Tuesday, December 2, 2008

Ceiling on Executive Pay

In previous posts, we had highlighted significant differences between the law on executive pay in the US and in India, and how the Indian regime may be more conducive to preventing excesses by corporate executives. In the US, the position is as follows:

Excessive managerial influence also extends to fixing managers’ own remuneration. In a book titled Pay without Performance: The Unfulfilled Promise of executive Compensation, Professors Lucian Bebchuk and Jesse Fried state that managerial influence can lead to inefficient arrangements and perverse incentives in fixing managerial remuneration that make the amount and performance-insensitivity of pay less transparent. These have resulted in CEOs and other senior officers of large U.S. corporates being paid colossal sums of money that do not necessarily correlate with the performance of the company or the value created (or destroyed) for shareholders. Golden parachute arrangements ensure that CEOs obtain large payments even when their services are terminated for poor performance.

Such arrangements for pay, whether in the form of salary, bonus or even stock options encourages short-termism that incentivizes managers to boost short-term profits of their companies and earn large sums of moneys, but at the cost of the interests of shareholders that tends to be relatively longer term. This mismatch of expectations and incentives makes managers take decisions that may in the end cause their downfall as we have seen in the recent failures.What is even more troublesome is the fact that remuneration of directors and senior managers is fixed by the board (or compensation committee), with no approval required from shareholders for fixing such remuneration. In other words, shareholders have no “say on pay” that is mandated by law, although there are proposals on the cards for requiring shareholder approval (at least on a non-binding basis).
However, the Indian legal position is far more stringent:
The remuneration of directors and senior managers in Indian companies are not comparable to the kind of stratospheric proportions witnessed in the U.S., although Indian pay-scales at the top echelons have seen a steady increase over the years. However, one key difference in India (at least in theory) is that senior management’s pay is subject to shareholders’ approval and also to certain maximum limits in view of Sections 309 and 198 of the Companies Act, 1956. To that extent, shareholders do have a “say on pay” that is mandated by law, unlike in other markets (such as the U.S.) where the decision is largely left in the hands of the boards of directors or their compensation committees.
Although the Companies Bill, 2008 had proposed to do away with ceilings on executive pay, and to leave its determination to market forces, it is reported that the Government may reconsider this issue. This is due to the fact that excess executive pay has been seen to have contributed to the financial crisis that emanated in the US.

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