Should top honchos be paid a commission on corporate profits? Not that it is really on offer. But hypothetically speaking, what would it take for a professional manager to volunteer to take up the job of CEO at Tata Sons and, by extension, the right of managerial oversight of all of the Tata Group companies?
Most would, perhaps, do it for free besides giving the metaphorical arm and a leg. The prestige and the sense of professional satisfaction that goes with the job is such that one can safely predict such an outcome.
Saga of the remuneration
As it happens, Cyrus Mistry, CEO of Tata Sons, which earned a record profit of ₹9,062 crore in fiscal 2015, was paid ₹11 crore as commission on profits of the company (0.10 per cent of profits), besides receiving ₹5 crore as salary. This was reported by a business daily the other day.
The report goes on to mention the salary and commissions earned by the CEOs of some other leading corporates listed on the Indian stock market.
Critics may carp at the substantial family stake in these companies that puts the CEOs in a vantage position in securing these compensation packages. But let it also be said that each of them is professionally qualified and comes with a lot of work experience. They perhaps deserve every rupee they earn.
But a striking feature of the remuneration of the companies mentioned in that story — and indeed, which could be said of many other companies in the listed corporate landscape — is this: A big chunk of their managerial remuneration is composed of a variable component, linked as it is to profits that the company earned in a financial year.
Kumar Mangalam Birla, for instance, earned his remuneration entirely as a percentage of profits. The Munjal brothers earned between eight and ten times their basic salary as commission on profits. For Onkar Kanwar of Apollo Tyres, it was roughly three times.
What it could mean
By structuring the managerial remuneration with a variable component, companies are effectively saying this: We just don’t know if you would be putting in your best after being appointed as the CEO of the company. To safeguard the firm’s interests, we are willing to offer a share of the profits which reflects your efforts on behalf of the company.
But there’s a problem with this line of of reasoning — by saying thus, the Board of Directors are implying that the number one employee of the company is not the most motivated individual in the organisation! Nothing can be more absurd. John Cryan, the joint CEO of Deutsche Bank, confessed some months ago in an interview to a news agency, that he doesn’t know why there is a variable component to his pay structure. He reiterated that he wouldn’t work any less or more because there is a reward in the form of a share of the bank profits. You can read the article here .
He has a point. Choosing the right man for the job also involves choosing a person with not just the talent and the requisite skill-set for the job but also commitment and devotion to the task at hand. Given that premise, it does seem odd that a fair and just remuneration for the job of a CEO should be embellished by a variable pay component linked to the performance of a company.
The only circumstance under which such a structure makes sense is where the Board doesn’t quite know what the CEO is actually worth and it would rather wait to see what the results of the company’s operations reveal later on, before coming to a conclusion.
If history has taught us anything…
The global financial crisis painfully brought home the truth that variable pay, far from incentivising people to scale newer heights of corporate excellence, actually sets their organisations on the path of ruin. Not surprisingly, then, questions are being raised about the wisdom of such a practice.
The latest to join the debate on the absurdity of a variable pay that is many multiples of the basic pay, is the Harvard Business Review .
A blog post on the journal’s website says that variable pay makes sense only when the task is repetitive and the relationship between input and output is evident. Where the focus is on creativity and continuous learning, an emphasis on performance-related compensation can be counterproductive.
For instance, a bricklayer can be compensated with variable pay if the output, measured as the length and the height of the wall constructed, is superior to some normative value of output. But CEO compensation is a different matter altogether.
No doubt, he does have responsibility for an objectively verifiable outcome (return on investment in the business). But the things that he must do in order to achieve that outcome can never be standardised and, even if they can be, can never be valid for all situations and at all other times.
The reasons
How did the world of business end up with a belief in variable pay as part of the top management compensation structure? Two reasons can be cited, of which one is peculiar to the Indian situation.
~ Reason one
Indian businesses were managed by entities under a system known as ‘managing agency’. These agencies were usually controlled by business houses such as the Tatas or the Birlas, and were appointed to manage the businesses promoted by these entities. On paper, they operated under the superintendence and direction of the Board of Directors of individual companies.
In practice, however, managing agencies could leverage better their connections and family networks as well as the brand equity of the promoter family to deliver higher returns than a Board-managed business could.
In one sense, they were under the control and oversight of the Board but functioned largely as autonomous entities. Even the notion that its services could be terminated was largely mythical as the majority stake held by the promoters precluded such a possibility. They were, thus, remunerated at a percentage of the profits of the company.
The managing agency system was abolished by law. But CEO pay, which in a way is a proxy for the managing agency system, retained the principle of remuneration as a percentage of profits.
~ Reason two
The second reason why variable pay came to be recognised as a standard feature of top management compensation, is rooted in the principle of separation of ownership and management of large corporations. Management literature of the 1960s and 1970s speculated on the possibility that the agenda of professional managers could be at variance with the long-term interests of the owners. This was referred to as the ‘Agency Cost’ problem.
Academicians in the management discipline argued that this problem could be handled by aligning CEO compensation to the profits of the firm. Thus was born the concept of variable pay, which has taken a form and shape out of all proportions to what its original proponents had envisaged. The 2008 global financial crisis clearly showed that variable pay does not guarantee prudent behaviour on the part of the top management.
So, looks like it's back to the drawing board to design the ideal compensation structure for top management.