Unlike Potter Stewart who said, I can't define pornography, but I know it when I see it, the answer to 'how much is too much' continues to elude most boardrooms. What else can explain why the top 10 Indian CEOs were cumulatively paid Rs520 crore in FY2016/17. And why, in the last five years, CEO pay in the top 500 companies has risen 85 per cent while revenues and profits have grown in the 40-50 per cent range.
The payouts have been startling, given that no other number is as closely scrutinised and discussed as CEO pay. Regulators have tried to address this by asking for more disclosures and by imposing profitability-related thresholds. But the lack of an overarching framework leads to excessive pay packages - thus explaining why compensation continues to draw the ire of investors and other stakeholders.
In part, this can be attributed to the innate complexity of the issue. It requires a fine balance between multiple, and often competing, factors - quantum, size, growth, peer benchmarks and company performance are just some of them. Navigating through these data points to arrive at an optimal pay level can be quite taxing, especially when clubbed with the concomitant goals of talent attraction and retention. For boards, a more germane approach would, therefore, be to increase its focus on the pay structure, rather than the final number.
Generally, pay structures comprise 'fixed' and 'variable' components. The variable part is linked to the performance of the individual (ability to meet revenue, volume or market share targets) or the company (profits, margins, market cap). On occasions, these may be supplemented with qualitative factors (leadership and engagement with stakeholders).
Fundamentally, higher variable pay helps align the interests of the CEO with that of the company. It is taken to an extreme in the US where, as per an Equilar study, the fixed component in the S&P 500 companies constitutes only 12.3 per cent of overall pay with the remainder being in the form of a cash bonus, stock and ESOPs.
In contrast, CEOs in India are paid almost 70 per cent as fixed pay. Also, very few have a long-term incentive (LTI) plan embedded in their pay structure - only 38 CEOs in the top 500 companies were paid ESOPs/RSUs in FY2016/17. It may not be an issue for promoter-run companies where the equity stake fosters a long-term view, but the lack of LTIs within a professional leadership runs the risk of creating and promoting an ephemeral view on the company's strategy.
From investors' perspective, there is an added dilemma as they are often called upon to vote on compensation structures that are ambiguous and carry few meaningful details on commission, performance metrics and the quantum of LTIs - effectively conferring on the boards with unrestricted discretionary powers in setting the final pay.
The practice is unlike most other markets. Over the past few weeks, Nikesh Arora's headline pay of $126 million has been in the news. However, a closer look at his terms of employment gives us a detailed breakdown. He will receive $1 million as salary and $1 million as a discretionary cash bonus. The bulk of his compensation is to be drawn from stock options, to be granted in a phased manner if he meets defined stock price targets.
In India, there have already been isolated cases of discontent regarding executive compensation. With the rise in institutional ownership, scrutiny will only increase. It implies boards need to be more proactive and devise compensation arrangements with well-defined performance metrics, which will help stakeholders understand payouts. The granularity of disclosures will also act as a self-regulatory tool by reigning in discretionary powers of compensation committees and make the pay structures more transparent, equitable and aligned to performance.
Debanik Basu is Group Head and Amit Tandon is MD at Institutional Investor Advisory Services India