October Newsletter 2024

Oct 17, 2024

Executive Pay | New Trends in CEO Compensation Linked to Outcomes Beyond Financial Goals

Corner room compensation at India’s top companies is increasingly being linked to outcomes, key results and even long-term benefits. Boards and nomination and remuneration committees are now scrutinising not only traditional key result areas (KRAs) and performance metrics like financial growth and valuation indicators such as return on equity and return on capital employed but also broader impact parameters.

These include launching new business ventures, exceptional contributions to brand building and employee engagement, establishing new supply chains, adopting emerging technologies and implementing transformative artificial intelligence (AI) and robotics solutions and such others that could have long-term benefits for the company.

“We are beginning to shift from simple KRAs to outcome and key results,” said Shailesh Haribhakti, chairman of audit and accounting firm Haribhakti & Co, who is an independent director at several Indian companies. “CEO pay is no longer just linked to enhancement in profit or turnover but to various long-term impact parameters such as curating a new business, stop disruption from happening, doing something spectacular in terms of employee motivation or to boost brand, adopting a new emerging technology and many such other outcomes that goes beyond just meeting budget parameters,” Haribhakti said.

An ET compensation analysis of 25 of the Nifty 50 companies run by professional chief executive officers, for which data was available, shows that India’s biggest companies by market cap compensated their managing directors and CEOs with hefty payouts and salary increases in FY24 at a time when there was robust increase in revenue and profitability in this cohort of companies.

The average pay increase of professional CEOs and MDs in FY24 was 22.16% compared to 15.02% in FY23. The revenues of these 25 companies increased by an average of 17.35% in FY24, while net profit surged by 22.63%. The handsome payouts to the top boss coincided with the market cap of this group of companies gaining 24% during the period, an indicator of higher shareholders returns.

The average CEO pay in FY24 was ₹22.54 crore versus ₹18.45 crore in FY23 and ₹16.04 crores in FY22. The salaries of professional MDs and CEOs ranged from ₹5.11 crore to ₹89 crore in FY24. The data include salary, bonus, allowances, commission, and other benefits.

One of the most prominent factors in competitive compensation is companies doing a periodic assessment and benchmarking of CEO/CXO compensation in the industry, said Arun Duggal, chairman of ratings firm ICRA.

Another important factor is the stock price or market cap of the company. “If investors are not getting rewarded, boards are reluctant to make very large increases in CEO pay,” said Duggal who is an independent director at several companies.

In addition, qualitative factors are increasingly playing a key role in pay increases. These factors include “the positioning of the company in the investor community, how dynamic is the CEO in terms of looking for key factors for growth, (and) how efficient is the person in resolving internal challenges, among others,” he added.

Multiple data points highlight India Inc’s strong performance in FY24. Corporate profits as a percentage of GDP reached a 15-year high, driven by improved profitability. Credit growth stood at 16%, while asset quality was the best it has been in a decade. Suresh Raina, partner at HR consulting firm Heidrick & Struggles India, said that the performance linkage of CEO pay is increasingly becoming dominant. Read More. 

Board Diversity, Equity, and Inclusion| Ways to Effectively Lead DEI Efforts Without Going Offside

Diversity, equity, and inclusion (DEI) are boardroom agenda items. Whilst much of the focus has been on achieving greater board diversity, the spotlight is increasingly moving towards the board’s responsibility for the organisation’s overall D&I strategy.

In a challenging landscape, with a variety of attitudes towards DEI being expressed by stakeholders, and legal limitations on what actions can lawfully be taken to improve DEI, how do boards safely drive change from the top? To what extent should boards intervene or let change happen organically? Applying a DEI lens to all decisionmaking may be the only authentic way for boards to achieve meaningful and sustainable change in DEI, whilst mitigating the potential challenge of positive discrimination and avoiding the meritocracy trap.

The current landscape for prioritising action to improve corporate DEI is more fragmented than ever before. To make sound, well-informed decisions in this area, boards must be alert to the battle of forces at play.

