The Board of Directors is responsible for establishing a committee that determines remuneration policy for directors, among other things. Therefore, it has become critical for boards to devise a fair, just and transparent remuneration process considering the intense scrutiny that may follow from shareholders and the media.

In India Inc., the establishment of Nomination and Remuneration Committee (NRC) under Section 178(1) of the Companies Act, 2013 and Compensation Committee under Regulation 5.2 of Securities and Exchange Board of India (Share-Based Employee Benefits) Regulations, 2014 is mandated for all Listed Companies, and Public Companies having paid up capital of Rs.100 crores or more; or in the aggregate, outstanding loans or borrowings or debentures or deposits exceeding Rs.50 crores.

The function of NRC is inter alia to devise a remuneration policy for the directors, key managerial personnel (KMP) and other employees. The policy relating to the remuneration shall be disclosed in Board’s report as per Section 134(3) of the Companies Act, 2013.
Although, it is suggested that the policy should also include the parameters on which compensation decisions were made other than qualifications and positive attributes, in order to commit to a fair, balanced and performance-based practices that align with long-term interests of shareholders alongside other stakeholders. Therefore, while framing such policies, the objective of the NRC should be as follows:

  • To attract and include directors, and motivate them to achieve results with fairness and integrity.
  • The policy should be designed in a manner that cultivates the spirit of teamwork and collaborative effort.
  • Fair and reasonable employment and working conditions with adequate internal communication and grievance redressal mechanisms.
  • Objective and transparent performance appraisal mechanisms.
  • To achieve a befitting balance between the interests of employees, shareholders and other stakeholders, the policy should take into account the status quo of working capital and long-term performance of the company.
  • It should reflect the value and responsibility of the roles that directors perform by balancing the fixed and variable incentive components. It should provide guidance in relation to the following aspects:
    • Fixed remuneration
    • Performance-based remuneration
    • Equity based remuneration
    • Termination payments

Since NRC is designed to formulate schemes of executive pay, the composition to that effect is given in Section 178(1) the Companies Act, 2013 as– three or more Non-Executive Directors (NEDs) out of which one-half shall be Independent Directors (IDs). The role played by NRC is integral in monitoring appointment, removal and remuneration of most senior and coveted directors of the Board.

In addition, there is an ongoing debate on whether NRC should be solely constituted by IDs, without executive influence, like in the United States of America (USA) and United Kingdom (UK), or it should have one-half as IDs. The propagators of the former notion believe that such a constitution will have demonstrable results in the growth of a company ensuring a fair and transparent mechanism for remuneration for directors. However, the latter believes it to be the result of concentrated ownership structures in the India Inc. It is suggested that barring the controlling shareholders from the NRC can be counterproductive as it involves not only the remuneration of directors but also of KMPs and other employees, as they work in close proximity with executive directors.

The key to a successful performance of the NRC is an unbiased and objective membership. There is no guarantee that the NRC based solely out of IDs will have these characteristics. It is something that the directors must cultivate on their own irrespective of their position on the board. Another point of concern is reciprocal arrangements wherein an Executive Director of the first company sits on the NRC of the second company, and the Executive Director of the second company sits on the NRC of the first company. Such reciprocal arrangements can vitiate the objective of NRC. India is yet to prohibit this practice, but a step forward in this direction would definitely be welcomed.

Author: Ananya Singh

Disclaimer: THE STATEMENTS HEREIN REPRESENT THE CURRENT OPINION AND BELIEFS OF THE AUTHOR ONLY AND NOT THE ASSOCIATION OF INDEPENDENT DIRECTORS OF INDIA (AIDI). UNDER NO CIRCUMSTANCES SHOULD ANYTHING IN THIS POST BE CONSTRUED AS INVESTMENT, LEGAL, TAX, REGULATORY, FINANCIAL, ACCOUNTING OR OTHER ADVICE.