect of the compensations along with the policies has to be there.
Introduction of variable components should be introduced which include the performance
for a certain time period. Improvements in board governance. To increase the likelihood
that the executive compensation-setting process is conducted on an arms-length
bargaining basis, we believe there should be sufficient independence of the corporate
board and a requirement of sufficient financial literacy for all members of the
compensation committees. The compensation committee can be composed of
independent directors. Moreover, the committee should retain independent compensation
consultants who are recruited by the board and not by the CEO.There should be enough
finance expertise on the compensation committee so that the committee understands
valuation and the role of the instruments used in executive compensation.

Advisory Say on Pay: Empowering shareholders :One prominent proposal is that all top-
management compensation planssalary, equity-linked compensation, and severance
packagesas well as material changes in these plans, must be approved by shareholders
through a proxy vote. Such an approach assumes that the shareholders are as informed
and experienced in assessing pay packages as the members of the board of directors.
Most corporate decisions are made by the board rather than shareholders precisely
because board members are able to become better educated about the issues confronting
the firm, and so bring about better outcomes than would result from direct shareholder
vote. One might argue that the situation is no different with executive compensation.
Shareholders are not necessarily as well-informed about the complexities of executive
compensation or the dynamics of the CEO labour market as are members of
compensation committees. The growth of shareholder advisory groups may work to limit
this concern, since such groups specialize in understanding the intricacies of pay structure
and may be in a better position to evaluate compensation plans relative to other firms

Disclosure Reform: Disclosure helps shareholders to understand how executives are


compensated and to make useful inferences about the incentive effects of executive pay.
We support more explicit disclosure for executive compensation. Disclosure should cover
all elements of executive compensation, including retirement benefits, severance
packages, perquisites, and other direct or indirect schemes of compensation. In our view,
companies should provide both summary and comprehensive detailed disclosures. While
summary numbers should be available for quick assessments of pay packages,
technological advances should be used to provide detailed disclosure for interested
shareholders, such as institutions that want to investigate all aspects of the compensation

package.

More often, CEO are being rewarded for increasing the short-term profit without adequate
recognition of the risks and long-term consequences that their activities posed to the
organizations. This practice need to be restricted as one has to weigh the long term consequences
of the decision.
Companies also need to publish a comparison between company performance and chief
executives' pay and data showing difference between executive pay and staff pay

Adhere to provisions of Companies Act of 1956 which caps total top management pay at 11% of
net profits of a financial year. Indian companies must also set up a committee comprising of 3
non-executive independent directors to decide on matters related to managerial remuneration.
Corporate governance norms should include independent board members in compensation
committee to ensure a realistic of CEO and other top executives salary.

Basing salary structures on performance rather than favourable circumstances is required.


Approval of Central Govt. is needed for payment of executive salaries if a company is making
inadequate profits.

The Indian Company Law Schedule XIII defines the method of calculation and limits of
managerial remuneration. The calculation should involve number of times the average salary of
workers to ensure balance between board, CEO and workers pay.

Public should play an active role in curtailing income disparities. The issues should be brought to
government and media attention.
An institutional investor advisory service advises strategy to voting.

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