Managerial remuneration, more specifically compensation packages of certain top bosses of Corporate India, has drawn the ire of shareholders in recent months. The most recent instance was a proposed 10% increase in the remuneration of Eicher Motors managing director Siddhartha Lal. The plan failed to get the required votes, particularly from institutional shareholders, forcing the board to rework the proposal.
Shareholders were irked by the proposal given that the company’s profits had contracted in 2020-21, and the median rise in salaries of employees was about 1%. Had the economic situation been different and the Covid19 pandemic not happened, shareholders might have cleared the proposal.After all, profitable companies have a lot of flexibility in setting remunerations of the top management under the Companies Act, 2013.
Eicher Motors was not the only company that approached shareholders for approval to increase remuneration paid to executive directors in recent months. Companies such as Bajaj Auto, Hero MotorCorp, Tata Motors and Apollo Tyres have also done so. Incidentally, many of the directors who would have benefitted from higher pay belong to promoter groups.
The proposals for higher managerial remuneration mostly comply with the provisions of the Companies Act, 2013. The problem lies outside the Act – a rise of inequality in the corporate remuneration structures. Workers at the lower levels of corporate echelons earn only a fraction of what the top management receives.
If you are wondering what is the fuss about, here is a primer to help you understand the issue.
What do the rules say?
The Companies Act has prescribed ceilings on remuneration paid to directors by public companies. The caps on managerial remuneration for companies making adequate profits are different from those that do not. Profitable public companies can use 11% of their net profits to pay executive and non-executive directors. If the profits are not adequate, directors are to be paid the amounts prescribed in the Act. Net profits for determining managerial remuneration are to be calculated in a manner specified in the Act.
Companies are allowed to pay more than the prescribed ceilings after obtaining the consent of shareholders through voting on a special resolution. Shareholders got the power to decide on managerial remuneration in September 2018 after the Union government amended Schedule V of the Companies Act. Until then, companies required the Union government’s approval to increase managerial pay beyond the ceilings. Companies do not need to do that any longer.
What about Eicher Motors?
In the specific case of Eicher Motors, the remuneration of the managing director was a little over 1.04% of the profits in 2020-21, according to a company statement on August 23. That is lower than the 5% of net profits cap allowed as remuneration of a managing director or a whole-time director of a company by the Act. The company had an internal cap of 3% of net profits for managing director’s pay. The Eicher board has now proposed a revised remuneration structure with a maximum cap of 1.5% of profits, the same statement added.
The Companies Act requires profitable public companies that pay 11% of their profits as remuneration to their directors in a financial year to adhere to some sub-caps within this overall limit.Thus, the remuneration of a single managing director, whole-time director and top management executive cannot exceed 5% of net profits. If the company has more than one managing director, whole-time director or top management executive, their remuneration cannot collectively exceed 10%.
The remuneration package of all non-executive directors cannot exceed 1% if the company has a managing director or a whole-time director. If a company does not have a managing director and a whole-time director at any time, remuneration paid to other directors can go up to 3% of net profits.
What happens when companies do not make good profits or make a loss?
If a public company does not make adequate profits or runs a loss during a period, managerial remuneration has to be calculated differently. It has to be linked to the effective capital of that company. The company can revert to paying a percentage of net profits as remuneration when it becomes profitable.
The managerial remuneration that loss-making companies can pay is prescribed in Schedule V of the Companies Act of 2013. Such companies have been categorised into four slabs. In the first slab are companies that have negative to Rs 5 crore as effective capital. In the fourth slab are companies with effective capital of Rs 250 crore or more.
Companies in the first slab can pay up to Rs 60 lakh as annual remuneration to their managing directors and whole-time directors and up to Rs 12 lakh to non-executive directors. Companies in the fourth slab can pay up to Rs 1.2 crore annually to managing directors and whole-time directors and Rs 24 lakh to non-executive directors. If the effective capital exceeds Rs 250 crore, remuneration equivalent to 0.01% of the effective capital above Rs 250 crore is also to be paid.
If the company desires to pay more, it will need to get shareholders’ approval through a special resolution.Effective capital is the aggregate of paid-up share capital, the amount in share premium account, reserves and surplus, long-term loans and deposits repayable after one year as reduced by the aggregate of any investments, accumulated losses and preliminary expenses not written off.