International Journal of Legal Studies and Research (IJLSR)
A RELOOK AT THE INCENTIVISATION PROSPECTS OF INDEPENDENT DIRECTORS IN INDIA Aratrika Chakraborty & Sukanya Bhattacharya1
Abstract Remuneration of non-executive members of the board has been an important part of corporate world discussions for quite a long time. The cardinality of this component for attracting efficient and eminent personalities to this post cannot be denied. The new Companies Bill, 2012 has restricted stock options as one of the means to remunerate the Independent Directors. The paper attempts to discuss the importance of incentives in appointing and retaining the Independent Directors to the board who are one of the bulwarks against corporate frauds and scam and further elucidates the viability of stock options as one of the remuneration forms. Some other types of remunerations have also been discussed with the respective advantages and disadvantages and lastly a suggestion of the remuneration pattern has been provided. KEY WORDS: Independent Director, Remuneration, Stock Option, Deferred Stock Units.
SCOPE OF THE PAPER Part I of the paper introduces the background of this topic. Part II of this paper discusses as to who are Independent Directors, their roles and liabilities. Part III mentions the present law with respect to remuneration of Independent Directors. Part IV enumerates the importance of suitable remuneration structure for the proper working of the Independent Directors thus furthering good corporate governance in the corporate world. The following part talks about the benefits and problems of stock options and other ways of remuneration. The paper concludes with a suggestion and a conclusion that a proper remuneration structure of Independent Directors including stock options cannot be done away with, as in its absence there can be a dearth of efficient and motivated Independent Directors.
1
Pursuing BPSc(Hons)LLB(Hons) [email id:
[email protected]] and BBA(Hons)LLB(Hons) [email id:
[email protected]] respectively, 4th yr, National Law University, Jodhpur.
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I. INTRODUCTION Due to a series of high profile scams both in India and abroad, the concept of Corporate Governance has gained a sudden importance. The post of an Independent Director being a sine qua non of good corporate governance has been scrutinized by the public and media time and again. In the aftermath of the Satyam Scandal, many of these Independent Directors resigned from their post. It was realized that the Independent Directors left their posts due to fear that they will also be liable for the acts of the company just like other directors even though they are not involved in the day to day affairs of the company and thus they faced a reputation risk as well. 2 This belief was further strengthened by the infamous Nimesh Kampani episode.3 These incidents posed a serious doubt as to the roles and extent of liability of Independent Directors. Clause 49 of the Listing Agreement4 governs the law relating to Independent Directors. However it was felt that with the change in the Indian Corporate scenario, the law also needs to be changed. Hence, the result of these scandals was the introduction of the new Companies Bill, 2012 by the Government. The need was felt to substantially tighten the corporate governance regulations and the provisions with respect to Independent Directors. Thus the new bill envisages a much bigger role of Independent Directors than what it was before. The Independent Directors after the passing of the bill will have substantial roles to play not only in the board room but also in the committees like the nomination and the remuneration committee. 5 However with the increased role, the remuneration of the Independent Directors has not been increased in the Companies Bill, 2012.6 In Clause 49 of the Listing Agreement, 2 percent or less than 2 percent of stock options was allowed as a form of remuneration.7 2
See, Vikramaditya S. Khanna and Shaun J. Mathew, Role of independent directors in controlled firms in India, NAT’L. L. SCH. OF INDIA REV. 22, P. 35 (2010) 3 See, Id ( Nimesh Kampani was an Independent Director in the board of Nagarjuna Finance from 1998 to 1999. The promoters and executives of Nagarjuna Finance were charged under the Andhra Pradesh Protection of Creditors Act as they failed to repay the depositors to the tune of Rs.100 crores during 2001-2002. The Government also charged Mr. Kampani even though he had left the board prior to any of the allegations.) 4 Clause 49(1) of the Listing Agreement of the Stock Exchanges 5 See, Clause 178(1) of the New Companies Bill, 2012 ( The Nomination and the Remuneration Committee shall consist of three or more directors out of which not less than half shall be Independent Directors. This Committee will work to frame the criterias of determining the qualification,, possible attributes, independence of a director and further recommend to the Board a policy to be adopted for the remuneration of key managerial personnel, directors and other employees) 6 Clause 149(9) of the New Companies Bill, 2012. 7 Clause 49(1)(A)(iii)(f) read along with Clause 49(1)(B) of the Listing Agreement
