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Executive remuneration: A look on the Indian Companies Act

Sadapurna Mukherjee and Priyoma Majumdar comment upon the ongoing debate between executives and shareholders on the topic of excessive executive remuneration.
Introduction

Issues of Corporate Governance, having gained stronghold in the developed nations of the West, have largely invaded the Indian Corporate Sector in the past decade. In present times, it has in fact reached a stature when Good corporate governance practices are a sine qua non for sustainable business that aims at generating long term value to all its shareholders and other stakeholders.

This paper essentially seeks to focus upon the ongoing debate between executives and shareholders on the topic of excessive executive remuneration.  The current global financial crisis has highlighted the importance of ensuring that remuneration packages are appropriately structured and do not reward excessive risk taking or promote corporate greed.

In the light of the same, an attempt has been made to provide an international overview of the growing concern pertaining to excessive executive remuneration. Australia along with U.S.A has been cited as illustrations since they record the highest setbacks and financial slowdown in respect of corporate malpractices with regards to payment of mammoth compensation to executives. While in India, the malaise of exorbitant executive pay package is yet to spread to the alarming levels as in the above cited nations, however it has been observed that executive compensations have been steadily on the rise in the recent past.

Moreover, a close analysis of the ground reality in India has revealed that the central problem in Indian Corporate Governance is the conflict between dominant and minority shareholders which is further aggravated by the statutory imposition of ceiling on remuneration of executives and inadequacy of remedies available to the minority shareholders to object to such remuneration. Thus Corporate Governance abuses perpetrated by a dominant shareholder pose a difficult regulatory dilemma to the Indian legislature. On the international front, remuneration practices have been identified by the G-20 and the Financial Stability Forum has considered excessive executive remuneration as a contributing factor resulting in the Global Financial Crisis. Keeping in mind this concern, we have attempted to examine and analyse related provisions in the Indian law in the light of the proposed Company Law Bill 2009 so as to strengthen the movement of Corporate Governance in India.

Case Studies  demonstrating the issue of excessive executive remuneration

The financial world, at present, is faced with a waging war on excessive executive remuneration in major companies across the globe. This segment shall display an abhorrent abuse of an executive’s position within an organisation with particular reference to Australia and U.S.A which account for the highest paid CEOs in the corporate sector. When Mr. John McFarlane, CEO of Australian &New Zealand Banking Company(ANZ) retired from office in 2007, his retirement package included $1 million with the objective of  enabling him to buy back his vested shares. Despite the considerable personal tax savings enjoyed by Mr McFarlane, the Board was of the opinion that it was against the “principle of equity” to necessitate payment of tax on such vested shares in case performance targets were not achieved. Such a scenario would, in effect entitle Mr McFarlane to a tax refund. This example is demonstrative of the sublime strategies of inclusion of shares, STI awards, allowances and other benefits within “remuneration” apart from the base salaries, pensions and bonuses.

In the year 2006, a sizable sum of $44 million in cash and shares were paid to departing secretaries of Promina Group, prided upon as one of Australia's leading insurance company at the time of its acquisition by Suncorp despite some such secretaries being re-employed as consultants. At this juncture it is also worth the while to note that executives include not only directors of a Company but its meaning has been expanded by the Government of Australia  to include members of each of the various entities within the consolidated group such as, secretaries , senior managers, partners; trustees and those mentioned in the Company’s remuneration report.Thus in the current example the secretaries of Promina would be considered as executives. In addition to a sanction of $8.1 million as termination payment, Mike Wilkins, CEO of Promina, received $1.5 million to provide consultancy for a period of six months which significantly exceeded the company’s profit margin for that period. This example demonstrates how remuneration was tactically manipulated by executives, in addition to of an offer of re-employment.

A similar grim scenario has likewise engulfed Corporate America as well. In 2008, Robert A. Iger, a senior executive of Walt Disney Company, revered as a leader in the American animation industry, raked in a mammoth sum of $51,229,341 in total compensation which marked an increase of 78% from the compensation package provided to CEOs in the previous year. Such exorbitant pay packages of CEOs of multinational companies observed even at the time of the ongoing global financial crisis is indeed appalling as well as disturbing. In 2001, Ford Motor Co. reported a loss of $5.45 billion. Workers were laid off, and salaries of large number of employees were slashed. However, in spite of adoption of such stringent measures Ford's CEO Jacques Nasser, received a massive sum of $20 million in compensation for the financial year.

