The Board of Directors are responsible for establishing a committee that determines remuneration policy for directors, among other things. Taking into account the intense scrutiny of the shareholders and the media, it is imperative that the board devises a reasonable, condign and transparent remuneration process.
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 to develop a remuneration policy for the directors, key managerial personnel (KMP) and other employees. The policy relating to the remuneration shall be disclosed in the Board’s report as per Section 134(3) of the Companies Act, 2013.
In order to commit to a fair, balanced and performance-based practice, it has been recommended that the policy should also encompass the parameters on which compensation decisions are made. Thus, while formulating such policies, the objective of NRC should be as follows:
1. To attract and include directors, and motivate them to achieve results with fairness and integrity.
2. The policy should be developed in a manner that cultivates the spirit of teamwork and collaborative effort.
3. Fair and reasonable employment and working conditions with adequate internal communication and grievance redressal mechanisms.
4. Objective and transparent performance appraisal mechanisms.
5. 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.
6. 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:
a) Fixed remuneration
b) Performance-based remuneration
c) Equity-based remuneration
d) Termination payments
Since the desideratum of NRC is to concoct schemes of executive pay, established in Section 178(1) the Companies Act, 2013 states that out of the three or more Non-Executive Directors (NEDs) one-half shall be Independent Directors (IDs). NRC plays an integral role in monitoring the appointment, removal, and remuneration of most senior and coveted directors of the Board.
In addition, debates regarding the constitution of NRC i.e. if or not it should solely be formulated by the Independent Directors (like in the United States and the UK) have been doing the rounds. The propagators of the former notion believe that such a formalization will have demonstrable results in the growth of a company ensuring a fair and transparent mechanism for remuneration for directors. However, the latter suggests that barring the controlling shareholders from the NRC would be counterproductive the remuneration process is not restricted just to the directors but also involves Key Management Personnel and other employees, who work in close proximity with the executive directors.
The key to successful performance of the NRC is an unbiased and objective membership. There is no guarantee that the NRC based solely out of Independent Directors 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 beneficial.