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With the increasing duties of an Independent Director, surprisingly more restrictions have been imposed on the remuneration pattern adopted by the companies by strictly prohibiting companies from paying the directors through stock options.8The strict approach has been followed because it is believed that remuneration through stock options will do away with the independence of the Independent Directors. This paper seeks to delve into the issue of importance of remuneration of the Independent Directors and how the lack of stock options will discourage new talent to join this post. II. Concept of Independent Director and its necessity in the present scenario In common parlance the expression “Independent Director” can be defined as a person who balances the interests of the various stakeholders of a company by providing an independent, unbiased judgment. The concept of Independent Director is not new. The idea of induction of non executive members to the board of directors was first propounded by the western nations in the 1950’s even before the legislations mandated the presence of non executive directors in the company to protect public interest. 9 However the specific concept of Independent Directors was introduced in the corporate governance framework in the 1970’s. The subsequent frauds of Maxwell communication and Bank of credit led to the formation of the Cadbury Committee in UK in 1992, which gave a detailed definition of an Independent Director and his role.10 The Cadbury Report defines ‘Independent Director’ as a person who apart from the director’s fees and shareholdings, should be independent of management and free from any business or other relationship, which could materially interfere with the exercise of his independent judgment.11 This report recommends that in the board majority of the directors should be independent. 12 The Hampel Committee of UK, 13 and the Blue Ribbons Committee of US, 14 8
Supra, Note 6 See, Krrishan Singhania, Dr. Olav Albuquerque and Darryl Paul Barretto, Independent Directors in Challenging Legal Scenario, (2013) 1 Comp LJ 10 Smiti Tewari, Evolution of Independent Directors in India, January 13, 2013, available at http.//www.jurisonline.in (Last visited on 22.6.2013) 11 Cadbury Committee, The Financial Aspects of Corporate Governance, available at http://www.ecgi.org/codes/documents/cadbury.pdf (Last visited on 20.6.2013) 12 Pg. 21, Para 4.12 of the Cadbury Committee Report 13 Hampel Committee, The Committee on Corporate Governance, Final Report, available at http:// http://www.ecgi.org/codes/documents/hampel.pdf (Last visited on 8.9.2013) 14 Blue Ribbon Committee, Report and Recommendations of the Blue Ribbon Committee on Improving the Effectiveness of Corporate Audit Commitees, available at 9
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further elucidated the concept of Independent Directors . After the corporate failures of WorldCom and Enron in US, the Sarbanes-Oxley Act was passed in 2002. The Sarbanes-Oxley Act defines the term ‘Independent Director’ as a member who other than in his capacity as a board member may not accept any consulting, advisory or other compensatory fee from the company or be an affiliated person of the company or any subsidiary thereof and other advisers, as the Act determines necessary to carry out his duties.15 The New York Stock Exchange Regulations further reiterates the importance of Independent Directors and demands that the majority of the board should comprise of Independent Directors and further all the important committees including the Audit Committee must consist only of Independent Directors. The concept of Independent Director is in fact quite new in India. The Indian Companies Act, 1956 does not differentiate between executive and non-executive directors; hence the act is silent about Independent Directors. It was only in 1998, the Confederation of Indian Industry first introduced this concept through its voluntary guidelines.16 The Report suggested that any listed company with a turnover of Rs. 100 crores and above should have professionally competent, independent, non-executive directors, who should constitute at least 30 percent of the board if the chairman of the company is a non-executive director or at least 50 percent of the board if the chairman and managing director is the same person. 17 The Kumar Mangalam Birla Committee later adopted this recommendation in their report. This committee was the first to define the term ‘Independent Director’ in India. The test to identify the independence of a director was laid down as to whether the person has any material pecuniary relationship with the company, which can hamper his independence. 18 However the discretion lies with the company to decide whether the pecuniary interest is material. SEBI formulated Clause 49 of the listing agreement based on these recommendations in the financial year 2000-2001 for Indian listed companies. In 2003, following the Narayan-Murthy Committee recommendations, Clause 49 was amended, and the present Clause 49 we
