Independence of remuneration committee & executive remuneration in India.

AuthorKang, Lakhwinder Singh
PositionReport - Statistical data

The present study explores the impact of independence of remuneration committee on the remuneration of executive directors in a sample of 51 listed companies in India for a period from 2003 to 2012. In companies having fully independent remuneration committees and independent chairmen, a negative impact of accounting performance has been found on the executive remuneration. However, results reveal a positive and significant impact of market performance on the executive remuneration. In the presence of an independent chairman of remuneration committee, promoters' shareholding has been observed negatively related with the executive remuneration. These findings can be useful for the regulatory authorities in framing and improving norms regarding the determination of executive remuneration.


The debate about executive remuneration has focused on three elements: structure, governance and disclosure (Ferrarini et al., 2003). Any governance mechanism designed to regulate executive remuneration should ensure the coverage of all these elements. The regulation should increase the possibility that the remuneration setting maximizes shareholder interests and does not become a skimming process in which the board is captured by management. In Anglo-American corporate governance, two devices have been developed to reduce the risk of a board's capture: the appointment of independent directors to the board and the creation of a remuneration committee consisting of non-executive/independent directors (Ferrarini et al., 2003). For efficient regulation, corporate governance codes have been introduced by almost all the countries in the recent past. For instance, the Combined Code on Corporate Governance, 2003 (UK); NYSE Listing Standards, 2004 (USA); Code of Corporate Governance, 2005 (Singapore); and Since 2003, ASX Corporate Governance Council (Australia) have been developing and re leasing recommendations on the corporate governance practices to be adopted by the listed entities.

In its effort to match with international best practices and improve the effectiveness of corporate boards and its committees, the Securities and Exchange Board of India (SEBI) has also introduced regulations. Since the notification of the Clause 49 on February 21, 2000, corporate governance regulations in India have rapidly evolved. Following the enactment of the Companies Act, 2013, the updated version of CL49 was notified on April 17, 2014. Based on the industry response, some provisions in CL49 were amended and the SEBI (Listing Obligations & Disclosure Requirements) Regulations were notified on September 2, 2015 (Sarkar, 2015). Clause 49 states that the board may set up a remuneration committee to determine on their behalf and on behalf of the shareholders with agreed terms of reference, the company's policy on specific remuneration packages for executive directors including pension rights and any compensation payment. The formation of remuneration committee was non-mandatory till 2013, but the Companies Act 2013 made it mandatory to have nomination and remuneration committee consisting of three or more non-executive directors, out of which not less than one-half shall be independent directors. As the remuneration committee is responsible for fixation of remuneration of the executive directors, it is important to examine the role of remuneration committee in setting pay of directors. The present paper attempts to examine the impact of independence of remuneration committee in determining the remuneration of executive directors of the listed companies in India. It also studies how the independence of remuneration committee affects the relationship of company performance, promoters' shareholding, and ownership concentration with the executive remuneration.

Review of Literature

The impact of presence or absence of the remuneration committee on the pay packages of CEOs and directors has been examined by only a few researchers. For example, Conyon (1997) reported that in United Kingdom, during the period 1988-1993, the directors' compensation in companies having remuneration committees grew at 2.6 per cent lower than the compensation of directors of companies without remuneration committees. But the presence of remuneration committee had not been found having any significant influence on the relationship between executive compensation and corporate performance. Benito and Conyon (1999) also found no significant impact of the presence of remuneration committee on the directors' remuneration in UK. However, they stated that pay-performance relationship might be stronger in companies having remuneration committees. Kuo and Yu (2014) examined the influence of remuneration committees in aligning the com pensation of CEOs with firm performance in a sample of 1311 Taiwanese firms for a period of three years (2008-2011) and found that companies which have voluntarily constituted remuneration committees early would show a stronger pay-performance link than those companies who formed remuneration committees mandatorily.

The findings of various studies which have examined the relationship between composition of remuneration committees and executive compensation are summarised in Table 1. Newman and Mozes (1999) reported no significant impact of the presence of insiders on the compensation of CEOs. Anderson and Bizjak (2003) concluded that neither completely independent committees nor the dominant presence of independent directors in remuneration committees play any role in determining the remuneration packages for executives. Moreover, the presence of insiders or CEO in the committee has not been found leading to excessive executive remuneration. Vafeas (2003) found no association of committee composition as well as the interaction between committee composition and performance with the pay levels of CEOs. But a positive and significant association between committee independence and CEO compensation was reported by Sapp (2008).

The cash compensation has been found more positively related to accounting earnings when compensation committee quality represented by CEO appointed directors, senior directors, CEO directors, director shareholdings, additional directorships, and committee size increased (Sun & Cahan, 2009). Sun et al. (2009) showed that as the compensation committee quality improved, CEO stock option grants were more positively related with the future firm performance. Gregory-Smith (2012) found that neither the committee size nor the committee independence affected pay of CEOs.

Anderson and Bizjak (2003) and Sapp (2008) have used the proportion of independent directors in remuneration committee as a proxy for the independence of remuneration committee, whereas in other studies the proportion of insiders, non-executives, affiliated directors, interdependent directors, etc. are used. In the present study, remuneration committee independence is represented through two variables i.e. a dummy variable taking the value one if all directors of committee are independent and another dummy variable which takes the value one if the chairman of the remuneration committee is an independent director and zero otherwise.

Remuneration Committee & Executive Remuneration

The directors of a company are seen as the stewards of the resources entrusted to them by shareholders and their personal needs are automatically fulfilled when they work towards the achievement of organizational goals (Davis et al., 1997; Daily et al, 1998; 2003; Wasserman, 2006; Andreas et al, 2012). The optimal contracting theory assumes an independent role of non-executive directors in setting remuneration of executive directors (Bebchuk et ah, 2002). According to Ryan and Wiggins (2004), an independent board meet the economic interests of the shareholders better. But Kaushik (2013) observed that independent directors are failing in their independent role. Both, 'agency theory' and 'optimal contracting theory' believe that an independent remuneration committee would ensure that shareholders' interests are safeguarded and remuneration decisions are made on fair and equitable basis. Thus, the independent directors are supposed to check excessive remuneration being paid to directors and linking it to the performance of the company. Due to increased public awareness about various governance issues including executive remuneration, the independent directors on remuneration committee are expected to check the executive directors' remuneration (Abdullah, 2006).

Hypothesis 1: Independence of remuneration committee is negatively related with the executive remuneration.

Independent Director as Chairman of Remuneration Committee

According to managerial power approach (Bebchuk et al., 2002; Barontini & Bozzi, 2011), the presence of executive director on the remuneration committee would give immense power to the executive directors to decide their own pay. Greater the power of executive directors, higher is the excess pay or rent earned by them over what they should actually get. Independent director as the chairman of remuneration committee is expected to ensure that the remuneration decisions are not affected unreasonably by inside directors on the remuneration committees. Independent director as the chairman of the committee is anticipated to make remuneration setting process to be more objective and reasonable.

Hypothesis 2: Independence of chairman of the remuneration committee is negatively related with the executive remuneration.

Executive Remuneration & Performance

Many studies have reported accounting performance of a company and/or its market performance as basis of payment to the directors. For instance, Cladera and Gispert (2003), Fatemi et al. (2003), Ghosh (2006), Su et al. (2010), Barontini and Bozzi (2011), Andreas et al. (2012), Wu (2013), Chen et al. (2014) have found executive remuneration linked positively with accounting performance whereas Ertugrul and Hegde (2008)...

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