Independent directors should be paid fairly, but the compensation factor should not affect their independence and integrity.
In the world of extreme business complexities, non-executive directors (NEDs) protect the interests of shareholders. Independent directors specifically represent the interests of minority shareholders along with other stakeholders and are true custodians of corporate governance. Although executive compensation is most talked about nowadays, independent directors bring their expertise and commitment to the table and should be compensated for the same. The structure of their compensation varies across countries and is influenced by local laws. In India, compensation to independent directors has two broad elements - sitting fee and commission. However, some companies offer a fixed retainer within the limit of 1 per cent of the net profit as specified by the Companies Act. It is interesting to look at the nuanced differences in payment for the value they bring to the table.
Overall compensation: Our analysis of the top 158 companies in India (excluding public sector enterprises) throws up some interesting insights. Overall, an independent director earns an average of Rs 28.8 lakh annually. Out of this, 23 per cent comes from the sitting fee and the balance 77 per cent from commission or fixed fee. The size of a company matters when it comes to such compensation, and if we consider revenue as a proxy for size and scale, we will see that total compensation varies between Rs 17 lakh and Rs 49 lakh on an average (see chart).
Sitting fee: An analysis of the sitting fee also shows some intriguing trends. As per the law, the sitting fee per meeting per director cannot exceed Rs 1 lakh, and the same can be paid for attending Board meetings as well as committee meetings. But there is a significant difference in the fee structure when one attends a committee meeting instead of a Board meeting. And it clearly shows the effort and time a director has to invest for the latter.
There is an exception, though. Audit committee members need to spend more time as their mandate is wide and requires specific skills for understanding company financials and, more importantly, for cutting through the numbers. With duties ranging from review and approval of critical accounting principles and any significant issue relating to financial statements requiring judgement on estimates, review of related-party transactions, and selection, evaluation and oversight of statutory auditors, a higher meeting fee for an audit committee does not come as a surprise.
As far as fees go, the audit committee is followed by the nomination and remuneration committee (NRC) and the risk committee. Post the Companies Act, 2013, the terms of reference for the NRC have expanded as well. Its responsibilities range from assessing the remuneration structure for directors, senior managers and key personnel to ensuring a balance between fixed and incentive pay in line with the short- and long-term goals of a company besides assessing the effectiveness of the recruitment processes for senior executives and members of the Board. Executive compensation being one of the hot topics, NRC members need to devote a lot more time in and outside of meetings to keep themselves updated on the nuances of the topic. Compensation of directors who are part of a risk committee varies considerably depending on the charter of the committee and may range from reviewing, identifying, prioritising and management of risks to defining the roles and accountability of the functions related to risk management. The time required to operate in other committees dealing with corporate social responsibility and stakeholder relationship is low, and the fees paid to attend these committee meetings are comparatively low.
Commission/fixed fees: About 77 per cent of the total compensation paid to an independent director comes from commissions/fixed fees or retainer. This amount depends on several factors such as the value of the contributions made by a director in Board and committee meetings, his skills and attendance, the number of committees of which he is a member and the number of committees he chairs.
The complexities of a company and the industry segment where it operates also define the quantum of commissions. Finally, all compensation (excluding sitting fees) paid to non-executive directors must be within the limit (1 per cent of the net profit) as specified by the Companies Act. Hence, a company's profitability also plays a role in determining the commission that non-executive directors get. Our analysis shows that commissions paid to independent directors in India can range from nought to Rs 46 lakh (10th- 90th percentile range) while the average is Rs 22 lakh. Overall, commissions paid to all non-executive directors range between 0.03 and 0.54 per cent of net profits while commissions paid to all independent directors range from 0.02 per cent to 0.27 per cent of net profits. It also means in many organisations, a large part of this is paid to non-executive non-independent directors who are usually from the promoter group or the promoter family.
It is well known that Board-level talent in India is scarce. There are organisations where independent directors do not join the Board for the sake of compensation, but companies need to ensure that their pay is worth the skill and experience.
The dichotomy is that while independent directors should be fairly compensated, the quantum of compensation should not be too high to raise questions about their independence. This is the logic that has made regulators say stock-based compensation cannot be granted to independent directors. But aren't profit-related commissions more short term and myopic?
The writer is Director, Executive Compensation, Aon Consulting