Assessment of the Role of Present Regulatory Framework of Executive Compensation in India: An Exploratory Study

Introduction

Risk preference and executives\' ability to take risk has crucial effects on executive compensation. These effects can sometimes be positive, negative, or insignificant. Especially for financial institutions, risky decision-making of deutsch the executives is expected only if equity interests are aligned with the executive remuneration. The Reserve Bank of India has also recommended that executive compensation must be subject to effective corporate governance and monitoring, effective alignment with judicious and restrained risk-taking, and effective supervisory control of stakeholders. Moreover, the establishment of a Remuneration Committee (RC) has also been recommended for non-governmental banking institutions (Reserve Bank of India, 2012).

The remuneration of executives has been comprehensively controlled and regulated by the Companies Act, 2013. The term \"remuneration\" has been described as -\"any money or its equivalent given or passed to any person for services rendered by him and includes perquisites as defined under Income-tax Act, 1961\" (Ministry of Corporate Affairs, 2013; p.11).

The Companies Act, 2013, states that the principal managerial personnel of a public limited company will be remunerated according to the recommendations of the Nomination and Remuneration Committee made to the Board of Directors [Section 178(1)]. Section 197 of the same Act states that there is a mandate for the listed companies to disclose the ratio of employees\' median salary and the remuneration of each director. In addition to that, the restriction imposed in the 1956 Act under Section 309 on receiving commission and remuneration from the subsidiary company has been removed in the 2013 Act; however, the Board report should reflect the remuneration received [Section 197 (14)]. This act has liberalised the administrative procedures of seeking permission from the central government for any special resolution taken for managerial salary determination.

This article primarily encompasses two major areas pertinent to executive remuneration corporate governance and managerial remuneration issues. The following section will illustrate these features of the Indian legal framework with necessary details.

Corporate Governance and Associated Indian Regulations - An Overview

The following sub-sections are going to provide an overview of the relevant corporate governance issues in the Indian context:

i. Appointment and Other Liabilities of Directors

In India, the Companies Act, 2013, has laid down the provisions of governance in corporate domain. Section 149(1) of this Act states the increment of directors\' number from 12 to 15. One director of the Board must be the resident of India for a minimum period of 182 days [Section 149(3)]. Moreover, the inclusion of one-woman director has also been prescribed in Section 149(1) (Ministry of Corporate Affairs, 2013).

The Companies Act, 2013, has made an attempt to maintain ethical governance practices and in view of that, Section 166(2) has laid down the provision of good governance by saying \"whole of the Board is required to act in good faith in order to promote the objects of the company for the benefits of its members as a whole, and in the best interest of the company, its employees, the shareholders, the community, and for the protection of the environment.\" In addition to that, ethical practices are further boosted as the Act lays down that whoever is unable to be elected as a director in a general meeting will not be qualified to be appointed by the Board of Directors as an additional director (Section 161).

ii. Role of Nomination and Compensation Committee

Every listed company has got a need to set up a nomination and remuneration committee. Other companies having paid-up capital of 100 crore INR or more or having aggregated outstanding loans or borrowing or debentures or deposits surpassing 200 crore INR also need to set up a remuneration committee. The role of the remuneration/compensation committee is highly influential and crucial as it reviews, formulates, and recommends the company strategies and policies to the Board of Directors about \"remuneration for directors, key managerial personnel and other employees, criteria for determining qualifications, positive attributes, and independence of director [Section 178(1)]\". Compensation committee plays a pivotal role in the supervision of the entire employee stock option scheme (Securities and Exchange Board of India, 2009).

iii. Appointment of Key Managerial Personnel

The executive compensation remains dependent on profitability of any organisation. Assuming a linear relationship between company profit and key managerial personnel\'s remuneration, the Companies Act, 2013 has laid down that the overall limit of executive compensation is set at 11% of the profit for the financial year (Ministry of Corporate Affairs, 2013).

The age criteria for the key managerial personnel have been revised in the 2013 Act. However, the predecessor of this Act, The Companies Act, 1956, stated the lower age limit of the key personnel appointment was 25. This limit has been relaxed to 21 years. In addition to that, the upper age limit has also been stretched in the 2013 Act and it prescribes that an individual over the age of 70 can also be appointed as key functionary of the organisation. According to Section 203, the appointment of the key managerial personnel like managing director, chief executive officer, managers, chief financial officer, as well as company secretary is mandatory for every listed company and every other company which has a paid-up share capital of 5 crores or more. In addition to that, appointment or re-entry at the same time for an individual in multiple capacities of chairperson, managing director, or chief executive officer has been barred in the same section.

