How CEO stock awards can push pay beyond Companies Act limits

CEO salaries may not have changed, but stock awards can still push total pay above legal limits. Here's how the Companies Act regulates executive remuneration

Several listed IT companies are approaching shareholders to approve a higher ceiling on chief executive officer (CEO) remuneration, even though they are not increasing fixed salaries. The trigger is long-term stock awards granted years ago that are now being exercised, pushing total remuneration above the limit prescribed under the Companies Act, 2013.

 

The issue made headlines after Mphasis sought shareholder approval to raise the remuneration ceiling for its CEO Nitin Rakesh, from 5 per cent to 7 per cent of the company's net profits.

 

Persistent Systems had earlier sought shareholder approval to increase the limit for CEO Sandeep Kalra to 21 per cent of net profits. In both cases, the companies said the proposals were driven by stock-based compensation rather than an increase in annual salary, a Mint report said.

What does Section 197 of the Companies Act say?

Section 197 of the Companies Act, 2013 governs managerial remuneration in public companies. It states that the total remuneration payable to directors, including the managing director, whole-time director and manager, in a financial year cannot exceed 11 per cent of the company's net profits, calculated in accordance with Section 198 of the Act.

 

Within this overall limit, the remuneration payable to any one managing director, whole-time director or manager cannot exceed 5 per cent of the company's net profits unless shareholders approve a higher amount through a special resolution. If there is more than one managing or whole-time director, their combined remuneration cannot exceed 10 per cent of net profits without shareholder approval.

Why is CEO pay linked to net profits?

The Companies Act links managerial remuneration to a company's profitability by prescribing the ceiling as a percentage of net profits. These profits are calculated using the method laid down under Section 198, which specifies what should and should not be included while computing net profits for remuneration purposes.

 

This means the permissible remuneration changes with the company's profits rather than being a fixed monetary limit.

How do ESOPs and stock awards push remuneration above the cap?

Technology companies usually compensate senior executives through a mix of salary, bonuses and long-term stock incentives such as employee stock options (ESOPs) and restricted stock units (RSUs).

 

These stock awards are often granted over several years but vest at a later date. If multiple grants are exercised or become payable in the same financial year, their value is recognised as part of the executive's remuneration for that year. As a result, total remuneration can exceed the statutory ceiling even when there is no increase in fixed salary.

 

According to Mint, Mphasis told shareholders that stock options and restricted stock units granted across different financial years could, if exercised in the same year, increase the perquisite value enough to take the CEO's remuneration above the 5 per cent limit.

Why do companies need shareholder approval even without a salary hike?

The Companies Act regulates total managerial remuneration, not just annual salary.

 

This means that if the value of exercised stock awards takes a CEO's overall remuneration beyond the prescribed limit, the company must obtain shareholder approval even if there has been no change in salary, target bonus or fresh stock grants.

 

Mphasis told shareholders that its proposal does not involve any increase in the CEO's annual salary or target bonus, nor does it seek approval for any new ESOP or restricted stock unit grants. Instead, the approval is intended to address situations where stock awards accumulated over several years are exercised in a single financial year, Mint reported.

Does this provision apply to all companies?

No. Section 197 specifically applies to public companies. It governs the remuneration payable by a public company to its directors, including the managing director, whole-time director and manager.

Why more technology companies could face this issue

Long-term equity compensation is common across the technology sector. Senior executives often receive stock awards that vest over several years instead of immediate cash payouts.

 

As these awards mature, particularly after strong gains in share prices, the value recognised in a single financial year can rise sharply. That increases the possibility of total remuneration crossing the statutory ceiling, which requires companies to seek shareholder approval even if executive salaries remain unchanged.

 

The issue is therefore likely to become more common among technology companies where stock-based compensation forms a major part of executive pay.