Wednesday, April 8, 2015

Corporate Governance - Independent Director's Remuneration - RBI Perspective

The Reserve Bank of India (RBI) in its  First Bi-Monthly Policy Statement 105-16 has dealt with the issue of remuneration to non-executive directors. The Statement states "In order to attract and retain professional directors, it is essential that they are adequately compensated." RBI proposes to issue guidelines to private sector banks on a policy on remuneration for the non-executive directors (other than part-time Chairman) that will reflect market realities and will be within the parameters specified in Banking Regulation Act 1949 and the Companies Act 2013. It will also discuss with the Government the adoption of a similar remuneration policy for the non-executive directors of the public sector banks. The issue raised by RBI is equally applicable to non-finance companies. 

Compensation to independent directors is a contentious issue. If, compensation is a high proportion of the total income of an independent director, there would be subtle pressure on the independent director to compromise with his/her independence. Although, non-financial motivating factors(such as, opportunity to learn, opportunity to contribute and self-actualisation) are important, financial compensation is also an important motivating factor. Therefore, if, the compensation is very low relative to the opportunity cost of the director, he/she will lack motivation to contribute and with increase in accountability it will be difficult to attract right individuals. It is difficult to decide what is the appropriate amount of compensation, particularly because independent directors include variety of professionals, such as, retired government officials, retired professionals, active professionals and senior management personnel. Current income differs among different groups and  a particular amount is relatively low or high depending on the current income.

The Companies Act 2013 has established a cap on sitting fees (Rs 100,000) and commission (1 per cent of net profit to all the non-executive directors together if there is a MD, whole time director or manager) payable to non-executive directors. We may assume that the limit is fixed after due deliberation and therefore, that is the appropriate amount of compensation, although the limit is arbitrary. 

Unfortunately, in PSEs the amount being paid as sitting fee is between Rs 10,000 to Rs 25,000 and there is no practice of paying commission. This needs revision. Similarly, private companies, which can afford to pay should pay a decent amount towards sitting fee and commission. Earlier director's job was a cushy job with  prestige and therefore, companies could retain directors without paying right compensation. Suddenly the job has become demanding and therefore, companies will do better to pay right compensation to attract talent. Independent directors should raise the issue in Board meeting.

We have to wait for RBI Guidelines to appreciate its perception of 'market realities'.

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