Finally zeroing upon India, it is interesting to note that in comparison to its western counterparts, the situation in India, as of now, continues to be under better control owing to the fact that the senior management’s pay is subject to shareholders’ approval and also to certain maximum statutory limits prescribed by the law. However, it cannot be dismissed that in spite of regulatory measures, the salaries of the CEOs of Indian companies over the past few years have been steadily on the rise. In the year 2005-2006, the salary of Naveen Jindal, Managing Director of Jindal Steel and Power, rose by a massive 248% to 13.54 crores whereas the profit growth of the company remained stagnant at 23%.In the same year, the managing director of Hero Honda, Pawan Kant Munjal, received a hike in salary at the rate of 15% even when Hero Honda being one of the world's largest two wheeler maker recorded decline in net profits to the extent of 11%.

Having demonstrated the concept of executives and remuneration it is now imperative to note that on the flipside, however a decision by directors to pay themselves large bonuses and fees is not necessarily oppressive and unfair, in instances where the company’s profitability has increased significantly because of their contributions and performance. For instance, no shareholder could grudge the 78% hike in the salary of Sunil Mittal, CEO of Bharti Airtel in the year 2005-2006, especially when his proficient control and management of Bharti Airtel, led the telecom service provider to deliver a 100% profit.

Further, a bona fide decision by directors to adopt a conservative financial policy involving payment of modest dividend is not oppressive if agreed to by the majority of members in the absence of any other factors pointing to unfairness. For instance, in India, in the wake of the global recession in 2009 there were several companies including the Spice Group which created a club consisting of CEOs and promoters who took voluntary pay cuts letting go of 60% of the cash component of their salaries until there was a revival in the market finances. However, such level of personal concern and involvement in the company's welfare can be particularly noticed in the case of Indian entrepreneurial companies as here the promoters of the companies are themselves the CEOs and hence they take the onus of the business more sincerely than an outsider. This throws light upon the fact that there is no one size fits all approach to arrive at what is a reasonable remuneration. The same can only be ascertained based on the facts and circumstances of every situation based on equity considerations that provides enhanced transparency on remuneration issues.

Analysis of legal remedies of shareholders and provisions related to managerial remuneration

It needs to be known at the outset of this discourse that though the crisis of excessive executive remuneration is, at present, at its nascent state in India, however this study has been undertaken particularly to examine the flaws in the Companies Act 1956 pertaining to managerial remuneration and remedies of minority shareholders in order to ensure that the same have been addressed in the Company Law Bill 2009 such that the abovementioned concerns may be nipped at the bud. The concern however stems from the fact that the Indian pay scales at the top echelons have seen a steady rise over the years which has been proving to be disconcerting for market watchers and regulators of the financial and corporate sector in India. The researcher proposes to analyse the current legal provisions in the Indian law and assess the effectiveness of the above in the light of the aforementioned issue. This is of particular significance at this time when the Indian legislature is engaged in the process of implementing the Company Law Bill 2009.

The Indian Companies Act, 1956

The Indian Companies Act 1956 contains provisions for managerial and executive remuneration which embody a self contained code in themselves. Section 198 of the Act fixes a ceiling on the overall maximum remuneration payable to the managerial personnel. It mandates that the total remuneration payable to executive personnel of a public company or subsidiary private company, in respect of a financial year, can in no condition exceed eleven percent of the net profits of the company. Further, the section prohibits payment of any remuneration to executive personnel exclusive of the fees which are payable under Section 309(2) of the Act in a year when the company has incurred severe losses or has garnered inadequate profits. Section 309 supplements the provisions contained in Section 198 to state that the remuneration of all whole time or managing directors taken together shall not exceed ten percent of the net profits of the company in respect of a financial year except with prior approval of the Central Government.