http://www.chugachelectric.com/pdfs/agenda/fcagenda_051403_ixd.pdf (Last visited on 8.9.2013) 15 Sarbanes-Oxley Act, 2002 available at http://www.sec.gov/about/laws/soa2002.pdf (Last visited on 20.6.2013) 16 Confederation of Indian Industries, Desirable Corporate Governance: A Code, 1998, available at www.nfcgindia.org/desirable_corporate_governance_cii.pdf. ( Last visited on 20.6.2013) 17 Id. 18 Securities Exchange Board of India, Report of the Kumar Mangalam Birla Committee on Corporate Governance, May 7, 1999, available at http://web.sebi. gov.in/commreport/corpgov.html.( Last visited on 25.6.2013)
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know about is the resulted amended form.19 The new Companies Bill, 2012 is based on the J. J Irani Committee Report published in 2004. The concept of Independent Director in the bill is significantly different from what is laid down in Clause 49. The most remarkable change in the definition of Independent Director has been observed in the bill, as it has replaced the phrase ‘no material pecuniary relationship’ with ‘any pecuniary relationship’.20 The presence of Independent Directors becomes imperative to ensure good corporate governance in a company. Corporate Governance is defined as the system of rules, practices and processes by which a company is directed and controlled.21 However it is not just a compilation of norms and procedures, it is the way in which companies conduct business. These norms embed the principles of transparency, ethics and accountability into the day to day operations.22 The shareholders are the owners of a company; however they do not run the company, rather they have entrusted the work of steering the company to the board of directors, who act as trustees of the shareholders. The Independent Directors of the board having no pecuniary interest with the company and its promoters other than their remuneration is believed to maintain transparency and accountability in the working, hence they act as forerunners of good corporate governance in the company. Thus lies the importance of the Independent Directors in a company with respect to corporate governance. Hence to ensure the presence of ethical conduct in the daily operations of the company, the Independent Directors have multiple roles to play. The Indian Companies Act does not specify the roles of an Independent Director; rather it provides the functions of the entire board of directors. Under section 291 of the Companies Act, board of directors is authorized to do what the company is authorized to do, unless barred by restrictions on their power by the provisions of the Companies Act.23
19
Securities and Exchange Board of India, Report of the SEBI Committee (N. R. Narayana Murthy) on Corporate Governance, February 8, 2003, available at http://www.sebi.gov.in/commreport/corpgov.pdf. ( Last visited on 21.6.2013) 20 Companies Bill, 2012, available at http://www.mca.gov.in/Ministry/pdf/The_Companies_Bill_2012.pdf (Last visited on 20.6.2013) 21 Definition of Corporate Governance, available at http://www.investopedia.com (Last visited on 24.6.2013) 22 Report by KPMG and the Associated Chambers of Commerce and Industry of India, Role of Independent Director ,Issues and Challenges, available at http://www.kpmg.com/IN/en/IssuesAndInsights/ThoughtLeadership/Role_of_Independent_ Directors.pdf (Last visited on 26. 06.2013) 23 S 291, the Indian Companies Act, 1956.
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In India, most of the companies are run by the controlling shareholders, thus the principle corporate law concern is that the controlling shareholder may be able to expropriate the assets of other shareholders or behave in some other opportunistic or non-value maximizing manner. 24 Thus the most important role of Independent Directors is to act as watchful monitors of promoters and management on behalf of the minority shareholders. Even though they do not have the voting power to stop these activities, he or she has the power to make public any wrongdoing.25 The role of Independent Directors are not only restricted to being watchdogs of the public shareholders, but they are also perceived as strategic advisors to the board. They enhance the firm value by providing their expertise and experience on the business matters before the board. Moreover in order to promote fair practices within the company, an Independent Director needs to identify the potential risks present in the various decisions of the company and also needs to check whether the internal control system is in place. Independent Directors also play a very important role when they serve on the audit committee. They keep a check and approve the accounts of the companies so as to avoid the frauds in case of collusion between management and the statutory auditors. 