Widening Chasm between Director Remuneration & ESG Investment in India

[Divyanshu Sharma is a 3rd Year BA LLB (Hons.) student at National Law University, Delhi]

The debate regarding the disparity in director remuneration between professional and promoter-group directors has been reignited in a recent study conducted by Institutional Investor Advisory Services. The study has unearthed numerous instances wherein the remuneration granted to promoter CEOs in India is 50 times more than the one offered to professional executive directors. According to the study, the reason for this trend is that a major component of director remuneration continues to be fixed pay, while the performance-based pay constitutes a relatively smaller part. Due to this, professional executive directors, whose compensation is primarily associated with the performance of the company, receive a meagre amount of remuneration against the promoter-group directors who earn a majority of their remuneration from the fixed-pay component.

The author believes that the results of this study can have a major impact on the availability of institutionalised investments for Indian companies. This understanding is grounded on the fact that institutional investors are rushing towards ESG-compliant companies, which recognise and reward the efforts of professional directors at par with promoter-group directors. In this post, the author intends to analyse the disquieting trend of biased remuneration policies in the Indian corporate sector. Further, the author aims to suggest some changes to be brought about in the corporate governance policies in India that are necessary for attracting investments from ESG-conscious institutional investors.

Family Name Pays Well

The Indian corporate governance landscape is still characterised by one of the highest number of family-owned companies globally. According to a recent study, 64% CEOs in the country belong to the promoter-group family, who draw the maximum amount of salary, irrespective of their contribution towards the company’s success. Conversely professional directors, who primarily occupy executive positions, receive meagre remuneration in comparison.

The root cause of this problem is the fact that the Indian legal system does not recognise the unequal treatment meted out against professional directors. The law only provides a ceiling on the compensation given to all the directors of a company. According to section 197 of Companies Act, 2013, a publicly listed company cannot grant remuneration to all its directors exceeding 11% of the net profits of the company for a financial year. Even Schedule V Part II of the Act merely provides for adherence to the above-mentioned ceiling. The law does not mandate a reasonable distribution of this amount among the directors, based on their performance and skills.

Furthermore, regulation 17(6)(e) of SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 mandates a special resolution if the remuneration paid to an executive director belonging to the promoter group exceeds INR 5 crores or 2.5% of the net profits, or in case the remuneration of more than one such directors exceeds 5% of the net profits of the company. Thus, the law assumes that if the shareholders do not approve of an enhanced level of remuneration to the promoter-group directors, and if the entire 11% net profits are used, then the remaining 6% of the net profits shall be distributed between all the remaining executive and non-executive directors. The applicable laws nowhere provide for any minimum level of remuneration for professional executive directors, who could contribute the most towards the success of the company.

A Feeble Approach to a Serious Problem

Despite the abovementioned provisions, there is a ray of hope for equal treatment towards professional directors in the form of the Nomination and Remuneration Committee (‘NRC’). The role of this committee is to oversee the appointment, removal and remuneration policies of directors and key managerial persons. Section 178 of Companies Act, 2013 provides for the constitution of an NRC in every public company with a paid up capital of INR 10 crores or more, or having a turnover of INR 100 crores or more, or having liabilities exceeding INR 50 crores or more (in terms of rule 6 of Companies (Meetings of Board and its Powers) Rules, 2014 ). The NRC is required to comprise of non-executive directors, with two-thirds being independent directors.  

While the composition of the committee hints towards it being a powerful independent entity, the same is sadly not true in practice. Recent events have brought to light inherent weakness in the power and authority of this committee. This is evident from the facts of the Tata-Mistry dispute. The Tata-Mistry dispute dealt with the removal of the Mr. Cyrus Mistry from the position of the Chairman of the Tata Group. The reason given by the Tata Trust for the removal of Mr. Mistry was his incompetence in leading the company, leading to financial losses for the stakeholders. Interestingly, a few days before the motion for Mr. Mistry’s removal was approved by the board, the NRC of Tata Sons commended Mr. Mistry’s work as the chairman. This report was accepted by the company’s board. Based on this report, several independent directors too appreciated Mr. Mistry’s performance as the Chairman.

