A research study by the Indian School of Business (ISB) indicated a progressive increase in the ownership stake held by family businesses. Over the past decade, promoters of family firms have increased their ownership stake in National Stock Exchange and Bombay Stock Exchange listed companies.
The study said that over 90% of all listed firms in India are family firms, which means they are either majority-controlled or majority-owned and in most cases are also run by the same family. Some prominent examples include Ambanis, Birla, Adanis, Jindals, Munjals of Hero, and more.
A study by the Institutional Investor Advisory Services(IIAS) in Mumbai has said that promoters are voting in their own salaries despite poor investor support. In 2022, IIAS examined 201 remuneration resolutions for promoters. It found that 34% (68 out of 201) of these resolutions would have failed if promoters were unable or chose not to vote.
There are many cases IIAS points out where the non-executive chairman took a large package while the CEO was paid much less. According to the report, the non-executive chairman in a north-based textile company was paid an aggregate remuneration of Rs 576.6 million in FY22 in a non-executive capacity, while the CEO’s remuneration aggregated Rs 19.2 million.
Govindraj Ethiraj founder, The Core, spoke to Hetal Dalal, president & chief operating officer of Institutional Investor Advisory Services India on the role of the regulator, the board of directors, and the institutional investors in addressing conflict of interest in executive compensation especially when promoters hold executive positions.
Here are edited excerpts from the interview:
In an interesting report, you analysed 201 remuneration resolutions for promoters and found that a third of them, about 34%, would have been defeated if promoters were not allowed to vote on compensation. This suggests that companies or promoters are granting themselves very high salaries. Is that your finding?
The way to look at it is: separating the role of managing the company vis-à-vis owning it. See, anyone managing the company, at the CEO level, will need to be compensated accordingly. Now, in the case of promoters, many run the companies and hence are part of the management too. As a result, they not only set their own compensation but are also voting their shares on it.
These are legitimate arguments. They need to be paid for running the company and they can vote their shares as shareholders. However, it also essentially poses a conflict of interest—setting one’s compensation and also voting on shares. So there is a conflict of interest.
Therefore to address the conflict of interest in transactions—called related party transactions– the regulator has now ruled that one cannot vote on transactions which have a conflict of interest. However, this doesn't apply to executive compensations. As executive compensations are out of the ambit of the related party transactions this
Let us look at the context. If one considers the resolutions in 2022 alone, here is how the numbers stack up: 201 resolutions for promoter compensations of which 68 — basically 34% — which is very high. If you look at the related party transactions where the voting is by majority or minority and the promoter group cannot vote, in all of 2022, only nine resolutions were defeated. In this particular instance, if this was put to a majority or minority vote like all other related party transactions, 34% of them would have been defeated.
This also suggests in this 34%, the other investors were actively voting against these high salaries
That is right. So, what you are seeing now in terms of voting outcomes is that more than 75%-80% of the capital is being voted upon. Institutional investors towards their stewardship responsibilities are voting on shareholder resolutions and seeing a certain increased participation from the retail channel as well.
So non-promoter investors have effectively voted in the majority against a particular remuneration. This happens due to a couple of reasons. First, is the absolute level of compensation — it would be very high for the size of the business or for the performance. We have seen instances, even during Covid, where promoters received increased compensation at a point in time when employees were let go or employee remuneration was cut down.
The second is the alignment of compensation to the company's performance. Thirdly, what are the standards or rules for other employees of the company? In some instances, the multiple to median employee remuneration can be as high as 2400. These are issues that institutional investors look at and therefore in certain instances, at least in 68 of the 201 instances, overwhelming investors have not supported these resolutions.
That is an interesting point: the median versus the absolute. I remember the Maruti Chairman, RC Bhargava once telling me that in Japan, the median to absolute compensation for the CEOs is amongst the lowest in the world. India, I think, is among the higher end and America the highest.
However, how does one judge? You mentioned some parameters like relative performance and so on. But does that cover everything that we need to cover?
See, there is no right way of looking at it…there is a mathematical formula for remuneration. There are several variables. Essentially what we look at is whether the remuneration is within a certain range for the size of the company, the performance of the company, and the structure in terms of alignment of performance.
Let us break it down. Let us look at compensation structures in absolute. If you look at the compensation structures of professionals versus promoters, promoters tend to have a higher degree of fixed pay. Professionals tend to have a higher degree of variable pay or even stock options–all of these require the individual to perform, generate wealth for investors and therefore get paid. When you have a higher fixed pay compensation, you get paid to come to work. So one is just the whole pay structure. And therefore you also ask the question of how much is the alignment.
Now, in some cases, we have seen that promoters have a flat commission of the profits independent of everything else. For example, if you are a commodity player, and the profits are booming, you have a flat shave of the profit level but other executive directors don’t. Therefore the question is: what is the kind of accountability for that pay? Has the performance target been achieved, at least to a certain degree, or is pay considered a mere right because one is also a promoter?
Third is if you separate the ownership and the management. If I have to hire someone in the market for the same role will I be paying that much money? Would I be getting someone as equally competent, sometimes even more competent to run the same role for a different level of compensation? And then there is benchmarking across peers — you look at an industry, a certain peer set in terms of the size in the industry, and see whether the remuneration is in a certain range. So, in 68 resolutions some of this does not really fit.
Looking ahead, how should shareholders and investors look at this if they want to? And secondly, how can companies be more responsive to it rather than being challenged?
Investors want two broad things. Firstly, they want clarity on what the compensation is. Today, you look at the way compensation resolution has actually come out, there is no real clarity and everything is open-ended. You do not really know what the final number is going to be.
Even when we look at remuneration resolutions, we make estimates based on past track records — the final number is based on what the starting number is. But it is actually hard to come up with greater clarity and say that this is going to be the definite range. There are instances, for example, if you look at Infosys and Salil Parekh’s compensation, that is clear in terms of the quantum and the period of the payment and the final numbers. But you see those in very rare instances.
The investors want clarity mainly on two aspects: What would be the final payout? Is it aligned to company performance and is there a certain degree of accountability to that compensation? Going back to Salil Parekh’s compensation at Infosys—it was around 81 crores, much talked about in the media but the resolution passed with overwhelming support.
So investors essentially want to see an alignment in the compensation with their own interest– in terms of creating shareholder wealth. If that is happening investors actually tend to be on board with the entire compensation.
In companies, I think boards, most importantly the nomination remuneration committees, are failing to establish clear performance boundaries for the promoter. In several instances, promoters tend to be part of the nomination remuneration committee. Companies can always argue that promoters cannot participate in the discussion of their own compensation as per regulations, it is hard to argue that the decision is not getting influenced in their presence. Some of these conflicts of interest in business continue when promoters hold executive positions and therefore it is incumbent upon boards to set greater clarity and expectations from the promoter while setting compensations.