26 With the new Companies Bill, 2012 coming into picture, their role will be further increased, as now they will also be a part of the nomination and the remuneration committee. He also needs to make sure that the company is following all the required statutory compliances. And lastly just like the other members of the board, he needs to exercise independent judgment with due care and diligence which a reasonable person placed at his position is expected to do. Thus in short, they are expected to function as vigilant watchdogs, conscience-keepers of the boards, implementers of regulatory norms and protectors of the interests of minority shareholders as well as other stakeholders who are not represented in the corporate decision-making. 27 On perusal of various roles of an Independent Director we see that a mere attendance of them in a few meetings a year will not suffice, rather they need to be actively involved in the working of the company. Now we see that not only their roles are vigorous, but they also are liable for the acts of the company just like other members of the board. Under the Securities Contract (Regulation) Act, 1956, in certain situations the directors are criminally liable for violation of Clause 49. Even outside 24
Supra, Note 2 Id. 26 Supra, Note 9 27 Kamal Kishore and Srirang Jha, Efficacy of Independent Directors in Corporate Governance: Indian Scenario, Journal of Politics & Governance, Vol. 1, No. 2/3, September 2012 25
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the purview of Clause 49, there are other provisions which are specifically directed towards imposing liability on directors. SEBI makes the directors liable for fraudulent and unfair trade practices in securities under the Securities and Exchange Board of India (Prohibition of Fraudulent and Unfair Trade Practices Relating to Securities Market) Regulations, 2003.28 The Independent Directors can also be personally liable under Section 62 and 63 of the Companies Act, 1956 for misstatements in prospectus. Moreover the directors can be liable for breach of trust and cheating under the Indian Penal Code.29 With the increasing complexity of the functions being performed by the Independent Director along with the increased expectations of the shareholders and the stringent regulatory norms (further increased by the new Companies Bill, 2012) will impose a huge pressure on the Independent Directors. This increased burden implies much more time and energy of the director being spent on the board. Thus lies the important question of deciding the remuneration of the Independent Directors. As too high remuneration will do away with the independence of the directors and too low remuneration will discourage them to join the post, the fixations of the suitable remuneration for Independent Directors become a very important issue. In the following part, we will see the remuneration pattern as of provided now by the legislation. III. Present law related to the remuneration of Independent Directors Clause 49 of the Listing Agreement does not provide for the remuneration of Independent Director; however it says that he will be entitled to receive directorial remuneration. The Independent Directors are paid their remuneration in accordance with the provisions of the Companies Act, 1956. Section 309 of the Act says that any director (other than a whole time director or a managing director) can be paid remuneration only in the form of fees for attending board meeting and profit related commission. Moreover the commission paid to the non-executive director cannot exceed one percent of the net profit if the Company has Managing Director or Whole time Director, otherwise the limit is three percent. 30 Rule 10-B of Companies (Central Government) General Rules and Forms, 1956 provides that companies having a paid-up capital and free reserves of Rs. 10 crores or above, or companies having a turnover of Rs. 50 crores or above can pay sitting fees not exceeding Rs. 20,000 and other companies can pay sitting fees up to Rs. 10,000. 28
S. 4, Securities Contract (Regulation) Act, 1956 S. 406 and S.420 of Indian Penal Code, 1860. 30 S. 309, Companies Act, 1956 29
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Further, Clause 49 says that the Independent Director cannot be a substantial shareholder of the Company, i.e. holding two percent or more than two percent of the block of voting shares. Thus to sum up, the total remuneration paid to the Independent Director includes, the sitting fees, profit related commission and stock options. The new Companies Bill, 2012 has changed the remuneration structure to some extent. Clause 149 of the Bill, allows the sitting fees and the profit related commission but the commission is subjected to a certain limit as will be prescribed by the Central Government. The most striking change in the Bill is that, it totally prohibits the Independent Directors to acquire any stock option. IV. The impending threat of disincentives for Independent Directors The importance of Independent Directors for effective corporate governance assumes a pivotal role. The corporate governance structure hinges on Independent Directors who are supposed to bring objectivity to the oversight function of the board and improve its effectiveness.31 However, we need to contemplate on the point that hoping for a utopian scenario where eminent and knowledgeable