Overview

It has been three years since Aon Hewitt India started the Executive Compensation Survey. When launched, this was the first such survey being conducted by any consulting firm in India. Over the years, the study has matured with not only a much wider pool of data collection (our database size has increased by 250% over the last two years) but also far greater granularity in data. This has enabled us to analyze the data along a wider set of parameters – industry sectors, ownership types, revenue and employee sizes, etc. We have also started analyzing predictive indicators in the form of regression equations by sectors and business sizes to be able to assist clients in judging appropriate pay levels through a triangulation approach of benchmark data, market pay equations and current pay levels.

This survey was conducted between July and October 2012 and over this period, data was collated from 205 companies across a set of 12 industry clusters and ownership definitions. Companies reported data for their CEOs and direct reports to the CEO across a variety of functions and roles. There has been a fair bit of outcry across different forms of media on 'excessive' executive compensation and our survey results present an interesting representation on that issue.

Aon Hewitt believes that there is no silver bullet solution to target setting. nonetheless, boards and compensation committees can institutionalize a reasonably comprehensive target setting framework to set the 'bar' for the value that the management needs to create for its shareholders, and can assess whether their actual performance has met expectations in a transparent and objective way.

A Background of Volatility and Uncertainty

Most of the data that you will see in the following pages pertains to compensation decisions that were taken in the period between March and May of 2012. This was a fairly bleak phase for India Inc., the last quarter of 2012 had closed with a 2.7% profit growth1 compared to the previous year. Certain companies and a few sectors such as banking, cement, technology and pharma were holding

As against an almost uniform trend of greater than 13-14% increase in salaries over the last 10 years (with the exception of 2008-09), this year the salary increases across most jobs were in single digits.

up the numbers and without them it would have actually been a 9.6% drop in net profit year-on-year. Fy2012 closed on a negative note, with about 55% of listed companies posting a dip in profits2. While companies showed an increase of more than 20% on revenues, there was a significant squeeze on account of higher input costs. There was a general environment of gloom with almost no visible reforms and no big ticket projects being undertaken by the government. The HSBC PMI stood at 54.7, a marginally improved number than the previous quarter but far lower compared to 2010.

Remuneration committees across the country decided salary changes in the background of this economic and business environment. Our analysis of the data shows that the mood guiding these salary changes was either cautious optimism or a resignation to the reality that Indian executives will need salary increases for them to be retained. Let us look at how the different elements of compensation played out over this period for executives in India Inc.

Highlights from Our Analysis

1. Early Signs of the Brakes Being Applied?

We had an interesting challenge this year, with the increase in the size of the database, the average pay data fell compared to last year. This was primarily on account of a set of smaller companies that entered the survey. Hence, while on an aggregate basis we found the median executive pay across most jobs to have dipped from last year, the reality is slightly different. We analyzed salary increases using a set of about 150 organizations that were participants in the survey across both years and the results showed only a slight deceleration in salary increases for executive roles. As against an almost uniform trend of greater than 13-14% increase in salaries over the last 10 years (with the exception of 2008-09), this year the salary increases across most jobs were in single digits with an average increase on fixed pay by about 10% and on total pay (including annual and long-term incentives) was between 11-12%. To a large extent, these averages are influenced by certain roles such as R&D, sales and marketing, etc. which saw fairly high salary increases. Across the 25 roles that we covered in this exercise, about 60% roles had less than 10% salary increases.

2. Dilution of Any Significant Industry Differentials in Compensation at the Very Top

The core message that emerges from analysis of sector-specific data is that there is only a marginal differentiation in compensation levels for positions such as the CEO, COO, or CFO across industry types. This however, is not true for many of the other executive positions such as Head of Sales/Marketing, etc. where there appears to be sufficient differentiation by industry. The data reflects the lowest standard deviation from the mean at the CEO level across different industries, increasing marginally for the COO, CFO and Head of HR roles and then increasing significantly for other positions. In theory, this indicates far greater mobility for the top 2-3 positions across industries and also the fact that some positions are more critical across certain industries than others, e.g. the Head of R&D in an FMCG/ pharma company, at an average, earns more than 2x of standard manufacturing companies or the Head of Service who earns a far higher premium in telecom companies compared to other industries. Companies should, while constructing peer groups for executive positions, keep this factor in mind and ensure multi industry peer groups for certain core general management roles – currently, most organizations (more than 75% of respondents in our survey) use a simplistic approach of using peer groups for executive pay that are identical with the rest of the organizations.

