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This proxy season has seen institutional minority shareholders expressing themselves strongly on chief executive pay. In September, the pay proposals of Ekta and Shobha Kapoor of Balaji Telefilms were turned down by shareholders. Earlier, Eicher Motors had failed to get approval for its proposed remuneration for Siddhartha Lal, its CEO. Institutional investors have opposed other pay packets as well, although in these cases the related resolutions passed with the help of promoter votes. About 78% of institutional shareholders voted against Hero Motors’s proposal to offer 10% higher compensation to its promoter-CEO Pawan Munjal, who has been one of the highest-paid executives in India for several years. Bajaj Auto’s proposal to offer its chairman emeritus Rahul Bajaj a pay package of 6 crore was opposed by over half its institutional investors.

Several changes in the regulatory environment have enabled increased participation of minority shareholders. First, e-voting, although introduced in Securities and Exchange Board of India (Sebi) regulations and the Companies Act years ago, has gained traction in pandemic times. Second, the proxy advisory business in India has evolved, with such advisors actively promoting shareholder awareness and also supporting institutional shareholders with analytical insights and recommendations. Most recent decisions by institutions were driven by negative recommendations on proposals by advisory firms such as IiAS, InGovern and SES.

Examples such as Infosys suggest that professional CEOs would be paid more than promoter-CEOs who also earn large dividends on their stock ownership. However, our analysis of pay package trends of NSE500 companies over the last five years shows the opposite: Promoter-CEOs’ pay is 50% higher on average than that of their professional counterparts. Further, this pay-gap is not explained by the size of companies managed and holds even after controlling for firm size measured by total assets.

The average ratio of CEO pay to that of the median employee for NSE500 companies in 2020 was 213:1 for promoter-CEOs and 152:1 for professional CEOs. These numbers are similar to those in the US, where the ratio was 299:1 for S&P500 companies in 2020, up from 264:1 in 2019. A comparison across countries for 2018 indicates that India is second only to the US in this pay-ratio. China, Canada, the UK and others have lower ratios.

Economic logic dictates that pay packages need to be adequate to attract, motivate and retain the right kind of talent. Besides economics, social views on pay legitimacy are also important. Organizations and organizational arrangements that lack legitimacy are unsustainable. Legitimacy also confers immediate advantages on the organization in terms of access to resources such as capital, satisfied employees and competent independent directors. A severe erosion of legitimacy could well find us slipping back to the days when the central government’s permission was required for pay packages, which were capped at a relatively low level back then.

Promoter votes in favour of promoter-CEO pay packages may suffice to get shareholder approval for resolutions, but obviously do not confer legitimacy. This is where the role of the nominations and remuneration committee (NRC) of a company’s board comes in. Sebi has recently modified its regulations to require that this NRC be composed of not just a simple majority but a two-thirds majority of independent directors. This is a step in the right direction.

NRCs must now fulfil their role by justifying pay packages in comparison with those of similar organizations, and through links with performance. These factors are relevant both for economic reasons and legitimacy. Proxy advisory firms and institutional investors are a useful barometer for NRCs in fulfilling their role, and can even act as allies, for their approval could help NRCs gain legitimacy. Engaging in a dialogue with them could establish trust with the broader shareholder base. Institutional investors with a significant stake in a company are usually not driven by extraneous factors such as political agendas. They are therefore allies rather than adversaries.

The Balaji Telefilms case highlights the importance of engaging with shareholders, particularly institutional investors. Its promoters abstained from voting on their own pay packages. Its institutional investors, holding 18% of the firm’s shares, did not vote either. Only a few public shareholders with just 0.21% of its shares voted and a majority of these votes turned out to be against the proposal. Engaging with institutional investors could have prevented this outcome.

Another basis for legitimacy is transparency in disclosures. Companies should disclose in their annual reports or proxy statements the rationale and basis for how the proposed compensation was arrived at and what specific performance measures were used. Compensation need not and should not be based on a mechanical formula, but the basis for judgement should be disclosed.

In conclusion, we are not expressing a view on whether promoter-CEO pay is excessive. We are calling for establishing the legitimacy of chosen compensation practices. To do so, a company’s NRC or stakeholder relationship committee of the board should engage meaningfully with stakeholders such as proxy advisors and institutional investors. Passing shareholder resolutions on the strength of promoter stakes is a recipe for neither legitimacy nor sustainability.

Sanjay Kallapur & Prasad Vemuri are, respectively, professor of accounting at the Indian School of Business (ISB), and an independent director on the Board of IDBI Bank; and a doctoral candidate at ISB

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