Is the company management eating away your share of profit?

Remember the chief of Goldman Sachs proclaiming to be doing God's work in 2009? This was just before the top brass of the investment bank drew flak for taking home obscene salaries.

When the going is good, no one bothers about the ills draining the resources of an entity. It is only when the tide turns that the change of fortunes become more apparent. Hardly ever before 2008 did hefty management compensation draw as much attention amongst shareholders and investors. It was only once the profits dried up that the salaries seemed to be at odds with the poor financial performance of the entity. The hefty bonuses paid for transactions entered into did nothing to reduce the ultimate losses in the client's portfolio. And that triggered the agony amongst shareholders too who found unworthy managements cornering disproportionate share of profits.

B Ramalinga Raju of Satyam Computers took home a stunning Rs 10.4 million in FY08, before he declared that the financial statements of the company were cooked up. Although this was less than 1% of the company's ‘reported profits' for the financial year, what followed left not just its shareholders but also employees an insecure lot. Vijay Mallya's remuneration in FY11 was not of the kind that would raise eye brows. However, Kingfisher Airline's salary deprived employees today wonder if they could get a hint of the coming financial distress from the management's remuneration. As per an article in Business Today, more than 800 corporate executives from 4,500 listed companies took home at least 8 figure salaries as early as 2010. The number has only multiplied since then. The average share of director remuneration to net profits was 4.1% for the companies forming part of BSE-500 in FY11. However, there were around 30 companies where the director remunerations exceeded 10% of profits! Also the average annual growth in managerial remuneration for BSE 200 companies has topped the growth in their profits over the past 5 years!

Disproportionate pay to top management, especially directors, could not just hinder the company's cash flow and working capital. It could also mean compromise on research and development efforts, marketing efforts and ad spends or technology initiatives. For firms that pay put bonuses based on expected profits, doing so before the profits are booked could be an impudent move.

That is the reason why it is important to not miss the disclosures on remuneration paid to the directors and top management of a company offered in its annual report. Comparison of the share of the same to net profits with the past financial track record, as well as to that of peers could give a fair idea of compensation policies. Missing this important disclosure while browsing through the annual report, could deprive you of an important cue that can help in judging the management.

Thus along with related party disclosures, the disclosures on management remuneration are as worthy of your attention for a through appraisal of a stock. We will bring to your notice more such pertinent disclosures in the subsequent articles, that will help you screen companies and look beyond the obvious.

Equitymaster.com