personalities will contribute towards such a herculean responsibility just for the sake of moral standards and ethical contribution to the society. The practicality is that attractive remuneration is indispensable to attract competent Independent Directors. The entire framework of the present and prospective legislation is to ensure the independence of the directors but restricting the compensation to solely cash -based is not the only way to achieve this. Entirely ousting them from equity ownership may not be a viable option. The path adopted should be to balance the necessities of these Independent Directors with the interest of the investors and shareholders. Independent Directors acting in their own interests will inadvertently also maximize the interests of the shareholders and would be more motivated to endorse value adding strategies.32 Absentee Independent Directors have already been a matter of concern and are a harbinger of the declining involvement in their responsibilities. Often the Independent Directors are eminent personalities who are associated with numerous other responsibilities. There are recent data showing a dismal attendance of even 1 out of 14 board meetings in 3 years in some well31
Ernst and Young, Corporate governance: Role of independent directors, available at http://www.ey.com/IN/en/Services/Assurance/Fraud-Investigation---DisputeServices/Corporate-governance--role-of-independent-directors ( Last visited on 26.06.2013) 32 Nithya Narayanan and Manali Gogate, Skin in the game : A case for incentivising Independent Directors, Journal on Governance, Vol. 1 No. 6, 2012
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known companies. 33 Moreover there are general studies showing an inadequacy in the number of Independent Directors in the market. PostSatyam scam, over 2,000 Independent Directors had resigned from the posts. It is learnt that India needs at least 30,000 Independent Directors to fill the statutory positions in publicly listed companies.34 With all these problems already at hand, sticking to strictly cash based compensation can act as an impediment in the proper recruitment of these directors. The proposed bill as well as SEBI’s consultative paper made in tandem with the bill has done away with ESOPS and limited the number of companies on which they can serve as Independent Directors to 10. The main idea behind doing away with the stock options is to ensure that there is no conflict of interest but this may not be the ultimate picture. Stock options essentially mean the "right", but not the "obligation", to buy or sell shares of a stock at a "set price" on or before a given "date". This is usually at a discounted price than that of the market value of shares at the time of grant. The Securities and Exchange Board of India (Employee Stock Option Scheme and Employee Stock Purchase Scheme) Guidelines, 1999 (‘SEBI Guidelines’) defines “employee stock option” as the 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. ESOPs are also defined in the Companies Act. 35 In view of Clause 4 of the SEBI Guidelines, as long as the non- whole-time director is not a promoter or does not belong to the promoter group or who, by himself, or through his relative or through any, body corporate, directly or indirectly, does not hold more than 10% of the equity shares of the company, such a non-whole-time director being an employee within the meaning of the ESOP guidelines shall be eligible to participate in the stock option scheme of the company.36
33
See, CNBC-TV18,India Inc's Absentee Independent Directors, September 15, 2011, available at http://thefirm.moneycontrol.com/story_page.php?autono=758187 (Lat visited on 26.06.2013) 34 Business world, Independent Directors May Have To Pay Service Tax Soon , 1st August 2012 ,available at: http://www.businessworld.in/en/storypage/-/bw/independent-directorsmay-have-to-pay-service-tax-soon/r441866.0/page/0#sthash.YzEOpp2W.dpuf (Last visited on 24.06.2013) 35
S. 2(15A), the Companies Act, 1956. LVV Iyer, Some Work & Some Pay, May 17, 2003,available http://articles.economictimes.indiatimes.com/2003-05-17/news/27524928_1_esopguidelines-employee-stock-option-scheme-companies-act (Last visited on 26. 06.2013) 36
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The stock options can actually be an effective way to retain the competent IDs and act as a major incentive for them; what is required is a limitation not prohibition altogether. Anandorup Ghose, head (executive compensation & governance) of Aon Hewitt says that globally at least 25% of the compensation is allocated to stock based compensation.37 When we talk of independence, achieving it through legislature is indeed a necessary condition but the sufficiency lies in the mentality of the person involved. It would be wrong to say that stock options would curtail the independence; what is required, is to develop a holistic environment that ensures such independence. In such a scenario where it’s a budding or incipient corporation, alternative means of remuneration is a must because it is not possible to have an adequate cash base right from the