Introduction
Under the Companies Act, 2013 (‘the Act’) and SEBI (Listing Obligations and Disclosure Requirements) Regulations (‘LODR’), the remuneration of directors is subject to shareholder approval. Specifically, Section 197 of the Act provides that directors remuneration shall be subject to shareholders approval. Similarly, Reg. 17(6) of LODR also requires that director remuneration is subject to approval by shareholders.
Proxy advisors play a crucial role in guiding shareholders on voting for resolutions related to director remuneration. In this article we would be highlighting areas that should be taken care of while proposing remuneration packages for whole-time and executive directors.
A. Governance Concern
1. Excessive Remuneration
Excessive remuneration is a critical governance issue, as it often reflects a lack of alignment between executive pay and company performance. When remuneration packages exceed industry standards or are not performance-linked, they can erode shareholder value and undermine confidence in the company’s governance practices.
The table below outlines specific concerns related to excessive remuneration:
| Sr. No. | Concerns Raised | Description | Detailed Examples |
| 1 | Excessive Remuneration Relative to Industry Standards | Excessive remuneration that far exceeds industry norms creates governance concerns as it indicates a lack of oversight and fairness. This may also reflect poorly on the company’s adherence to governance best practices. | In one case, the promoter directors were proposed to receive remuneration that accounted for nearly 5% of the company’s EBITDA and 18% of the total wage bill. This figure was far above industry norms, raising concerns about whether the remuneration structure was a result of undue influence rather than performance-based merit. |
| 2 | Remuneration Misaligned with Company Performance | A governance concern arises when executive remuneration is significantly higher than what is appropriate for the company’s performance and size, leading to potential misalignment with shareholder interests. | Directors remuneration was benchmarked against far larger and more profitable companies, despite the executive’s company having posted financial losses for several consecutive years. Observers noted that such misaligned pay undermines governance, as compensation should be more closely tied to actual company performance. |
| 3 | Excessive Perquisites and Stock Options | Disproportionate stock options or perquisites raise governance concerns, particularly when they are not fully justified or lack transparency. | A CEO’s compensation package included stock options valued at ₹128 crores, which accounted for 2% of the company’s share capital. The lack of transparency regarding the criteria for awarding these options, coupled with the significant value, raised governance concerns, especially as other employees received far lower benefits. |
2. Lack of Transparency in Remuneration Packages
Transparency in executive pay is vital for ensuring that shareholders can assess whether remuneration is justified. Without clear disclosures on pay structures, bonuses, and stock options, companies risk facing governance challenges and losing shareholder trust.
The table below outlines specific concerns related to Lack of Transparency in Remuneration Packages:
| Sr. No. | Concerns Raised | Description | Detailed Examples |
| 1 | Lack of Transparency in Bonus Payments | Governance and Transparency Concerns arise when companies do not disclose the basis for determining bonuses, raising potential conflicts of interest. | CEO received a one-time bonus of ₹25 crores without any clear disclosure on how the amount was decided. This lack of transparency led stakeholders to question whether such an extraordinary payment was necessary, as no performance criteria were provided. |
| 2 | Unjustified Increments | Lack of transparency in justifying significant pay increases undermines governance, as shareholders are unable to evaluate whether the increments are deserved. | Director’s remuneration was set to increase by 240% over two years without any clear justification or performance metrics to support such a large raise. This raised concerns about governance, as the pay increase was not adequately explained to shareholders. |
| 3 | Lack of Transparency in Stock Options | Lack of clarity on the criteria for awarding stock options can undermine governance by creating opportunities for unfair practices. | A CEO was awarded stock options worth ₹128 crores without sufficient disclosure regarding the conditions for receiving such options. The lack of transparency in this case created concerns about governance, as stakeholders could not determine whether the award was justified or fair. |
| 4 | Lack of Performance-Linked Criteria | When variable pay or commissions are not linked to individual performance, it raises governance concerns, as remuneration may be disproportionate to actual contributions. | A Managing Director’s remuneration included a 1% commission on profits, but there was no maximum cap or performance-based criteria tied to individual contribution. This lack of alignment between pay and performance raised concerns about potential overcompensation and misaligned incentives. |
3. No Absolute Cap on Remuneration Packages
Setting a clear cap on executive remuneration is a key aspect of governance. Without fixed limits on pay, there is a risk of excessive and unchecked compensation, which can lead to governance failures and potential regulatory issues. The table below outlines specific concerns related to no absolute cap on remuneration packages:
| Sr. No. | Concerns Raised | Description | Detailed Examples |
| 1 | No Absolute Cap on Remuneration | Governance and Legal Concerns arise when there is no clear maximum limit on executive pay, as this can lead to unchecked and excessive remuneration practices. | In one instance, a company sought approval for the Executive Chairman’s pay to exceed ₹5 crores without setting any upper limit. This lack of a cap raised legal and governance concerns, as shareholders were unable to assess whether the remuneration was reasonable. |
| 2 | No Cap on Variable Pay | Variable pay components without fixed caps present governance risks, as they leave too much room for discretion and potential overpayment. | A company’s proposal for increased in remuneration of managing director included a variable pay component with no fixed upper limit, although the total remuneration exceeded regulatory thresholds. The absence of a cap on variable pay raised concerns about excessive remuneration practices. |
| 3 | Excessive Increments Without Cap | Large pay increases without an upper limit and clear justification present governance risks, as they undermine shareholder oversight. | Remuneration for two Promoter Executive Directors increased by 60% and 733%, respectively, without any fixed cap or clear justification. The lack of limits on their variable pay components heightened concerns about unchecked pay practices and weakened governance. |
Conclusion: Remuneration packages for whole-time and executive directors are a key area of focus for both shareholders. These packages must not only comply with the applicable legal framework but also adhere to the principles of good governance. Fixing remuneration without following a set process would lead to an inference that board of directors were arbitrary in fixing remuneration. In order to avoid this, it should be demonstrated that is ascertaining remuneration of directors of the company it was ensured that:
- Process as prescribed by law is followed in deciding remuneration.
- Rationale for quantum of remuneration: If adequate disclosure is provided with respect to parameters taken into consideration while deciding remuneration and as to how is the remuneration aligned with vision and goal statement of the company, then it is visible that the remuneration is based on some rationale.
- Consistency and disclosure: following parameters for fixing remuneration consistently and continuous disclosures in this regard would help investors map performance of company and directors’ remuneration.
This article is published in Taxmann. The link to the same is as follows:
This article is written by Vallabh Joshi – Senior Manager– vallabhjoshi@mmjc.in and Animesh Joshi – Research Associate – animeshjoshi@mmjc.in