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Institutional EYE

Commentary on Corporate Governance Issues

Shouldn’t pay only be for performance?

Compensation is payment for what has been done. Performance is all about what has been achieved. Both can be measured. Surely, it cannot be so difficult to link the two and pay for performance.

There are two numbers that have been unconnected with a company’s financial performance for a while. First is its share price and the second is the CEO’s pay. The share-price – atleast I would like to believe, is not something that the company has any control over. And the market price does periodically correct itself (- or atleast the divergence comes down for a short while). The CEO’s compensation is determined by a tighter group: the board, its remuneration committee, and the shareholders. In a more perfect world, you would expect far greater alignment between performance and pay. But we are seeing this gap increasing rather than coming down. That all promoter-managers get to vote their salary increase, helps explains this.

Data published last year showed that over the previous five years, the revenues of the BSE500 companies went-up by 47%, their profits went-up by 56% and the CEO’s salary by 72%. IN FY19, CEO salary increased by over 16%, while on average a company’s wage bill increased by 9-9.5%.

What this implies that the ‘inequality’ in the pay structure is rising. The CEO’s remuneration of a BSE500 company was over 100 times the median employees’ remuneration in 2019 (88 in the previous year). At the extreme, the CEO of one company was paid 4045 times the median employee salary, and over ten CEO’s were paid 700 times the median salary paid (- in the US , at 287-times, the commentary is that the number is obscene). That the median has remained low is because of the presence of PSU’s and some small companies in the BSE500, who just cannot afford to pay their CEO’s more. We will need to wait and see whether the pandemic has led to some tempering, but unless there is more scrutiny on pay versus performance, I expect this trend to gather steam. After all if, as promoter, you can vote your on salary, why limit it by how you perform?

‘Promoters’ tend to take higher fixed salaries and higher bonuses: a ‘promoter-CEO’ in the same industry earns about 1.6 times a ‘professional-CEO’. They have ingeniously argued that as regulation do not allow them to receive ESOP’s, they need to be ‘compensated’. Years ago, when Steve Ballmer ran Microsoft, its remuneration committee baldly stated that since Mr Ballmer is a significant shareholder in the company his wealth is linked to the value of the company ergo he needs to be paid a lower compensation than others.

The key to attracting and retaining people is the overall pay: its mix between fixed and variable. The key to greater alignment between pay and performance is setting the right performance goals. Long-term incentives or stock-options is the thread that runs across. And then there are the usual rules of thumb. The more senior you are, the higher the variable component. Variable, in a normal goes-up more than fixed.

Although India Inc now has the elements of the pay structure in place – fixed, short-term incentives (cash bonus), long-term incentives (stock-options), they have consistently slipped behind in explaining themselves. In fairness - other than at the extremes, this is not easy. The chairman of State Bank of India, at Rs 3,120,000 is low. The chairman of a company at Rs 1.21 billion (yes, that’s right) is obscene.

For shareholders, who are supposed to sign-off on the compensation numbers, understanding what matrices are being used to arrive at the pay, the short term and long-term incentive, remains a black-box. Today companies have started making motherhood statements like variable pay will be linked to the company achieving performance linked targets, they continue to shy away from disclosing what these targets are. Boards and promoters want to keep wiggle room for themselves. And while they could get away with not disclosing targets when the salaries were low, as these have steadily crept-up, and the pay-versus-performance relationship has weakened, they will come under greater pressure to so. The 30% against vote earlier this month, by Wipro’s institutional shareholders on its new CEO’s (appointment), reflects their dissatisfaction with the disclosures.

To provide context, HSBC has 26 pages of its annual report devoted to discussions relating to compensation(Pg186-210). Importantly, they have specified what they are measuring and the weightage both quantitative and qualitative. PBT (10% weightage), positive jaws (5%), revenue growth (10%), RoTE (5%), strategic (30% - accelerate revenue growth from Asia, turnaround US business), and so on. On what parameters was money paid, is also discussed. For example, one of the strategic objectives was deliver revenues from international business. The boards assessment: Revenue growth from international clients of 2.0% was below the full-year target range of 3.5 to 7.5%. This measure carried a 5% weighting and has not resulted in any payout. Parts of this are extracted and shown as Annex1.

And this level of detail is not just for banks. Pick-up the annual report of any widely institutionally held company, and you will see page after page after page discussing the salary for the CEO, the executive management and even the board about why it is paying itself what it is. And if global companies can do so, why can’t India Inc.?

Compensation is payment for what has been done. Performance is all about what has been achieved. Both can be measured. Surely, it cannot be so difficult to link the two and pay for performance.

This blog appeared in Business Standard on 23 July 2020.

You can access it by clicking this link:

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