beginning. Apart from ESOPS, Deferred stock units (DSUs) are also gaining popularity which will be discussed in the next chapter.Moreover, the major impact will be on smaller companies. Big corporations already have the required base and infrastructure. But more incentives are required for small firms. The adequacy of the remuneration is indeed judicious issue- ensuring the sufficiency as well as the non- excessiveness. Doing away entirely with stock options would have a significant impact on some prominent companies. For the financial year 2012, ITC issued 10,000 stock options each to 5 of its Independent Directors. Other major companies that have issued stock options to Independent Directors in the recent past include L& T , Dr. Reddy’s ,HDFC, M& M. 38 Since neither the Companies Act 1956 nor the SEBI’s stock option plan guidelines as of now altogether eliminate the granting of stock options, the new proposed law can prove to be a drastic step. V. Some alternative forms of remuneration and their viability in the present scenario. According to the bill, Independent Directors wouldn’t be entitled to any remuneration other than sitting fees, re-imbursement of expenses for
37
Business Standard SEBI may make independent director post unattractive, Wednesday, June 12, 2013, available at http://www.business-standard.com/article/companies/sebi-maymake-independent-director-post-unattractive-113011300071_1.html (Last visited on 26. 06.2013) 38 See, Business Standard, No 'options' left for independent directors on companies' boards, Wednesday, June 26, 2013, available at http://www.businessstandard.com/article/markets/no-options-left-for-independent-directors-on-companiesboards-112122300068_1.html(Last visited on 26. 06.2013)
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participation in board meetings as well as other meetings and profit related commission as may be approved by the members. The existing law as of now does not prohibit Independent Directors from holding stock options but whether stock options should be ideally given to the Independent Directors has been a matter of debate for a long time. Various countries (US, UK, Canada, Australia, Singapore, and Hong Kong to name a few) do not prohibit stock options for Independent Directors. Considering that stock options are growing in popularity, it may be more relevant to place restrictions either on the total amount of options or on the manner in which these options are exercised (stock options exercised and converted to shares by an Independent Director may not be sold for a certain predetermined period after exiting from the board) instead of completely prohibiting stock options.39 Stock options can ensure greater involvement but the flip side of the coin is also that the moment you link performance of the company to the interest of the director there arise a situation where their decisions would suffer from lack of independence as they become an interested party. There could be several problems associated with stock options and it may not be in the best interest of shareholders as the Independent Directors will not suffer any loss, even if price of the shares fall as they don’t buy these shares. But shareholders would suffer. Thus there is no commercial downside for directors with stock options; In other words the directors and shareholders win together but do not lose together. 40 However since shareholders approval of ESOPS are require by a special resolution and since Independent Directors have to make proper disclosure about their shareholding as per SEBI regulations, there can be a framework by which shareholders’ democracy can work in tandem with the adequate independence and incentive for Independent Directors. Because of asymmetry in shareholders and directors benefit from stock options as discussed above, DSUs can be another form of viable of incentive. DSUs are a type of stock grant. Unlike stock options, stock grants result in a change of directors and shareholders wealth in the same direction. DSUs are gaining huge popularity in several US and Canadian corporations. DSUs in essence entitle directors to stock appreciation rights in the future41.and this right is usually subject to vesting. As a long term incentive mechanism it fares most favorably on the performance sensitivity i.e. link between a 39
Supra, Note 23 Supra, Note 33 41 Shamsud D. Chowdhury, Director Compensation: The Growing Popularity of Deferred Stock Units,Ivey Business Journal (January/February 2009),available at http://www.iveybusinessjournal.com/topics/leadership/director-compensation-the-growingpopularity-of-deferred-stock-units( Last visited on 24.06.2013) 40
