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Vulgarity in executive compensation? A point of view

October 12, 2009 12:11 IST

While the definition of what is vulgar is relative, there is little doubt that Board-level compensation committees are given short shrift in India, Pratip Kar.

The meaning of a word is intrinsically connected to its definition. It is determined fully by how we choose to define it. Since we have chosen to define the day as the period of time which elapses between sunrise and sunset, we call that time the day; we could have reversed the definition and called it night.

We have elected to call a colour green, so it is called green, we could name it red as well. Take the word vulgar for example. What is vulgar would depend very much on how we opt to define it. Would we in India call the Khajuraho sculptures, or those which adorn the walls of some of our temples, vulgar? Well we may hesitate to do so and try and find a convincing spiritual rationale for it.

But someone else from another land may not agree, since his definition of vulgarity is different. There are sections of our society who would call a nude painting vulgar, rationalise vulgarity with vehemence and may create situations which result in banishing the artist from his motherland.

Others would see a Michelangelo's David, a Raphael or a Gauguin and all the navarasas may overflow. Thus definition is important. Interestingly, the definition of vulgar or vulgaritiy has a relativistic angle also - it is both temporal and spatial.

What may be vulgar at some point of time in some country or society may not be considered so, at a different point of time in the same society and country or at the same time in a different society or country.

The situation gets even more complicated when the word is used in conjunction with executive compensation. For example, till the global financial crisis happened, not many eyebrows were raised over some CEOs being paid several millions of dollars in cash and perquisites, in addition to stock options and severance, even if the company went bust as a consequence of the CEOs action. But the financial crisis changed all that.

It placed executive compensation, especially CEO compensation in a completely different perspective and under the public lens.

Suddenly, the compensations merrily enjoyed by CEOs started seeming morally vulgar to public and the governments.

It lead President Obama to sign the American Recovery and Reinvestment Act of 2009, which placed new limits on executive compensation.

But what is so vulgar about executive compensation in India and in general? Why is it that when Corporate Affairs Minister Salman Khurshid spoke of vulgar salaries, it had the private sector collectively up in arms? Does a compensation package become vulgar when what the CEO gets is several multiples of what the rest of the company gets? Or is it vulgar in India, because we are not a rich country as yet and hence salaries of several crores go against the moral norms which society has appointed for itself? For example, an executive compensation of a crore may not be too high in the private sector, but it is vulgar when compared to the counterparts in the public sector.

At what level does a compensation package acquire the stigma of vulgarity? What about someone who gets a salary of several crores but chooses to spend a major portion on charity? Would it absolve the person from the taint of vulgarity? If that be the argument, then is it that we are bothered not by the monetary value of compensation but by the use we put the compensation to?

Three other questions demand our attention. One, would the compensation package be under the lens if the company was not publicly listed? Second, is the compensation package under question in India because most of our listed companies are promoter-driven and owner-managers keep for themselves a large portion of sales/profits? Third, why does the criticism of vulgarity not apply to the Bollywood actors who earn a lot more than many of our CEOs? The answer perhaps lies in the argument that a CEO of a public listed company is managing other people's money.

The Board of the company as a trustee of the shareholders, is responsible for other people's money. Holding that line of argument, the executive compensation packages, the CEO's salary, how much should the promoter manager be paid, should become a matter of public concern and debate and there is very little point in being defensive about it by saying that the CEOs' earnings in India are well within the limits set by the Companies Act.

Extrapolation of this argument takes us to the debate of whether compensation packages need to be regulated (more severely than they are being regulated now) or should the decision be left to the companies? A related question worth examination is whether a person would commonly be expected to say that the compensation package that is being given to him is too high and the company should reduce it. This would be like saying that please don't pay me more, I don't want more money, more ESOPs, more perquisites. There seems to be an element of ridiculousness in such an argument.

What is important with compensation packages is to understand how they are determined. Besides, it needs to be appreciated that whether it is a laissez faire or a laissez passer system, executive compensation packages would be under a public scrutiny, just in the same way as all hell breaks loose when there is salary hike of government employees though the hike to each employee may be only a miniscule portion of what the private sector executives get.

But of course austerity should be the hallmark of public servants because they are servants of the public. But by the same logic, the executives and the CEO and the Board of the listed companies are the servants of the shareholders, because it is their money that is under risk.

Should legislation have a role in determining the compensation packages? This cannot be completely ruled out; but that would not be the only way to remove the stigma of vulgarity from executive compensation. Here are a few things worth paying attention to:

The compensation or remuneration committee of the Board must take the lead in working out the compensation package. This committee in most companies in India is given short shrift.

The committee must report to the Board which must then use its collective judgement.

The committee must know what performance it is measuring and what performance it is rewarding. This cannot be done without understanding the drivers of the business, its cyclicality and volatility of earnings.

Performance measures based on financial targets are not sufficient; there must be non-financial targets too such as innovation, branding, leadership development, performance relative to competition.

The committee must dig deeper and go into the structure of the package - a judicious mix of fixed and variable components.

The committee and the Board need also to use judgement without losing objectivity.

This can be done with the Board clearly articulating a 'compensation philosophy; and be open to shareholder evaluation, for they need to know.

(The author is associated with the IFC's Global Corporate Governance Forum and the World Bank; he was formerly the Executive Director of Sebi. Views expressed are personal.)
Pratip Kar
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