Large institutional shareholders — and public shareholders — are not taking kindly to promoter-directors upping their remuneration takeaways at a time when the prospects of business recovery are clouded by the anticipated third wave of the Covid-19 pandemic, says Sudipto Dey.
Earlier this month, Sobha Kapoor and Ekta Kapoor, part of the promoter group of Balaji Telefilms, faced shareholder ire when they failed to obtain the requisite votes on resolutions proposing pay increases for them.
In recent months, several promoter-directors, including Siddharth Lal of Eicher Motors and Pawan Munjal of Hero MotoCorp, have faced similar situations.
Clearly, large institutional shareholders — and public shareholders — are not taking kindly to promoter-directors upping their remuneration takeaways at a time when the prospects of business recovery are clouded by the anticipated third wave of the Covid-19 pandemic.
The onus, say experts, is on the Nomination and Remuneration Committee (NRC) in the board of directors of a company to bring more transparency, objectivity and fairness in arriving at promoter-remuneration and hikes.
“There is a sense that promoters need to share in the pain in this Covid year.
"When growth in revenue and profits has slowed, or is negative, how can a disproportionate increase in remuneration only to promoters be justified?” asks Shriram Subramanian, founder and managing director, InGovern Research Services.
The reason for shareholder angst is not hard to figure out. Aon India’s Executive Compensation Study for 2021, released in April, suggests that promoter-CEOs in BSE 100 companies earn, on an average, 30 per cent more than professional CEOs.
In India, the skew in remuneration between promoter-director and professional director could be as high as 20-30 times, J N Gupta, managing director, Stakeholders Empowerment Services, a proxy advisory firm, points out.
Most experts feel the weakest link in bridging the remuneration gap between promoter-directors and professional directors is the NRC.
“Performance evaluation by the NRC is a mere formality today, except for true-blooded companies,” says Prabal Basu Roy, director and advisor to chairman of corporate boards.
Gupta describes them as “puppet” NRCs.
“Often, the NRC does not apply its mind on matters related to promoter-director remuneration,” he adds.
Board evaluation of directors’ performance is largely an internal exercise with few companies using external professionals to support their evaluation effort.
Experts point out that the NRC while assessing remuneration of promoter-directors tends to forget that the wealth of the promoter is tied to their share ownership — the average promoter holding in listed companies in India is said to be pegged around 45 per cent, and that two out of every three listed companies are controlled by families.
Amit Tandon, founder & managing director, Institutional Investor Advisory Services (IiAS), a proxy advisory firm, says the quickest way to ensure adequate checks are in place is to treat promoter-director remuneration as a related party transaction.
This would mean companies would need to have approval for these payments from majority of minority shareholders.
The Companies Act, 2013, does not differentiate between promoter-directors and professional directors when it comes to remuneration.
It also does not put any legal ceiling on managerial remuneration, provided the company gets due approval of shareholders or lenders for the same.
A profit-making public company is allowed to pay its managerial personnel remuneration up to 11 per cent of net profit. Anything beyond this would require a special resolution that has to be approved by 75 per cent of shareholders.
However, the Securities and Exchange Board of India’s (Sebi) listing regulations specify that the annual remuneration of a director who is part of the promoter group cannot be more than 2.5 per cent of net profit, or Rs 5 crore, whichever is higher.
Anything beyond that would require the company to seek shareholder approval through a special resolution.
Some experts, such as InGovern’s Subramanian, think promoter-directors should cap their cash compensation, and take the bulk of their pay-outs in the form of dividends.
“That way, it is equitable for all shareholders who have taken the risk in investing and backing the promoter.
“Compensation should be benchmarked to Total Shareholder Return,” says Subramanian.
Not everyone agrees with this line of thinking.
IiAS believes that dividend declaration should not favour a specific class of shareholders, namely promoters or controlling shareholders, as that may impact the long-term interests of shareholders.
Performance-driven agreements for promoter pay-outs are seen as a more viable option for fixing promoter remuneration.
“Sebi could perhaps mandatorily require listed companies (with a turnover of above Rs 500 crore) to adopt a Key Managerial Remuneration policy approved by the shareholders, and an independent expert.
"We have seen similar developments in the case of dividend declaration policy as well,” says Amit Agarwal, partner, Nangia & Co.
But one thing experts agree on is that the NRC has to bring in more transparency in promoter-directors’ performance appraisals.
“It is important to establish and publish the principles for assessment to evaluate the effectiveness and contribution by each of the directors.
"While establishing this assessment, NRC should consider the relative performance of the organisation in comparison to a relevant peer group,” says Pothen Jacob, practice leader - executive compensation & governance at Aon India.
Building linkages between the relative performance of the organisation to the compensation of the directors can make the compensation proposal a lot more credible and acceptable to the shareholders, he adds.
Experts point out that the mix of promoter remuneration pay-out vis-à-vis what promoters earn through dividend has a tax planning angle too.
Typically, in the case of a company promoter earning more than Rs 5 crore as annual income, dividends will be taxed at the peak rate of 42.74 per cent (30 per cent tax + 37 per cent surcharge + 4 per cent cess).
In the hands of the company, however, the dividend pay-out is not tax deductible, so there are no inherent tax advantages for the company, except outflow of cash, and depletion of reserves.
But the payment of promoter remuneration is completely tax deductible in the hands of the company.
“Thus, an obvious tax planning follows, to the extent that there is a tax arbitrage in cases where a company opts for a promoter remuneration pay-out vis-à-vis dividend,” says Agarwal.