An additional check to the executive remuneration is contained in Section 200 which prohibits any company from paying remuneration free of taxes or such reference to its executives. Although a bare perusal of the above mentioned sections seem to provide elaborate safeguards for purposes of ensuring that pay scale of executives of Indian companies are subjected to a “checks and balance system”, yet on a closer analysis certain ambiguities are revealed. While Section 198 read with schedule XIII of the Act fixes a ceiling for managerial remuneration, however the same is applicable only for public companies and private companies which are subsidiaries of a public company. This effectively excludes private companies which are then provided a free rein to remunerate their executive personnel without operation of any statutory ceiling.

Moreover, Section 198 of the Companies Act has been assailed by financial experts and market watchers not from India alone but Western Countries as well on grounds of statutory imposition of caps on compensation. It has been logically argued that administrative imposition of ceilings on managerial remuneration may not only prove to be arbitrary in various circumstances but instead of achieving the objective of curbing unregulated use of corporate power it may adversely affect incentives to effort and risk taking. While it is undeniably essential that a company’s finances cannot be permitted to be directed by the executive elite to their personal accounts without operation of checks and balances, however the same should be left to the decision of shareholders who are always in the best position to determine the welfare and needs of the company. Such imposition of ceiling tends to undermine integral elements for deciding upon managerial remuneration which includes the size of the companies and their profits and turnover in various financial years. Pay of executives must depend upon the prevailing market standards which cannot be predetermined by the government through prescribed ceilings.

However, in spite of criticism of the statutory imposition of ceilings it is also vital to keep in mind that shareholder’s powers in determining remuneration of executives can be exercised in a legitimate manner only if the Act contains adequate provisions outlining the rights and remedies of minority shareholders thereby proving that the two concerns are inextricably linked. Thus in the backdrop of the existing Companies Act 1956 which has been subjected to immense criticism over the years, for failing to provide adequate remedies to minority shareholders, the complete removal of caps on remuneration might do more harm than good since the same may be manipulated by the dominant shareholders to the detriment of the interests of the minority. This situation of deadlock however has been attempted to be eradicated by the proposed Company Law Bill 2009 which has been discussed in the following segment.

The Companies Act 1956 has been criticized many a time for failing to provide elaborate remedies to minority shareholders in instances which include the concern addressed in this paper. Excessive remuneration paid to executive personnel at the cost of the company's worth and profit, to lure them into assuming office may often have an adverse impact on the interests of minority shareholders who have their stakes in the company as well. Sections 397 and 398 of the Act empower any member of the company to approach the tribunal for relief, if they are of the legitimate opinion that the affairs of the company are being conducted oppressively or being mismanaged so as to injure public interest or the interests of the company at large. The tribunal if satisfied with the adequacy of such complaint can then make an order to such effect. Such order of the tribunal however, is limited only to the mode prescribed under Section 402 of the Act which include termination, setting aside of agreements and regulation of company’s affairs including winding up. It is thus disturbing to note that no remedy is available to shareholders to claim damages in case of oppression or mismanagement.

Moreover, the course of judicial interpretation of the above mentioned sections has brought to light several inadequacies which act as a deterrent in serving the interests of minority shareholders. In order to attract Section 397 and 398, there should be present and continuing mismanagement of the affairs of the company. Thus, if there has been any instance of mismanagement in the past then same shall not be envisaged within the ambit of the Section to provide relief to shareholders. Moreover, under section 397 and 398, the powers conferred upon the Tribunal are of wide and discretionary nature wherein the Tribunal shall pass an order only upon its own assessment and interpretation of “oppression” and “mismanagement” of affairs of the company. In practice, then, the rights and redressal mechanism of shareholders is devoid of objective parameters and is subjected to the Tribunal's interpretation of what must be ‘just and equitable’ to provide remedy.

Addressing the issue in concern, if the Tribunal is of the opinion that such excessive payment rendered to executive personnel is beneficial to the long term interests of the company, then such minority shareholders are left with no remedy. More importantly, judges are often faced with a dilemma when they have to deal with cases where a resolution passed by directors may be perfectly legal yet oppressive to the interests of the company. All these legal inconsistencies have been found to occur particularly because the aforementioned sections nowhere provide objective grounds on which remedies might be sought by shareholders.