Compensation of Executives

This is perhaps the most significant section of this article discussing the remuneration practices of executives as guided by Indian regulations. Such remuneration practices are principally guided by two sets of legal guidelines i.e. the Companies Act, 2013 as well as Securities and Exchange Board of India Guidelines, 1999 (updated up to September 3, 2009). In our ambit of discussion thus far, we have cited the evidently linear relationship between profit earning of the organisation and healthy executive compensation, irrespective of controlling factors such as country or economic diversities. Now, the question is relevantly raised as to how an inadequate degree of profit impacts executive remuneration. Section 197 of the 2013 Act provides necessary explanation to this question. This section explains the applicability of provisions of managerial remuneration restricted to public limited companies only. In order to maintain transparency, it has been made mandatory for the listed companies to unveil the ratio of compensation of each director to median remuneration of general employees.

Apparently, the precursor of the 2013 Act i.e. the 1956 Act, was comparatively stringent, as Section 309 of the old Act restricted the managing director or whole-time director of a subsidiary company from obtaining commission from the holding and subsidiary companies simultaneously. However, the 2013 Act has obliterated the aforementioned restriction, but such benefit should be declared in pertinent reports [Section 197(14)] (Ministry of Corporate Affairs, 2013).

Remarkably, the definition of remuneration has evolved in the 2013 Act. Section 2(78) has defined remuneration as \"any money or its equivalent given or passed to any person for service rendered by him and includes perquisites as defined under the Income-tax Act 1961\" (Ministry of Corporate Affairs, 2013, p. 11). In the previous Act of 1956, under Section 200, any remuneration paid to top-notch executives without tax component was restricted. The present Act of 2013 carries the same spirit as the above-mentioned definition which involves direct tax attachment to compensation components (Ministry of Corporate Affairs, 2013). Moreover, executive compensation is also defined as \"the total cost incurred by the company towards employee compensation including basic salary, dearness allowance, other allowances, bonus and commissions including the value of all perquisites provided, but does not include:

• The fair value of option granted under an Employee Stock Option Scheme; and
• The discount at which shares are issued under an Employee Stock Purchase Scheme\" (Securities and Exchange Board of India, 2009, p. 1)

According to Section 198 or the 2013 Act, the allowance and deductions pertaining to executive remuneration should be accounted for calculating the profit (Ministry of Corporate Affairs, 2013). This provision of the Act strengthens the proposition that executive remuneration affects a firm\'s financial performance.

i. Regulatory Guidelines on Employee Stock Option Scheme (ESOS) and Employee Stock Purchase Scheme (ESPS)

The Securities and Exchange Board of India has provided these guidelines on executive compensation in India under Section 11 of the Securities and Exchange Board of India Act, 1992. In the previous section, the definition of executive compensation as explained by the Securities and Exchange Board of India (SEBI, hereon) has been provided.

SEBI specifies the definition of ESOP as \"option given to the whole-time Directors, Officers, or employees of a company which gives such Directors, Officers, or employees, the benefit or right to purchase or subscribe at a future date, the securities offered by the company at a predetermined price\" (Securities and Exchange Board of India, 2009, p. 1). ESOS or employees stock option scheme refers to a scheme which allows the organisation to grant stock option to employees. On the other hand, ESPS or employee stock purchase scheme allows the employees to purchase share as a part of the public issue. The term \"market price\" refers to \"the latest available closing price prior to the date of the meeting of the Board of Directors in which options are granted/shares are issued, on the stock exchange on which the shares of the company are listed\" (Securities and Exchange Board of India, 2009, p. 3). SEBI further explains the term \"share\" as equity shares and the securities which can be converted into equity shares.

The eligibility for ESOS has already been explained in the preceding section and ineligibility is extended to an employee who is the promotor or belonging to the promotor group of the company as well as a director who holds more than 10% of the outstanding equity shares, either by himself or through relationships. We have already illustrated the role of compensation committee in the prior section and would now try to shed light on the role of shareholders. In order to ratify an ESOS for offering to employees, shareholders must approve the scheme through a special resolution in the general meeting (Securities and Exchange Board of India, 2009).