  • At a societal level, organisations and their business leaders are expected to prioritise DEI but are also facing conflicting views characterising DEI as ‘wokeness’ or raising concerns over misplaced priorities on DEI at the expense of profit and stakeholder interest.
  • At a legal level, employers are permitted to take positive action to achieve progress on DEI but must do so in an environment of increased scrutiny and heightened legal risk of claims of unlawful positive discrimination.
  • At a regulatory level, DEI is increasingly becoming part of the supervisory and enforcement framework. In the UK, for example, the financial services regulators have recently published proposals making clear that boards should be responsible for oversight of a firm’s DEI strategy.
  • At a political level, DEI is a common policy issue and used to differentiate ideologies of politicians across the political spectrum, with new proposals either to accelerate or reverse DEI strategies and protections for disadvantaged groups being championed, any of which will have long-term impacts for businesses.
    In such challenging times, what can boards do?

Targets: Though an effective tool to drive forward short-term progress on DEI, targets can also carry greater legal risk. Many listing regimes already require in-scope companies to report against targets on the representation of women and ethnic minorities on their boards and executive management, and many organisations set voluntary targets or commit to diversity benchmarks to improve short-term DEI. While the setting of targets themselves is not unlawful, the measures firms take to achieve them can be if targets are in fact treated as quotas rather than aspirational goals.

Incentives: Many organisations already use nonfinancial metrics linked to DEI in their performance and remuneration assessments. Whilst doing so can demonstrate business leaders are taking DEI seriously, it is difficult to translate DEI metrics into short- and medium-term remuneration targets, and setting remuneration policies which link directly to the achievement of DEI targets may also have the effect of incentivising behaviours which could be seen as positive discrimination. The challenge of setting stretching, but not too stretching, targets has also led many business leaders to consider longterm shareholding as a better alternative to achieve sustainable progress on DEI.

The gift of time: Over the next generation, a broader cohort of diverse candidates should, in theory, be climbing the corporate ladder and entering the talent pool at firms which foster healthy cultures of inclusivity and equality. The focus by boards should not, therefore, just be on short-term diversity progress, but long-term initiatives necessary to nurture the next generation of talent coming through the ranks. Boards are instrumental in developing the right environment and culture for this.

The DEI lens: Ultimately, there are tools which boards and senior leaders can use to intervene and drive short-term results in DEI. But efforts may be futile unless a board’s mindset on DEI is applied holistically and embedded within an organisation’s governance framework. From acquisition to risk management, to policy, finance and succession planning, to managing strategy and performance: applying a DEI lens to all decision-making may be the only authentic way for boards to achieve meaningful and sustainable change in DEI, whilst mitigating the potential challenge of positive discrimination and avoiding the meritocracy trap

  1. Social mobility: Organisations are increasingly recognising the need for workplace diversity initiatives to cover socio-economic backgrounds. Expect greater focus on socio-economic diversity of boards in the coming years.
  2. Diversity shortlists: Be watchful of relying on candidate shortlists based on diversity strands. Such measures have become common practice but carry great legal risk and may be unlawful.
  3. The regulatory spotlight: DEI is increasingly becoming a regulatory concern, as regulators recognise that good diversity and inclusion practices promote healthy cultures, sound risk management, reduce groupthink and facilitate better decision-making. Whilst changes to legal frameworks can take time to come into force, regulatory change can happen quickly.
  4. Positive action vs positive discrimination: The assumption that well-intentioned measures designed to correct historic unfairness will be lawful has never been a safe assumption, and as challenges of positive discrimination become better known and more prevalent, understanding this often blurred line has become ever more important.
  5. The political agenda: DEI is increasingly becoming politicised and used to frame party manifestos. In the UK, for example, Labour, the current opposition party, has already committed to mandate ethnicity pay reporting if it makes it into government, alongside a new Race Equality Act, enabling minority ethnic and disabled workers to bring equal pay claims. Read More.