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director’s performance and compensation and interest alignment of share holders and director, because DSUs tie the directors’ and share holders’ wealth equally 42 . However the associated costs with DSUs can be much more as compared to stock options. DSUs are actually less tax- efficient than ‘Restricted Shares’. The practice of restricted shares is also prevalent in Canada and because of greater tax efficiency same net remuneration can be given by the corporation at a substantially reduced cost. While all income received under a DSU programme is tax deferred until eventually paid out, all is taxed at full employment income rates upon receipt. In contrast, while restricted shares are taxed upon grant, all increases in share value from the point until the time of disposal are taxed at half the rate applicable to DSUs because they constitute capital gains43. Apart from these kinds of incentives, indirect compensation like retirement pension plans or additional incentives based on performance or some pre defined criterion such as a substantial contribution to the corporation could also encourage more professionals opting for Independent Directorship. Keeping in mind the persistent problem of absenteeism as discussed above a good performance based incentive could be linked with the attendance in board meetings. Since the advice and suggestions provided by the Independent Directors are very valuable to the company such attendance norms for incentives would ensure a greater participation from their part as well as benefit to the companies. VI. Some suggestions on remuneration policies In the previous parts of this paper the extensive duties and vigorous liabilities of the Independent Directors have been discussed. In the context of the various duties and liabilities, the importance of an Independent Director’s remuneration has been understood. Thus on the basis of the present provisions of law and the changing corporate environment, the following suggestion is being given. First of all, the remuneration structure should be composed of both fixed and variable pay. A fixed pay pattern only, will not pose sufficient challenge to the Independent Director to perform well. In the absence of variable pay, the Independent Director will agree to all the board decisions and the consent of an Independent Director will turn out to be a mere rubberstamp. 42
Id PWC, Rick Schubert and Chris D'Iorio, Companies can reduce compensation costs by switching from deferred share units (DSUs) to Restricted Shares, available at http://www.pwc.com/ca/en/directorconnect/directors-remuneration.jhtml, ( Last visited on 24.06.2013)
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Moreover new talents in the corporate world will not be attracted towards this post as performance of an individual will not be recognized if all of them are only paid a fixed amount as remuneration. Hence in structuring the remuneration pattern special focus should be given to the variable part of the pay. The variable part of the remuneration should be attractive enough to lessen the steep demand of new Independent Directors in the corporate world. Thus we suggest that around 60 percent of the pay should be fixed, with the rest of the remuneration being variable in nature.44 Now the variable part of the pay should be a combination of various types of incentives. The UK Corporate Governance Code suggests that the amount of remuneration should reflect the responsibilities and time commitment of the Independent Director. It is indeed a viable option which can be adopted in the Indian scenario as well. Thus some part of the variable pay can be incentives for the number of board meetings attended by the Independent Director and the extent of responsibilities handled by him. This means the extent of strategic advices given by the Independent Director to the board, the other roles performed by him diligently will be some factors of determining his variable remuneration. If he is a member of some committee the pay will vary in accordance with that. Thus the roles played, responsibilities undertaken by him in each of those committees, the number of meetings of that committee attended by him, he being chairman of that committee will be taken into consideration by the independent body who decides upon the remuneration of non-executive directors. The concept of stock options has already being discussed previously in this paper. It has been seen that stock options ensure an increased involvement of the Independent Directors towards the welfare of the company. Thus within the variable pay construct, stock options can be a way of incentivizing the Independent Directors. Globally also, the remuneration of Independent Directors is a highly debated topic. In US, the Dodd-Frank Wall Street Reform and the Consumer Protection Act have been introduced, which have mandated shareholder’s vote on executive compensation. 45 Even the UK Corporate Governance Code has suggested that previous approval of the shareholders should be taken in case of stock options. Rather than putting a maximum cap on the stock option to be granted to the Independent Directors, it will be much more convenient if the shareholders of the Company decide the extent of granting stock options to the directors. However stock options are not hassle free, it has some disadvantages too. Thus the variable pay rather than restricting itself to only stock options should comprise of other pay options 44 45
Supra, note 23 ( Countries like France, Germany have less than 60 percent as fixed pay) Id.