An adequate quantum of corporate governance has been ascertained with respect to ESOS and disclosure report by the Board of Directors which contains intricate details like \"options granted, pricing formula, options vested, options exercised, the total number of shares arising as a result of exercise of option, option lapsed, variation of terms of options, money realised by exercise of options etc.\" (Securities and Exchange Board of India, 2009, p. 11).

On the other hand, ESPS resembles ESOS in terms of eligibility, shareholder approval, vesting schedule and other identical parameters.

Critical Appreciation of Regulatory Framework of Executive Compensation in India

The Ministry of Corporate Affairs (MCA) is the principal government body which administers the Companies Act with the current 2013 version. Of late, the Companies (Amendment) Act, 2015, has come into force as well. The Companies Act is enforced by the Company Law Board (CLB). The other primary body regulating the security market since 1992 is SEBI. Therefore, corporate operations in India are under constant monitoring by multiple regulatory bodies (Pande & Kaushik, 2011).

There has been a conflict between regulations laid down by the MCA and SEBI. For example, Clause 49 or Equity Listing Agreement and the 2013 Act have some overlapping mandates regarding the appointment and tenure of service of the independent directors as well as the grant of stock options for independent directors (Ministry of Corporate Affairs, 2013). However, to avoid this conflict, the Standing Committee of the Parliament in its final report in August 2010, recommended that for establishing \"minimum benchmarks\", SEBI should be allowed to act according to their jurisdictional extent (Pande & Kaushik, 2011, p. 17).

Corporate governance is the presumed panacea to curb every corporate malpractice. Beyond its therapeutic nature, corporate governance is used to align different corporate exercises to socioeconomic ethical standards of the country. The Confederation of Indian Industries (CII) has introduced the practice as a voluntary method to ascertain the values and ethics in Indian corporations; however, soon it got mandatory status through Clause 49 of the Equity Listing Agreement which consists of eight attributes of corporate governance like Board of Directors, Audit Committee, Remuneration of Directors, Board Procedure, Management, Shareholders, Report on Corporate Governance, and Compliance. In the later half of 2009, voluntary guidelines were prescribed by the Ministry of Corporate Affairs (Pande & Kaushik, 2011).

The main objective of corporate control in organisations is to ascertain appropriate executive remuneration practices. This \"control\" is exercised through an adequate corporate structure, especially referable to the role of directors as well as composition of the Board of Directors. In an attempt to ensure gender diversity, the attempt to incorporate female directors in the Board has been made in the Companies Act, 2013. The most significant feature of this Act is the number and functions of independent directors. These directors are also held responsible along with the members of the Board of Directors if any malpractice takes places.

In light of the occurance of financial frauds, SEBI has incorporated several corrective measures including disclosure of pledged shares, peer review, compulsory dematerialization of promoter holdings etc. (Securities and Exchange Board of India, 2003).

Executive remuneration is reported to be ineffectively managed by family-owned firms. Organisation for Economic Co-operation and Development (OECD) has highlighted the disadvantages of related party transactions (RPT), which are attributable to organisations being managed by a family or multiple families integrated together through relationships. In such companies, the shareholders force the remuneration committee to accept reckless recommendations about executive compensation (Organisation for Economic Co-operation and Development (OECD), 2014).

Even though the presence of structured legislations for executive compensation in India is observed, the mismatch in the payment structure between private and public sectors in India is evident. The private sector is paying exorbitantly high remuneration to its public sector counterparts (Sridhar, 2021). The regulatory control on executive remuneration in India has been criticized for being too normative, with limited scope for shareholders to share their opinions on the issue of hefty managerial compensation (Khurana, 2022). However, the Companies Act, 2013, has guided the establishment of the \"Nomination and Remuneration Committee (NRC)\" with active participation of independent directors in corporate governance matters including executive compensation (Kishore, 2021).

Over the years, Indian corporate regulations, with relevant amendments and necessary alignment with international corporate practices, have been handling executive remuneration as well as related corporate governance issues efficiently. However, the instrumentality of the regulatory system is not beyond question, and recent studies have shown little impact of corporate governance on the growth of the financial market in India. Moreover, the effective implementation of the governance system could possibly induce the growth of the Indian economy (Guha, Samanta, Majumdar, Singh, & Bharadwaj, 2020).