What is perhaps the primary impediment which thwarts the remedies of minority shareholders under the Act is Section 399 which mandates certain limitations for minority shareholders to claim their rights under Sections 397 and 398 of the Act. In case of company having share capital, not less than 100 or one tenth of the total members, or members holding more than one tenth of the share capital are qualified to seek redressal. In case of a company which doesn’t have share capital, not less than one fifth of the members may apply to the tribunal. This essentially raises concern over the unfair treatment meted to those shareholders who are not able to satisfy the above prescribed statutory requirements. Such shareholder’s in spite of their stakes in the company are rendered powerless to seek remedy for any form of legitimate grievance under the grounds mentioned above.  This clearly establishes the proposition sought to be advanced through this paper, that the remedies provided by the Companies Act fail to comprehensively safeguard the rights and interests of minority shareholders which remain subject to the whims and interpretations of the judiciary.

Proposed reforms for the Crisis Management

As it has been established in the above segments, all over the developed world, a vital source of shareholder grievance has been traced to the levels, structure and payouts of executive compensation. Hence, in this segment, an attempt has been made by the researchers to focus on recommendations and reforms which might redress the grievance and help in stabilisation of corporate finances. For this purpose the focus has been primary centred upon India. Following the aftermath of the Satyam Fiasco which does remain a one-off incident in India, the Naresh Chandra Committee proposed certain recommendations for dealing with the concern of excessive executive remuneration.

Recommendation 3 of the Committee suggests an amendment to the Companies Act 1956 such that companies have the option of giving a fixed contractual remuneration to non executive directors which should be determined by the size of the company. It specifies that such remuneration should be subject to ceilings depending upon the net worth of the company. The same has been suggested by the Combined Code in U.K. More importantly, Recommendation 5 necessitates the establishment of a Remuneration Commitee by the Board of the Company which should supervise a formal and transparent procedure for developing policy on executive remuneration and for fixing remuneration packages of all executive directors and chairman. The same recommendation has been proposed as mandatory by a Report of the ICSI in 2009 after studying the situation in Australia and U.S.A.

This Report further elucidates that the main task of the Remuneration Commitee for purposes of ensuring fair and responsible pay should concentrate on demonstrating a direct relationship between key executive performance and remuneration.  This would help to avoid the ambiguity which currently prevails in India, as well as other developed countries over executive pay packages. At the same time “Voluntary Guidelines” issued by the Ministry of Corporate Affairs in 2009, under the guidance of Corporate Affairs Minister Salman Khursheed, emphasises that such remuneration should be reasonable and sufficient to attract, retain and motivate qualified directors for successful management of the companies.

Clause 175 of the Companies Law Bill 2009, has been introduced taking into account the widespread dissent and removes the ceiling imposed on managerial remuneration empowering shareholders to decide upon the same, depending upon the size and turnover of the company rather than following any fixed ceiling prescribed by the government which might not prove to be feasible at all times. This is supported by the economic theory that right to appoint agents and fix their compensation should always be in the hands of the principals i.e., the shareholders.
This clause may be however, be regarded as a prudent and welcome change to the existing Section 198 of the Companies Act which fixes a ceiling on executive remuneration, only on the pre-existing condition that the establishment of a Remuneration Committee must be made mandatory by the Company Law Bill 2009. The importance of this Committee shall lie in the fact that it shall ensure that remuneration of executives has been fixed by shareholders after proper evaluation of their contribution and qualification and any incentives should be subject to the direct relation between contribution of such executives to the net profits of the company. This would help to ensure that funds are not directed by executives to their personal accounts in detriment to the interests of the company and its shareholders.

Furthermore, Clause 175 of the Bill removes the discrimination created by Section 309(6) of the Act against whole time and managing directors by permitting them to receive commission from their holding or subsidiary companies along with ordinary directors subject to disclosure of the same by the company in the board’s report. Moreover, Clause 176 of the Bill has gone a step ahead of its predecessor Act, to lay down clear grounds and mode of payment of remuneration to ordinary directors so as to eliminate any instances of ambiguity or mismanagement. Finally what is of utmost importance, is the fact that the aforementioned clauses of the Bill have consistently used the term company thereby making the provisions of the Bill applicable to public and private companies alike. This has been a much needed departure from the Act where certain provisions pertaining to remuneration were applicable only to public companies and its subsidiary private companies.