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as well. As discussed above Deferred Stock Units (DSUs) and Restricted Shares are free from many of the disadvantages stock options face; hence they can be adopted as a means of remuneration along with conventional stock options. Above all remuneration payable to Independent Directors cannot be the same for all the Companies and should vary depending on the net-worth and turnovers of the company. Therefore, a remuneration matrix must be developed by the regulators wherein the range of allowed remuneration for Independent Directors should be specified depending on the net-worth and turnover of the company.46 So what we propose is that the variable component be a combination of stock options which can also be in the form of restricted shares and DSUs; performance related commission linked to meeting attendance, contribution in board meetings, ability to stay abreast of industry and company developments and performance as measured by objective board evaluations47 and profit related commission as given in the companies bill; and the whole package should depend on the net turnover of the company. This structure will give much more margin of appreciation to the companies and keeping shareholders’ democracy in mind the entire policy should be approved by the majority of shareholders. At present Remuneration committee is not a mandatory requirement under the Clause 49 in India. A Remuneration Committee should be made as a mandatory requirement with clear terms of reference to determine the compensation of senior officers and directors including Independent Directors. Non-executive directors should not be over compensated to the extent that their independence may be compromised. The remuneration of non-executive directors should be appropriate to the level of contribution, taking into account factors such as effort and time spent and responsibilities of directors. Any remuneration in addition to the sitting fees for attending board meetings within the stipulated caps should be carefully reviewed by the remuneration committee.48 The pension incentives which we have discussed earlier can also be a good move but it also has its own restrictions as of now because the Indian economic scenario is not that efficient for social security benefits especially
46
Frontiers of Corporate Governance: Companies Bill, 2012 ,available at http://www.moneycontrol.com/news_html_files/news_attachment/2012/Frontiers%20of%2 0Corporate%20Governance%20-%20Companies%20Bill%202012.pdf ( Last visited on 22.06.2013) 47 Supra, Note 23 48 IAP Comment Letter to SEBI, available at: http://www.cfasociety.org/india/Submission/IAIP%20Comment%20Letter%20to%20SEBI %20%20Review%20of%20Corporate%20Governance%20Norms%20Jan%202013%20.pdf (Last visited on 26.06.2013)
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for small enterprises. So the viability of this kind of incentives has to be still explored in the coming times. VII. Conclusion In conclusion we can say that all the slew of proposals made by the upcoming bill as well as SEBI’s proposals though aim at making the corporate field a safer place with stringent corporate governance rules and additional norms incentives do play a noteworthy role as far as those persons are concerned who are the persons responsible for being the watch guard of these corporate governance norms. Legislation is well desired but there should also be a proper leeway far the corporations so that they can decide the remuneration policies and have adequate independence to decide how to entice and retain their Independent Directors. We have concentrated more on the importance of stock options because as we have discussed above, this has been a convention practiced in many countries as well as in our country. Suddenly taking away that margin could also have negative repercussions which may not be at all desirable. We can restrict and make norms for regulating the adequacy and pattern of the incentives but altogether abolishing a long practiced convention; this is something which needs a second thought. If we come across a dearth in responsible persons wanting to take such enhanced duties and responsibilities of an Independent Director there could be a persistent problem of deterioration of corporate governance. In the prevailing era where the Indian economy is slowly but surely integrating with the global economy, the first hundred companies in India cannot ignore the need for globalize and global reach. It is true that business families today own quite a few of first hundred companies in India predominantly. It is not an exaggeration to say that such companies would have to grow at an exponential rate in order to acquire global size and reach. For an exponential growth rate for such companies the capital requirements would be beyond the reach of the controlling families. Such companies would have to access necessarily both domestic and global capital markets for their capital needs. This can be done well only if the governance standards are quite high with very competent Independent Directors providing the much needed reassurance of the same.49Independent Directors also bring in the much needed professional expertise since they are individuals with wide experience in running companies as well as the fact
49
L.VV.Iyer, The Institution Of Independent directors :Some Thoughts, available at http://www.icsi.edu/docs/WebModules/Programmes/CGAward/2005/3lviyer9-11.pdf (Last visited on 20.06.2013)
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that they sit on the boards of other companies which means that they are abreast of the latest happenings.50 Following a balance of proper training, accountability and incentivisation is the need of the hour. As an effort is being taken to demarcate the roles, responsibilities and liabilities as well as formal training for Independent Directors as envisaged in the Companies bill as well as SEBI’s proposed amendment to the listing agreement, 51 equally effort should be taken to provide proper and sufficient financial motivation to incorporate and retain them in the companies. The Independent Directors to the board are one of the bulwarks against corporate frauds and scams and in the present times when there is a lot of growing volatility and uncertainty among the capital market, if India is to become a key player in the corporate world then they assume a massive role. Keeping this in mind adopting a strictly cash based compensation for Independent Directors which is very much limited by legislation may pose an upcoming danger of tinkering with this indispensable institution.
50
The Role of the Independent Directors, available at http://www.managementstudyguide.com/role-of-independent-directors.htm (Last visited on 26.06.2013) 51 The Indian Institute of Corporate Affairs is developing a orientation programme aimed at sensitizing independent directors about their significant role in the decision making of companies. The move comes against the backdrop of the new Companies Bill. See , The Economic times, IICA plans orientation course for independent directors, , May 1, 2013 available at http://articles.economictimes.indiatimes.com/2013-0501/news/38958054_1_independent-directors-orientation-programme-corporate-affairsministry(Last visited on 20.06.2013)
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