Over the past two years, investors in the US have become proactive about the compensation received by top executives of companies. Motorola shareholders recently approved a 'say on pay' proposal, even as they criticised the management on its functioning. The Bank of America and Verizon have also seen a strong shareholder intervention. These developments are a fallout of the crashing of asset values witnessed by the investors in the past two years.
In India, however, shareholders do not participate actively in decisions regarding the pay packages of top executives. According to company laws, the managing director's remuneration and employee stock option (Esop) schemes have to be passed by shareholders in general meetings. Listing regulations also prescribe that the remuneration and compensation committees of the board, headed by independent directors, should approve major decisions on compensation. In actual practice, there is very little participation by external entities. In the past 30 years, no proposal on executive compensation has been turned down or substantially modified by shareholders.
Another peculiar and undesirable feature is the pay packages received by owners, who also act as managing directors. Take the Ambanis, who, despite being the promoters and biggest shareholders of Reliance, draw crores of rupees as salaries. As risk-takers, the owners should take a share of the profit, not a fixed amount every month.
Why should shareholders be bothered? It's because when executives are paid large salaries and given stock options, these are charged to the profit and loss account of the company. So, the profit available to shareholders is less. The more the owner and executives take as pay packages, the less the small shareholder gets.
Let's assume a company has a paid-up capital of Rs 20 crore, its profit is Rs 10 crore and the top five executives draw Rs 10 crore. If their salary is reduced to Rs 5 crore, the net profit rises to Rs 15 crore and the earning per share increases from Rs 5 to Rs 7.50. If the share trades at a PE of 20, it translates to an extra share price of Rs 50. The market capitalisation goes up by Rs 100 crore (50 x 2). The loss of Rs 5 crore to top executives is magnified to Rs 100 crore in the market capitalisation of shareholders.
Though small shareholders can arouse public consciousness, it's the institutional investors who should become more active. Those who hold stakes of more than 25 per cent, such as insurance companies and mutual funds, should use their voting power to ensure that the pay packages do not work against external shareholders.
I am not against competitive compensation. We live in a globalised world, and to attract and retain talent, Indian companies should pay well. However, the owners and top executives should enjoy and suffer in the same way as the small investor, who has trusted the company by buying its shares.
P.N. Vijay is a New Delhi-based investment adviser