Industry News | Emergence of Nuclear Energy Use to Achieve Net Zero and to Power Future Data Centres

Google has ordered six to seven small modular nuclear reactors (SMRs) from Kairos Power, becoming the first tech company to commission new nuclear power plants to provide low-carbon electricity for its energy-hungry data centres. Google and Kairos said on Monday that the tech company had placed an order for SMRs with a total capacity of 500 megawatts, helping Kairos, a seven-year-old start-up, to bring its first commercial reactor online by 2030 and additional reactors by 2035.

The agreement was “a landmark for us at Google in our 15-year clean energy journey”, said Michael Terrell, the company’s senior director of energy and climate. “We feel nuclear can play an important role in helping us to meet our demand, and helping us to meet our demand cleanly and round the clock,” he said. Asked if the reactors would feed into the grid or be directly connected to data centres, Terrell said Google was considering all options.

The two companies declined to comment on the agreement’s value, or on whether Google would fund the construction of the SMRs upfront or simply pay for power once they were built. Last month, Microsoft announced that it would commit to buying 20 years’ supply of electricity from the mothballed US nuclear power plant Three Mile Island if Constellation Energy restarted the site. Tech companies are increasingly interested in nuclear as a medium-term solution to providing low-carbon electricity to meet their data centres’ energy demands.

Google’s deal with Kairos is the first in which a tech company is helping to commission the building of a nuclear power plant. The US has brought only three reactors online in the past 20 years. Terrell said SMRs offered “a simplified, inherently safe design, faster construction, and flexibility on deployment location” compared with large-scale nuclear plants. “Obviously, this is a bit of a longer-term bet, but it is an incredibly promising bet. If we can get it to scale globally, this will deliver enormous benefits to power grids around the world.”

While Google was leaning “heavily” on renewable energy to power its data centres, Terrell added, its modelling had made clear “that to really get grids to be carbon-free it will take more than just wind, solar and lithium ion storage; you are going to need this next set of advanced technologies”. Kairos, based in Alameda, California, has developed a reactor cooled by molten fluoride salt, rather than water. In December, it received a construction permit from the US Nuclear Regulatory Commission to build a 50MW demonstration reactor in Tennessee called Hermes.

This was the first approval for a new type of reactor in the US for half a century. The US Department of Energy is investing about $300mn in Kairos’s Hermes project through its Advanced Reactor Demonstration programme. The US has thrown its weight behind companies seeking to build smaller nuclear reactors that can be built in factories and assembled on site, in order to cut costs and speed up the construction of plants. Kairos’s molten salt reactor uses ceramic-coated TRISO fuel and operates at close to atmospheric pressure, transferring heat from the salt to generate steam and run a turbine.

The company began construction on its Hermes project in July and is aiming for it to be operational by 2027. In September, it said it would build a salt-production facility and two fuel labs in Albuquerque, New Mexico. Mike Laufer, Kairos’s chief executive, said the commercial-scale SMRs that the company planned to build for Google would have a capacity of 75MW and that the company was focusing on the US market. Read More.

Board Composition And Independence| Governance Practices For Pre & Post-IPO Boards

Talking points:

  • Transitioning from a private company to a public one is an exciting step in a company’s evolution.
  • Following leading practices for board composition, structure, and governance policy can help you create an effective and connected governance framework.
  • Although there are governance requirements that need to be met on Day 1 as a public company, others allow for a transition period post-IPO; effective governance is a continuous journey.
  • The latest US IPO market numbers are in, and the Q1 2024 data looks promising. After nearly two years in the doldrums, the number of US IPOs increased to 43 from 34 for the previous quarter, with deal value more than tripling to $6.2 billion from $2 billion.1 Could this be the start of a sustained upward trend?

While a quarterly upturn can be cause for optimism, we know that preparing to go public often takes longer than a quarterly market cycle. The IPO readiness process could take anywhere from six to 18 months of intensive planning, and building your governance foundation is an important part of this pre-IPO preparation. My advice to clients going through this process doesn’t change based on market conditions. I tell them: Don’t delay; start early because there’s a lot to do in a compact window.

