Shouldn't pay be for performance?

Compensation is payment for what has been done. Performance is all about what has been achieved. Both can be measured. Surely, it cannot be so difficult to link the two

There are two numbers that ha­ve been unconnected with a co­mpany’s financial performance for a while. First its share price and second the CEO’s pay. The share-price — at least I would like to believe, is not something that the company has any control over. And the market price does periodically correct itself (or at least the divergence comes down for a short whi­le). The CEO’s compensation is determi­ned by a tighter group — the board, its remuneration committee, and shareho­lders. In a more perfect world, you would expect far greater alignment between performance and pay. But we are seeing this gap increasing rather than coming down.

Data published last year showed over the previous five years, the revenues of the BSE500 companies went up by 47 per cent, their profits by 56 per cent and the CEO’s salary by 72 per cent. In FY19, the CEO salary in­cre­ased by over 16 per cent, while on an average a company’s wage bill increased by 9-9.5 per cent.

What this implies is that the “in­equality” in the pay structure is rising. The CEO’s remuneration of a BSE500 company was over 100 times the me­dian employees remuneration in 2019 (88 in the previous year). At the extreme, the CEO of one company was paid 4,045 times the median employee salary, and over 10 CEOs were paid 700 times the median salary paid (in the US, a 287-ti­me multiple of CEO pay to employee median remuneration is considered ob­scene). That the median has remained low is because of the presence of PSUs and some small companies in the BSE500, which just cannot afford to pay their CEOs more. We will need to wait and see whether the pandemic has led to some tempering, but unless there is more scrutiny on pay versus performan­ce, I expect this trend to gather steam. After all if, as promoter, you can vote your on salary, why limit it by how you perform?

“Promoters” tend to take higher fixed salaries and higher bonuses as a right: A “promoter-CEO” in the same industry earns about 1.6 times a “professional-CEO”. They have ingeniously argued that as regulation do not allow them to receive ESOPs, they need to be “compensated”. Years ago, when Steve Ball­mer ran Microsoft, its remuneration co­mmittee boldly stated that since Mr Ballmer is a significant shareholder in the company; his wealth is linked to the value of the company; ergo, he needs to be paid a lower compensation than others.

The key to attracting and retaining people is the overall pay, and its mix between fixed and variable. The key to greater alignment between pay and performance is setting the right goals. Lo­ng-term incentives or stock-options is the thread that runs across. And then there are the usual rules of thumb. The more senior you are, the higher the variable component. Variable, in a normal situation, goes up more than the fixed.

Although India Inc now has the elements of the pay structure in place —fixed, short-term incentives (cash bo­nus), long-term incentives (stock-op­tio­ns) — they have consisten­tly slipped be­hind in explaining themselves. In fairness, other than at the ex­tremes, this is not easy. The chairman of State Bank of India, at Rs 31.2 lakh is low. The chairman of a company at Rs 1.21 billion (yes, that’s right) is obscene.

For shareholders, who are supposed to sign off on the compensation nu­m­bers, understanding what matrices are being used to arrive at the pay, the short-term and the long-term incentive, re­mains a black box. While companies make motherhood statements like variable pay will be linked to the company achieving performance-linked targets, they continue to shy away from disclosing what these targets are. They want to keep some wriggle room for themselves. And while they could get away with not disclosing targets when the salaries we­re low, as these have steadily crept up, and the pay-versus-performance relationship has weakened, they will come under greater pressure to so. The 31 per cent against vote earlier this month by Wipro’s institutional shareholders on its new CEO (appointment), reflects their dissatisfaction with the absence of be­nchmarks rather than the choice of the CEO.

To provide context, HSBC has 26 pa­ges of its annual report devoted to discu­ssions relating to compensation. Im­por­tantly, they have specified what they are measuring and the weightage, both quantitative and qualitative. PBT (10 per cent weightage), positive “jaws” (5 per cent), revenue growth (10 per cent), Ro­TE (5 per cent), strategic (30 per cent, accelerate re­venue growth from Asia, turnaround US business), and so on. On what parameters was the money paid, is also discussed. For example, one of the strategic objectives was deliver revenues from international business. The boards assessment: Revenue growth from international clients of 2.0 per cent was below the full-year target range of 3.5 to 7.5 per cent. This measure carried a 5 per cent weighting and has not resulted in any payout.

And this level of detail is not just for banks. Pick up the annual report of any widely institutionally held company, and you will see page after page discussing the salary for the CEO, executive mana­gement and even board about why it is paying itself what it is. And if global companies can do so, why can’t India Inc.?

What does this imply? First that the remuneration committee must be independent with appropriate industry kno­wledge and skills. There are far too ma­ny instances of family members sitting on these committees only to recuse themselves when a brother’s or a niece’s compensation is being discussed. Two, they need to articulate the rationale and benchmarks for determining the compensation structure, clearly and comprehensively. Obfuscation will not help. And three, investors need to demand more granular compensation information: for far too long they have meekly accepted the argument that disclosing performance parameters is akin to disclosing competitive strategy. Investors judge businesses on the trading floor — each nano-second should see value in better quality information. Their global peers ask for and receive this. They must also learn to differentiate between im­provement in performance and an in­crease in market capitalisation.

Compensation is payment for what has been done. Performance is about what has been achieved. Both can be me­asured. Surely, it cannot be so difficult to link the two and pay for the performance.

The author is with Institutional Investor Advisory Services, India. Views are personal 

Twitter: @AmitTandon_in