CEO pay package: Is it time for better shareholder democracy?
How far are the shareholders' voices heard in the decision-making process to nominate and elect directors or determine the pay structure of Board of Directors?
Does the top boss’ contribution commensurate the compensation?
By KP Shashidharan
It’s interesting to note that the Securities and Exchange Commission (SEC) of USA added a new rule on 5 August 2015 mandating pay ratio disclosure for improving corporate governance. The new rule requires a public company to disclose the ratio of the compensation of its chief executive officer (CEO) to the median or for simplicity let us say, average compensation of its employees in compliance with the Dodd-Frank Wall Street Reform and Consumer Protection Act, 2010. The rule is scheduled to be effective from January 1, 2017. About 3,800 companies have to disclose pay ratio as per this new rule and it may cost them initially about $1.3 billion. Does it help?
The CEO’s remuneration has been a topic of heated debate since long. American banker JP Morgan and management Guru Peter Ducker’s view that CEO’s pay should not exceed 20 times of the emoluments of an average worker stands as a benchmark.
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However, the Economic Policy Institute, Washington has found in its recent study that the ratio of CEO pay to a typical worker’s earnings has been increasing over the years. The ratio on an average went up from 20 times in 1965 to 30 times in 1980 and about 300 multiples in 2013. SEC also specified the methodology to calculate the ratio to reduce the compliance cost. Additional disclosures required under the new rule are: ‘(1) the median of the annual total compensation of all of their employees, excluding the CEO, (2) the annual total compensation of the CEO and (3) the ratio of the annual total compensation of the median employee to the CEO’s annual total compensation’. Is the pay-ratio a good benchmark to gauge CEO performance? Is it so that the time has come for this new rule because shareholders have been granted the right to cast votes on executive pay?
In India, the new Companies Act, 2013 was enacted in August 30, 2013 and rules were framed there under overhauling corporate governance norms in March, 2014 applicable for every company or a class of companies, both listed and unlisted. The Securities Exchange Board of India (SEBI) has reviewed the provisions of the Listing Agreement aligning with the Act, 2013, incorporating best practices. SEBI revised Clause 35B of the Equity Listing Agreement and Clause 49 of the Equity Listing Agreement applicable to all listed companies with effect from 1st October 2014. All existing material related party contracts or arrangements are required to be placed for approval of the shareholders.
In the backdrop of dynamic corporate governance regulatory framework, SEBI may like to deliberate: Are Indian CEOs overpaid or do they deserve what they take home? Hasn’t the time arrived for better shareholder democracy to reduce the gap by enhancing the pay and perks of the lower rungs of employees? Many corporates like ITC, Axis Bank, HDFC Ltd., Wipro, HUL, ICICI, Vedanta, Reliance are reportedly paying their CEO’s over 70 times of the average employee of the organisation. If the total CEO compensation, combined with stock options, bonuses and non-salary perks is taken into consideration, it is much more. Does the top boss’ contribution commensurate the compensation?
The key objective of SEBI is to protect investors by regulating corporate disclosures enabling the investors to take informed decisions. SEBI’s job is to protect shareholders against abuse of board’s powers and to safeguard the investors. Is CEO’s pay in excess compared to public and private companies in the same industry? Is the board acting at arm’s length? Are the managers’ incentives aligned with their performance? Is there downsizing for inadequate performance? Does CEO have capital at risk?
Public CEOs are paid from shareholder capital based on board’s decision. How far are the shareholders’ voices heard in the decision-making process to nominate and elect directors or determine the pay structure of Board of Directors? Boards may not like dissension when it decides CEO/BOD pay on the basis of recommendations of the Compensation Committee. Shareholder democracy has so far remained an oxymoron on issues like executive pay.
No doubt, shareholders’ active involvement in the decision-making process is a vital determinant to safeguard against board’s decision to go for excess compensation; but how far is it practical in the extant corporate scenario? By incurring more cost on compliance, will the investors get benefit by bringing better shareholder democracy?
– The writer is former DG, CAG of India and a Member in SCODA of SEBI. Views are personal.
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