Tuesday, May 29, 2007

Do Highly-Paid Indian CEOs Really Add Value?

It seems that CII (Confederation of Indian Industries) may soon decide not to invite politicians to their parties, summits, meetings, or whatever... First it was Mani Shankar Aiyer in April, who raised the question:

"Industry has been enormously benefited by the processes of economic reform that we have seen in this country over the last 15 years or so. But the benefits of these reforms have gone so disproportionately to those who are the most passionate advocates of reforms that every five years we are given a slap in the face for having done what the CII regards as self-evidently the right thing for this country."

...and then, last week, it was Manmohan Singh, the Prime Minister himself, who in his Ten Point Social Charter, gave a not-so-gentle reminder to the CII members about their social responsibility: "corporate social responsibility must not be defined by tax planning strategies alone".

Predictably, among all the other points, it was the fourth point about the CEO salaries - i.e., about "excessive remuneration", "conspicuous consumption", "vulgar display of wealth", "ostentatious expenditure", etc. - that caused much flutter...
(I used the term "Predictably", since all other nine-points were about the nice things that the industry should be doing. This was the only one which mentioned what the audience of CII conference, the CEOs, should not be doing. This is what he said:

"...Four, resist excessive remuneration to promoters and senior executives and discourage conspicuous consumption. In a country with extreme poverty, industry needs to be moderate in the emoluments levels it adopts. Rising income and wealth inequalities, if not matched by a corresponding rise of incomes across the nation, can lead to social unrest. The electronic media carries the lifestyles of the rich and famous into every village and every slum. Media often highlights the vulgar display of their wealth. An area of great concern is the level of ostentatious expenditure on weddings and other family events. Such vulgarity insults the poverty of the less privileged, it is socially wasteful and it plants seeds of resentment in the minds of the have-nots."

The "damage control" started immediately. Sunil Mittal, CII's newly elected chief, complemented the Prime Minister for his "unusual and landmark" speech, but also pointed out the CEOs' salaries "cannot be legislated", since there is a crunch of talent.

Financial Express was quick to point out that its research on the salary increase of top 100 CEOs ("only 30%" increase from Rs 189.98cr to Rs 246.96cr between 2005 and 2006) shows that "wealth generated by 100 big companies has been greater than the pay growth of their bosses." - FE's criteria of "wealth generation", however, was not profits/sales of the companies, but the increase in their market-capitalisation (and that too duing one year!)... I am not sure why FE did not look at profits, turnover, or other more tangible and sustainable criteria of corporate performance to prove its point...

Mainstream media also went into a spin to point out the wasteful government expenditure, and/or why Manmohan Singh had to make this speech after his party was rejected by the "aam aadmi" in the UP election, and/or his speech was like a simplistic Sunday sermon, etc., etc...

...all of which may - or may not - be valid reasons to reject the suggestion. However, even if one acknowledges these counter-arguments as valid, and that if industry has to become competitive, there should not be a bar on CEO salaries to attract the world-class talent, it is worth asking the question:

Do the Highly-Paid Indian CEOs Really Add/Create Value to Business?

The only comprehensive study which related the CEO salary and corporate performance, that I could recall, was done by two of my colleagues - Profs Ramkumar Kakani and Pranabesh Ray - a few years back. A report on the study - titled CEO Salaries Outstrip Growth of Profits (The Hindu BusinessLine, Aug 9, 2002) - can be accessed here.

A two part article by the authors can be accessed here (Part 1) and here (Part 2).

I find this study more comprehensive because:

  • it covered the trends over 22 years, from 1979 to 2001 (and so, the conclusions are not based on temporary up-/downturns and business cycles), and

  • it compared the the hikes in CEO's salaries with increase in (1) employee wages, (2) sales and (3) Profit before interest depreciation and tax (PBDIT).

    Quoting from the findings:

  • "in the last 22 years, growth in managerial remuneration was almost five times that of the same in employee wages. Between 1992-93 and 2000-01, the compounded annual growth rate of sales was 11.52 per cent, 13.84 per cent for PBDIT and 9.81 for employee wages. However, managerial salaries grew by 33.1 per cent."

  • "...the welfare expenses and return on capital employed decreased over the year. Even the return on equity dropped sharply between 1995 and 2001."

    Conclusion of the Study:
    "It implies that while the compensation for the CEOs has increased, this has not resulted in a positive change in the performance from the point of view of all other stakeholders including equity shareholders. This in fact raises the question of justification in the phenomenal rise in managerial remuneration."


    Santhosh said...

    I think the Prime Minister's speech is clearly a valuable direction for Indian companies. Increasing inequality could also result in re-distributive policies by many state governments, adversely affecting the environment in which these companies operate under.

    I hope companies soon realize that Formula One tracks and Diarrheal Deaths cannot co-exist. Its common sense.

    bhupinder said...

    The "common sense" wisdom in linking the high salaries with "talent" is misleading- some kind of a mythical belief in the "invisible" magical hand of the market. What is forgotten is that, at least in case of the CEOs, a lot many are either promoters or from their families- not  even managers  recruited from the market.

    The highest paid CEO in India is Naveen Jindal, MD of Jindal Steel and scion of the promoter's family. His salary rose by about 250% in 2005-06 to Rs. 13.54 crores. Similar is the tale of some other CEOs. At least 7 of the 11 CEOs listed in the table are promoters or belong to the promoter's family (always the sons of the family, no daughters, I am afraid).

    After having unleashed "market forces" and promising the trickle down to happen, 16  years after the so called reforms were launched, Manmohan Singh has little to show by way of its "trickle down" effect- his own statement is a reflection of the failure.

    A prime minister who does not even have the decency of getting elected to the Lok Sabha rather than the Rajya Sabha (that too, from a state with which he has no connection at all), can only cry in wilderness.

    The only thing that will change in the next Lok Sabha elections is the party in power- not the economic policies.

    bhupinder said...

    The story is similar in the neo- liberal paradise.

    "(in the US) thirty to forty years ago, the CEOs of major companies earned 80 percent more, on average, than the third-highest-paid executives. By the early part of the twenty-first century, however, the gap between the CEO and the third in command had ballooned up to 260 percent."

    Madhukar said...

    Thanks for the comment, Santhosh. Actually, in some ways, the inequality has already impacting the business...

    Thanks for the links. In the list of 11 CEOs, 8 - not 7 - are the promoters (I think you missed out Patel of Cadila)...
    ...it is ironical that nowhere the "invisible hand" of the "free market" has not worked to create the trickle-down effect. My own understanding is that the 'free-market' doctrine, as it is practiced, does encourage entrepreneurship and helps creating economic wealth. However, it also comes packaged with its own mechanism of distributing (or rather concentrating) the wealth to a few.

    Though, I do agree with your comments about Manmohan Singh's "reforms" and lack o political base, but would also like to add that the "reforms" of the 91 were not the bainchild of either Narsimha Rao or Manmohan Singh. What happened in 1991, was a roll-out of the promises madein the Congress election manifesto. The manifesto was created when Rajiv Gandhi was alive.

    Similarly, the "aam admi" theme is also basis of Congress manifesto of 2004 elections. The present govt is merely caught finding a balance "between the masses and the classes" in trying to roll it out. What comes out, unfortunately, is a confused muddled up approach to issues....