Pre-IPO governance planning is just one workstream in the interconnected readiness process. When a company prepares for the public markets, it can establish a governance framework that evolves effectively over time by focusing on three priorities: board composition, board structure, and governance policies and practices. How should you address each? Here are some leading practices to consider.

Board composition: Shaping your board for public company operation

The IPO governance process typically begins with shaping your board of directors to meet the requirements of operating as a public company. Key considerations in the process include:

  • Establishing an effective recruiting process to build a quality candidate pipeline.
  • Composing a board with skill sets aligned to company strategy and goals.
  • Adapting the size of the board to staff the required committees.
  • Meeting rising board diversity requirements.
  • Continually refreshing the board using a board matrix.

Recruiting—the thread that runs through most of these considerations—demands a great deal of thought and planning. Board members typically serve in their roles for many years. Conducting the required due diligence to find board members with skills that align to the company’s strategy as well as members who fit into the board (and company) culture can take time; and it will serve your company well to vet a broad slate of candidates. In addition, companies should be prepared to meet any respective regulatory, exchange, state, investor, underwriter, and other stakeholder expectations.

Refining your board structure
Board structure goes hand in hand with board composition. Most public companies in the United States are required to have three standing committees of the board: Audit, Compensation, and Nominating/Governance. However, requirements differ by listing exchange, and there may be exemptions to this structure depending on several factors.

The role of each committee is documented in a formal committee charter; each committee may have Securities and Exchange Commission (SEC) and listing exchange requirements to consider. The board committee structure allows the full board to focus on monitoring the execution of the strategy while other specific topics can be presented at a deeper level in committee meetings (e.g., a deep dive on financial performance or specific risks).

Formalizing leading governance policies and practices
As you continue to put the new board and related governance committee structure in place, formalizing your governance policies and practices should be a top priority. This process includes defining corporate governance guidelines and policies; establishing a board calendar that sets meeting dates; and starting the collaborative board-management process for creating board meeting packages, agendas, pre-read materials, and communication policies. Understanding the shareholder/proxy advisor landscape and role of the board as a governing body are also important considerations.

Although many of these requirements must be in place on Day 1 as a public company, others may be met over time. Keep in mind that establishing corporate governance practices is a journey, and there may be a transition period for meeting some of the requirements. Even with the best preparation, it may take time to adjust to the new level of scrutiny from the SEC and investors. Read More.

Board Effectiveness | Common Practices To Nurture CEO-Board Chair Relationship

data-first-paragraph=”true”>Over the past decade, a growing number of U.S. boards have followed their European counterparts by separating the chair and CEO roles. Today, almost 60% of S&P 500 companies have done so, with 39% appointing an independent board chair, which we define as a director meeting applicable NYSE or Nasdaq rules for independence.

It’s a trend many shareholders applaud, arguing separation increases the board’s independence and leads to more effective oversight. But it’s an approach that’s not without risk.

Separating an organization’s two most powerful leadership roles introduces a critical new dynamic: the relationship between the board chair and CEO. A poor relationship can affect the performance of the board, which can extend to the top team. Yet the relationship can’t be so friendly that it undermines the board’s independence, objectivity, and ability to act on behalf of shareholders. It’s a delicate — and deeply personal — balance to get right.

So, what distinguishes an effective chair-CEO relationship? It’s not role clarity or the chair’s knowledge of the business and quality of advice. Nor is it the alignment of goals, performance measures, and board processes. While these are important, based on our experience, conversations with numerous CEOs and chairs, and a survey of nearly 200 directors and 30 CEOs of S&P 500 companies, we identified trust as the critical factor driving an effective relationship between the chair and CEO.

Trust is founded on authenticity, empathy, and logic. We’ve found that chairs and CEOs build trust over time by being vulnerable, open, and transparent about their expectations and their challenges. Our work has also identified five critical moments that can build — or destroy — trust between chairs and CEOs.

Building trust begins even before the CEO is offered the job. Compensation negotiations can set the stage for productive interactions throughout the CEO’s tenure.

