MCA plan to cap pay puts outside directors in a bind

By Harish Kumar, L&L Partners

The Ministry of Corporate Affairs (MCA) on 5 November 2018 called for public comments on a slew of proposed amendments to the Companies Act, 2013, with a view to strengthen the corporate governance framework in India. One of the proposed amendments, to section 149(6) of the act, seeks to cap the remuneration of independent directors (IDs). At a time when an increasing burden is placed on IDs, the move to cap their remuneration is curious, particularly given the practical difficulties in implementing a cap. In this article, we discuss some such practical difficulties and suggest alternatives to the MCA proposal.

Harish KumarPartnerL&L Partners
Harish Kumar
L&L Partners

The MCA proposes to cap the remuneration payable to an ID as an amendment to section 149(6)(c) of the act, provides that the total pecuniary relationship between the ID and the company (including its holdings, subsidiaries etc.) should not exceed 25% of the ID’s total income. The proposed amendment was suggested by the MCA committee set up earlier to review offences under the act. In addition to its recommendations on relevant offences (many of which have already been incorporated under the act by way of a recently promulgated ordinance), the committee suggested further amendments to strengthen the corporate governance framework.

The move to cap ID remuneration is in response to media reports about rising ID compensation of a select few IDs, who are currently serving on multiple boards and are generously compensated. Serving on multiple boards raises concerns over their independence, especially if the companies in question operate in the same sector. Concerns over remuneration, however, are misplaced, as over-compensated IDs constitute a relatively small number.

As it stands, IDs are paid a sitting fee and a profit-linked commission unlike executive directors, who are guaranteed a minimum remuneration (even in companies with losses/inadequate profits) under schedule V of the act. The requirement to obtain central government approval for payment of remuneration to executive directors has also recently been removed.

The proposal compensation also runs contrary to the increasing responsibilities placed on IDs. The primary role of an ID was to act as an integrity check on the overall performance of the board of directors, however, under schedule IV of the act, their role has steadily expanded, requiring considerable time and energy. From evaluating the performance of the board, to managing conflict within the board and acting as a whistleblower in case of fraud, IDs’ responsibilities are numerous. IDs are also expected to stay informed about the activities of the company and oversee vigilance mechanisms within the company.

The MCA proposal will also be difficult to implement. For instance, top companies reportedly pay their IDs around ₹15 million (US$211,000) a year. If the MCA proposal is implemented, an ID in such companies must already have an annual income of at least ₹45 million to meet the 25% cap. With such a threshold, most IDs would be ineligible to serve on the board of such companies.

A more immediate and pressing concern is that the well-compensated IDs (often retired bureaucrats with a wealth of managerial experience) currently serving on the board of such companies will have to resign if the proposed amendment were to take effect.

Alternatives to MCA proposal

  • India is one of the only countries where ID remuneration is fixed by law. In most countries, remuneration is subject to shareholders’ approval and/or disclosure. A similar model could be implemented, where shareholders have the final say on ID remuneration. The act can instead prescribe criteria for ID remuneration. For instance, the act could prescribe a fixed component linked to the discharge of their duties. An additional variable component could be based on their contribution to board meetings, ability to stay informed about company activities and other performance criteria.
  • MCA may consider exercising its power under section 149(6)(f) to prescribe additional qualifications for IDs such as prior managerial experience to ensure more objectivity in the board’s functioning.
  • The Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015 limits IDs to directorships in seven public listed companies. A similar cap can be extended to unlisted public companies under the act, where the current cap is 10 public companies.

Harish Kumar is a partner designate at L&L Partners.

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