As regards the remedies of minority shareholders are concerned, The Company Law Bill 2009 has introduced Section 216 which mandates “Class Action”. This section departs from the limitations imposed upon minority shareholders to seek remedy under Section 399 of the Companies Act and empowers any one or more members or a class of members to apply to the tribunal for remedy, if he is convinced that the affairs of the company are being run in a manner prejudical to his own interests as well as interests of the company. This clause lucidly outlines the various grounds on which a shareholder may seek an order from the tribunal. These grounds would be integral in providing objective parameters for remedy to shareholders and would simultaneously fetter the discretion of the Tribunals in passing orders for the same. A perusal of the grounds indicates that payment of excessive remuneration against a resolution passed by all shareholders would empower the minority to approach a tribunal seeking remedies. However, although Clause 216 has radically widened the ambit of shareholders who may seek redressal yet, similar to its predecessor Act, this clause fails to recognise the shareholder’s rights to claim damages from the company in case of violation of grounds mentioned in it.
                                                           
It may be observed at the conclusion of this discourse, that while the Company Law Bill 2009 has indeed traversed a substantial path in managing and allocating responsibilities for fixation of fair managerial remuneration and empowering minority shareholders, there are however certain areas which demand deeper introspection. At a time when the Standing Committee of the Parliament continues to scrutinize the Bill, it might be prudent to take a closer look at such areas.

Conclusion

Shareholder Activism in India is at a nascent stage and comes to the fore only in instances where institutional investors holding a significant stake in the company decide to question the quality of corporate governance. As minority shareholders may not have complete understanding of their rights or awareness of the avenues through which these rights could be exercised, increased activism from institutional shareholders and reinforcing the role of independent directors on the board is likely to take shape in the near future in the light of the proposed Company Law Bill 2009. This paper has attempted to trace the inadequacies in the legal provisions governing executive remuneration along with corresponding remedies available to minority shareholders which has inextricable implications on Corporate Governance of a nation. Comparative research involving International contexts has further facilitated understanding of the origins and persistence of excessive executive remuneration as a threat to the global economy as a whole. Exploration of other governance mechanisms, such as remedies available to the minority shareholders to combat excessive and exorbitant remuneration packages, has been explored in the Indian Corporate Arena so as to obtain holistic understanding of the need for an up gradation of remedies to combat corporate malpractices.

Having analysed the aforementioned aspects it can be stated that shifts in values of corporate governance over the past decade in the backdrop of liberalization, industrialization and globalisation, has resulted in shifts in institutional and legislative frameworks, which, in turn, promises to ensure more transparency and fairness in the remuneration process. The proposed Company Law Bill 2009 envisages implementation of appropriate strategies that result in the achievement of shareholders’ objectives along with managing adequate remuneration packages and mitigating risks arising from excessive compensation packages of executives to successfully revive finances of companies in the wake of the global financial crisis.

It needs to be primarily noted that the proposed Indian laws discussed in the paper, aim to effectively enhance the mode of corporate governance by vesting greater powers in minority shareholders, laying greater emphasis on self-regulation through a “check and balance” mechanism operating within each company, minimization of regulatory approvals, and most importantly, an increased transparency and disclosure regime in companies. However, successful implementation of the same necessitates firm commitment on part of managerial personnel of companies and adoption of ethical practices by organizations across their value chain and in all of their dealings with a wide group of stakeholders encompassing employees, customers, vendors, regulators and shareholders (including the minority shareholders), in times of market prosperity as well as down surge. To achieve the same, the aforementioned legal provisions proposed in the committee reports and Bill need to be legally enforced such that they may yield beneficial results for India thereby setting an inspiring example for Australia along with other developed countries in the West.
PRUJOMA MAJUMDAR & SADAPURNA MUKHERJEE are 4th year students pursuing B.A.LL.B (Hons) from NALSAR University of Law, Hyderabad.
 
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