Directors should therefore align their views on pay philosophy before negotiations start, including what directors think are healthy pay practices for the CEO and the management team more broadly and how to set pay relative to peer group benchmarks. Especially when the share price does not yet reflect the progress the management team has made, the CEO may have different views on how to structure compensation, so the board and CEO views may have to be harmonized.

As part of these discussions, the chair should be candid about the board’s expectations and work to understand what the CEO is looking for out of the compensation package. For example, for some CEOs, the most important aspect of compensation is their pay relative to proxy peers. For others, it is the absolute amount of compensation over time based on equity performance.

Selecting a compensation advisor is incredibly important to this process. The best compensation consultants go far beyond providing benchmarking data to structuring approaches to align to the selected compensation philosophy and advising and challenging the board’s comp committee.

For example, we worked with a leading global hospitality company whose prior CEO had been removed for performance reasons, triggering an embarrassingly large separation payment (due to accelerated vesting of previously awarded stock options). When the board interviewed the three finalist candidates, one of their key questions was about each executive’s compensation philosophy. In the end, the newly selected CEO agreed to a contract that limited accelerated vesting to one year if he was to be removed for reasons other than cause (e.g., performance). The frank and transparent discussion about compensation philosophy and company values during the search process ended up helping set the tone for a strong working relationship that has endured for a decade.

Our survey found directors (42%) were much more likely than CEOs (14%) to say one of the most helpful ways to build trust was the CEO’s recognition of the board’s feedback conveyed by the chair/lead director. Managing a transparent and effective performance evaluation process means allowing for an open dialogue about the management team’s achievements, challenges, and needed support. A process that lacks integrity or fairness can leave the CEO feeling unsupported or without clear expectations. Ideally, there should be no surprises on either side.

Chairs can make the process more productive by distilling the board’s feedback into the key priorities to focus on for the year rather than overwhelming the CEO with multiple to-dos. “The chair drafts the review and sends it to the board, so that we can get the most important messages agreed to,” former PayPal chair John Donahoe said. “It was helpful to narrow it down to a few key themes that both the CEO and board can stay focused on over the coming year. This also helped form a basis of trust for when new issues or topics arise during the year. We noted them but tried to stay focused on the key themes for the year.”

For their part, CEOs need to be open to feedback from the chair and develop relationships with individual directors to understand what matters to each. “Critical skills for an effective CEO are the ability to listen, an eagerness to learn and consider advice, and the wisdom to know what advice to take and not take,” Bose chair Bob Maresca said.

Independent directors ideally meet in executive session without the CEO at every single board meeting. These sessions can make CEOs uncomfortable because they’re not in the room to hear what’s on directors’ minds. And since these director-only sessions are typically unstructured, the conversations tend to move organically and expand in time spent, often making a CEO back in their office or in a conference room anxious.

Board chairs can build trust in this uncomfortable situation by quickly, honestly, and empathetically delivering director feedback to the CEO. We found 43% of CEOs and 39% of directors said an important way to build trust is ensuring the chair effectively — and immediately — communicates the board’s feedback to the CEO following executive sessions.

“I prioritize conveying feedback in a constructive way; synthesizing what the board members want to see, are concerned about, and want to encourage,” eBay chair Paul Pressler said. “Allow the CEO time to digest the information so you can have a robust, open, and honest conversation. Asking the CEO to translate the feedback ensures clarity and understanding.” During an executive session, chairs should focus the board on the most important issues and ensure all voices are heard, but prevent “piling on” or veering too far off topic. The chair needs to know how to read the room and manage the clock. (Executive sessions are typically at the end of board meetings and director travel logistics are often a forcing device for finishing the meeting on time.)

It’s equally important that the chair encourages the board to be as open as possible when the CEO is in the room, particularly when the board has concerns about performance. If directors are grumbling to one another or sharing sideways glances, the CEO will pick up on it.

