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How much should an executive make?

As the US takes a hard look at top executive pay packages, does India Inc., too, need to introspect? Two views from experts.

Print Edition: February 21, 2010

Executive pay tracks growth

The issue of executive pay in India needs to be seen in a somewhat different context from the global one. Perhaps, the strongest factor that drove spiralling executive pay here was shareholder concern about the opportunity cost of a non-performing senior team in a high growth market like India. Weighed against the millions of dollars of investments, could the cost of a handful of senior executives matter?

The rates of growth of CEO pay in the high-growth years of 2004 to 2007 have, in some instances, been close to 80 per cent annually. Is this level of growth justified? Unfortunately, growth in CEO pay is not always correlated with improved performance or business results. Even in a "difficult" year for the economy, the level of pay for the head of the organisation grew at the median level by over 16 per cent based on analysis of 30 listed organisations that are considered to have good practices. In 2009, the correlation between rate of increase in median CEO pay and increase in profits was barely 0.4.

Here are some principles guiding on how pay structures should be developed:

  • Pay and benefits should be set relative to competitive and internal considerations. Shareholders owe it to CEOs to reward them competitively with respect to their peer group. What is important here is to set that peer group appropriately and ensure the nature of business, size, complexity of operations, and skill-sets are comparable. Internal equity considerations also matter; for, organisational results flow from collective efforts though the person at the helm may play a key stewardship role. The "top floor to shop floor ratio" is a reflection of the organisation recognising contributions at all levels.
  • Pay design, in terms of the elements of pay, needs to reflect a reasonable proportion of pay "at risk", which gets earned based on key shareholder goals being met. Bringing in a balance between the immediate and the long term perspective becomes critical here, to ensure sustainability of organisational success.
  • The measures need to be aligned to the strategic direction and expectations of shareholders (represented by the board) and the company leadership. Measures could be top line, bottom line or valueoriented depending on where the company is in its life cycle and shareholder philosophy.

Growth in senior executive pay in India has come about as a result of economic and corporate success; it has also sent a message to aspiring managers that rewards do follow hard work. At the same time, unbridled growth in pay is not in the interest of our nation or of shareholders. Boards and compensation committees need to ensure we do not veer away from the tenets of responsible executive remuneration. Institutional shareholder groups have played an active role in setting norms such as mandatory stock ownership by senior executives and pushing for full disclosure on pay in the West; India could also benefit from a greater voice of such groups.

- Padmaja Alaganandan, India Business Leader (Human Capital) at Mercer

Moral element vital in payouts

Unless compensation is commensurate with effort, I believe, it will lead to a "regression to the mean" syndrome (or, in other words, reversion to mediocrity) and cause the entire organisation to become lazy and sick - in effect unprofitable and ultimately insolvent. While each person derives inspiration and motivation from different things, it is also true that majority of the world is motivated by money.

Even so, 2008 will remain in the annals of history as a momentous year for having taught humanity valuable lessons in ethics and moral leadership. The economic meltdown could singularly be attributed to the replacement of rewards by greed and of profitability by profiteering. Now is, perhaps, a good time to back track a bit. Prior to the economic liberalisation that began in 1991, India Inc. followed a compensation structure that was largely flat in nature.

In our attempt to bring Indian companies to sustain world competition, we have adopted several management practices of the West-one of them compensation packages with performance-driven incentives, which rewarded a manager for the risk he undertakes to ensure exponential growth and returns. No doubt such compensation structures are mandatory, a complete dependence on financial data to calculate them is not ideal as it promotes "earnings manipulation" and falsification of facts. Thus, bottom line has little sanity with the reality being the cash flow.

Further, where the incentive portion is completely dependent on corporate financial performance, the risk preferences of the investor (risk averse) and the manager (likely to be in the high risk, high return category) lead to goal incongruence. In order to eliminate or reconcile this difference, it was suggested that stock options or other indices such as economic value added (or EVA, a measure of economic profit) could be adopted. The problem with the EVA index is that it still doesn't guarantee shareholder value and remains a predominantly financial index.

Then came the post-1996 Balanced Score Card Index, which surmises that up to 85 per cent of a stock's price appreciation is due to non-financial figures per se (such as operational excellence, innovation, brand image, customer centricity, etc.). Now, we have witnessed that even these non-financial figures can be fudged as in the case of Satyam and, previously, Enron. To date, unfortunately, we have not perfected an index that allows us to successfully implement an incentive-based pay structure.

What is required is, perhaps, a coupling with a balanced human approach-the index needs to be supplemented with a moral and emotional quotient that ensures the manager's responsibility, character and integrity. Of course, it is imperative that regulatory bodies (like Securities and Exchange Board of India, Ministry of Corporate Affairs, etc.) should play a crucial role in putting in place a regulatory framework to periodically check for fraudulent manipulations and imperfections. Otherwise, irrational exuberance and an unregulated free market economy will constitute a lethal combination.

- Bala V. Balachandran, J.L. Kellogg Distinguished Professor of Accounting and Information Systems, Northwestern Univ.

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