Considering this, the National Company Law Appellate Tribunal (‘NCLAT’) held that since the NRC had no issues with the work of Mr. Mistry and that its report was accepted by the board, the Tata Group’s reason for Mr. Mistry’s professional incompetence does not stand ground. Thus, the NCLAT relied on the independent analysis of the NRC, and reinstated Mr. Mistry. However, NCLAT’s judgement was overturned by the Supreme Court and Mr. Mistry’s removal was held to be valid. But the Supreme Court did not discuss the NRC report and the decision of the Board considering it. In any event, a review of the Supreme Court’s ruling has been admitted.

This dispute is the apt manifestation of the issue that the promoter group directors can overlook the recommendations and observations of the NRC. The NRC is a special committee which has been constituted under law to independently analyse the performance of directors and grant them remuneration according to their skills and performance. However, the recommendations of this specialised committee seem to have less than desirable impact on the decisions of the promoter-group controlling shareholders, who dominate the board-room decision making process. This attitude of the corporate sector would severely hamper the ESG goals of companies, which must be fulfilled for attracting investments.

ESG & Professional Directors

The last few years have seen an integration of the ESG principles with the investment decisions of institutional investors. Institutional investors are large financial entities that invest funds in a company on behalf of others . These investors include mutual funds, pensions, and insurance companies. These entities consider the adherence of companies with the ESG fundamentals while making investment decisions. One of the principles that they consider are good corporate governance policies, which include diversity on boards, tenure of members and executive compensation.

ESG-conscious investors prefer to invest their money in companies whose boards have a high degree of professionalization. Institutional investors believe that young, educated, experienced directors can lead the companies towards ESG-friendly policies, which would benefit all the stakeholders. Professional directors, with the requisite experience, have the energy and enthusiasm to take risks, and engage with institutional investors for better ESG policies. However, these professional directors, like everyone else, need motivation to use their skills and expertise for the growth of a company, in which they have no vested interest like promoter-group directors.

Performance-based compensation is one of the ways through which these professional directors can be motivated to use their expertise for the welfare of the company. However, the current gap between the remuneration awarded to promoter-group directors and professional directors seems to do just the opposite. The apparent disparity in the compensation given to professional directors hampers their zeal to ensure the company’s success.

One can argue that the rise of ESG in India has been accompanied by increased shareholder activism. Several instanceshave come to light wherein institution investors have collectively voted against all resolutions for enhanced promoter-group director compensation beyond a reasonable limit. However, this does not mean that controlling promoter-group shareholders are not using their superior position to draw the maximum amount of compensation. For instance, in the case of Sun TV, the promoter-group directors single handedly won a resolution for exorbitant remuneration, even when all institutional investors voted against the motion. Thus, even if institutional investors vote against a resolution, the same is not indicative of the defeat of the entire motion.

Making Some Changes

The author believes that changes are imperative to ensure that company policies are aligned with the demands of ESG-conscious institutional investors. One of the possible changes should relate to the authority of the NRC. The author believes that while the NRC is an independent body in its structure, it needs greater authority and power to bring true changes in corporate remuneration schemes. This can be effected if the board of directors is made answerable for overlooking the NRC’s reports and suggestions. At present, this scheme has been adopted in case of the audit committee. According to section 177(8) of the Companies Act, 2013, if any suggestion of the audit committee is not acceptable to the board, the reasons for the same must be disclosed. If such an authority is given to the NRC, it would be binding on the board members to pay heed to the NRC’s recommendations and work on them.

Furthermore, the legislature and regulators can also refer to the UK Corporate Governance Code, 2018 which incorporates interesting suggestions for increased transparency in remuneration policies. The Code provides that the remuneration given to a director should be commensurate with the commitment of the director to the company’s success, which can be judged from the past performance of the director. It also suggests that detailed disclosures regarding the quantum of compensation given to directors, the rationale behind the remuneration awarded and pay gap ratios. The author believes that such disclosure would enhance the degree of transparency and would deter promoter-group directors from demanding unreasonably exorbitant remuneration.

Lastly, the author believes that the legislature needs to intervene and create new norms regarding the range of remuneration given to executive professional directors, out of the total 11% quantum. This could include a range of reasonably acceptable ratios between the performance-based and permanent components of director remuneration, and a range of equitable director pay remunerations between the two classes. The author believes that such changes and increased disclosures would ensure that Indian corporate sector is able to attract greater institutional investment, which needs companies to enhance the degree of professionalization on boards.

Divyanshu Sharma

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