Boards build trust with the CEO when they hold themselves accountable for their own performance, including having the right skills and experience in the boardroom. As they plan for board succession, the chair and CEO, along with the governance committee, should ensure that they’re in agreement about the skills and capabilities that will complement those of the existing directors. They should be thoughtful about what is needed to support the CEO’s success, and they need to consider the board culture and dynamics as well.

“We spend a lot of time on director selection and composition — the skills we need of course, but also the chemistry of the boardroom,” MetLife Chair Glenn Hubbard said. “Trust gets back to selection. Be careful about selecting the board and the chair to make sure you don’t have a personality that is going to be a clash with the CEO. That’s not going to work irrespective of how smart they are.”

The chair and CEO should regularly align on the pulse of the board and evolving composition needs. Candid, ongoing communications pays dividends when the board runs into uncomfortable territory, such as the need to transition a director off the board — a fraught situation that has the potential to be destabilizing if not done effectively.

Holding the board to a high standard of excellence and addressing disruptive or underperforming directors through periodic director assessment processes helps clarify expectations and, when done successfully, reinforces the integrity of the board and can deepen the sense of trust between the chair and CEO. “The board’s role in overseeing the company and its long-term strategy is critical,” said The Hartford CEO and chairman Christopher Swift. “For that reason, having in place strong board evaluation and director succession processes is paramount. The Hartford’s lead director, Trevor Fetter, and I work closely together to ensure we are not only addressing the issues of today but planning for the future.”

he CEO and chair will inevitably face a challenge at some point in their tenure together. Boards get nervous when things aren’t going well and may react by pulling the CEO in multiple directions or becoming more critical and unsupportive. How the chair responds when “the temperature in the room rises” can greatly impact the ability of management — and the company — to respond to the crisis.

Chairs help boards operate most effectively when they support the CEO, keep the board calm, make sure the CEO’s energy is not consumed by the board in counterproductive ways, and digest what the CEO needs to hear from the board in a simple and straightforward way.

“An important role the board chair plays in difficult times is absorbing the board’s questions and concerns in a manner that allows the CEO to stay focused on the business,” said Donahoe, who emphasized his commitment to serving as a source of stability for both the CEO and management team. “If the CEO is concerned about what directors are thinking, it can be a distraction and the CEO may be less effective — either feeling uncertain or insecure — and, as a board chair, that’s the last thing you want to see.”

CEOs can build trust in good times by regularly previewing good and bad news and potential strategic pivots so there are no surprises. “Trust is so important, and it does build over time,” Bose CEO Lila Snyder said. “We have a not-so-silent agreement about ‘no surprises.’ That level of transparency helps to build and maintain the trust over time. We also talk a lot and that helps. Frequency is important. We’re not playing catch up. When I do have issues or need advice, I’m not spending 30 minutes catching Bob up to where we are.”

A transparent, trust-based relationship between the board chair and CEO can unleash the full potential of the board, CEO, and entire leadership team. A difficult relationship can distract the CEO, erode the board and leadership team’s confidence in them, and ultimately have real consequences for value creation and management. “The leadership team and company more broadly feed off of the board to a large extent,” MetLife CEO Michel Khalaf said. “If there is misalignment or insufficient alignment, that’s very difficult to conceal.”

Our interviews, data, and experience show that the most effective chairs and CEOs are highly attuned to this dynamic and remember that building trust is about both competency and context — demonstrating critical behaviors, day in and day out, that strengthen it, while putting extra care into the scenarios where it is most likely to be deepened or lost. Read More.

Featured Blog

The Evolving Role Of Board Of Directors And Management Teams

As boards navigate the complexities of global market dynamics, technological evolution and stakeholder expectations, boards are compelled to transcend traditional fiduciary duties and embrace a diverse as well as evolving proactive stewardship. Management teams are tasked with supporting board directives yet ensuring alignment on vision while adapting to real-time market dynamics. This dual evolution signifies a governance model where agility, accountability and shared leadership meet to drive sustainable value creation in a volatile landscape. Read More.

Readworthy Resources

The Increasing Focus Of Organizations On Sustainability And Long-Term Value Creation
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Building A Diverse Board