3. Deriving Predictability and Patterns Executive Pay Levels Remains Elusive

The survey analyzes data across a range of anchors that go beyond just industry differentials. The purpose of this exercise is to identify patterns that can help us create predictive equations for our clients. In this, we came upon a range of interesting outcomes on the behavior of executive pay data:

a) Correlation of executive pay with financial scope factors: The survey had a fair mix of companies with revenue sizes ranging from less than `100 crores to greater than `50,000 crores. Given the wide range of sizes, we ran regression tests on pay data. The results showed a low Pearson Coefficient of Correlation (R2) value of 0.28 between pay and revenue size. This number looks particularly stark when compared to the same data for US CEO pay and revenue size, which stands at approximately 0.6. Similar comparisons apply for CFO/COO/CHRO roles as well, where the R2 value in India stands at approximately 0.30 as compared to US levels of 0.6-0.7. If we ignore the statistical considerations and look purely at the raw data, the average ratio in compensation between CEOs managing businesses in the range of `500–1,000 crores and CEOs managing businesses with more than `30,000 crores in revenue is only about 1.7x on fixed pay and about 2.9x

The average ratio in compensation between CEOs managing businesses in the range of `500-1,000 crores and CEOs managing businesses with more than `30,000 crores in revenue is only about 1.7x on fixed pay and about 2.9x on total pay.

on total pay. So, while the business size might be six times, the compensation multiple is never more than three times.

b) Correlation of executive pay with employee size: We included a comparison with employee size primarily so as to factor in the technology companies that have a very large employee base but may not necessarily be very large in revenue. Unfortunately for us, given the large number of unlisted companies in the survey, using market capitalization as a scope factor for business was difficult. Perhaps predictably, the R2 values were even lower with the number for CEO pay with number of employees being 0.12. The number for direct reports to the CEO was approximately 0.15-0.25. Again the raw data reveals very narrow compensation changes even when the size of the employee base changes significantly – a ratio of 2.0x on fixed pay between CEOs managing employee sizes of more than 25,000 as compared to CEOs managing a workforce of less than 500. The similar ratio on total pay is just 2.6x.

c) Correlation with ownership dynamics: In our study last year, we found some interesting trends in how CEO pay is very clearly correlated with the nature of ownership. not only is there a significant differentiation between pay on account of whether a company is listed or not, there is also a clear differentiation in pay on account of whether the company is promoter-driven (and this is largely the case in Indian companies) or shareholder-led (here it could be Indian companies as well as MnCs). Let us first look at the listing criteria. There exists approximately a 2x multiple between the pay for a listed company CEO and that of an unlisted company. We analyzed companies of similar size that were promoter-run versus those that were shareholder-run and as with last year's study, there appears a fairly clear premium for

There are still some gaps that remain in the whole structure of executive pay when compared to global standards – the pressing need is to ensure that the governance of executive pay is more rapidly aligned to global standards.

CEOs in shareholder companies vis-à-vis promoter-run businesses (only considering for jobs where the CEO is a professional and not a part of the promoter group).

d) Within all our different buckets of revenue, employee size, ownership types, etc., we found a distinctly wide range in compensation data, e.g. for companies within a revenue range of `1,000-2,000 crores, the minimum to maximum range on total pay was approximately 300%. Similarly, for companies in the revenue range of `2,000-5,000 crores, the range on total pay was approximately 230%.

The analysis across all of these various anchors leads to a basic fact that there is yet no clearly discernible pattern with regard to factors that determine executive compensation. And while we are able to generate some level of predictive equations in certain sectors and in certain size buckets, a more broad-based index is still almost impossible to create.

4. Pay Mix Continues to Evolve into a More Performance-driven Structure

The mix of pay for executives across fixed, annual and Long-Term Incentives (LTI) has evolved continuously over the last decade. The move has been towards a far greater performance alignment in the overall pay for CXOs. This year, we see the pay mix for the CEO reflect an almost equal split between fixed and variable and the variable component being structured marginally more on LTI as compared to annual bonuses. This approach is replicated across direct reports to the CEO with an approximately 57-43 split between fixed and variable compensation, and variable pay being split with a higher weightage towards LTI. It is interesting to note the trend towards greater prevalence of LTI in overall CXO pay, seems to be gradually getting aligned with the global phenomenon of increasing focus of incentives to payout over a longer

term as opposed to annual. However, the fact is that even though executive pay has a significant presence of LTI, the benchmarking approach is still largely anchored around either fixed pay or fixed pay and annual incentives (71% of companies reported either as their anchor for positioning), therefore it will still take time before long-term incentives get inherently anchored as an element of compensation.

However, pay mix for Indian executives still seem very different from global patterns, with variable component for Indian CEOs being much lower as compared to most Western geographies. As the chart below represents, except for China, most countries have more than two-thirds of total CEO pay being delivered through incentive compensation. India, in comparison, has so far moved up to having only about half of compensation being incentive-driven. For direct reports to the CEO, India is also far more conservative as compared to most global economies where at least 50% of the total pay for these positions is delivered through a combination of annual and long-term incentives. Interestingly, we did not find any clear differences in the pay mix between heads of support functions and individuals heading business roles.

Annual incentive structures are primarily defined around business incentive awards, while long-term incentives are largely driven on stock option programs with almost 50% of all LTI plans being structured around the option program. The prevalence of deferral in annual incentive structures is still fairly nascent in the Indian context, and most annual incentives plan payout in the same year as they are earned. From a LTI context however, we find most plans being structured on a 3-5 year vesting schedule with a greater prevalence towards the shorter end of the spectrum.

5. Performance Pay is Driven Entirely on P&L Metrics

A discussion on incentive compensation is incomplete without an analysis of what drives incentives for executive jobs across organizations. Particularly in long-term growth economies such as India, the choice of metric goes a long way in determining the extent to which the earning potential of an executive is tied to real performance. Our study collected data on performance metrics for CEO, business head and functional head roles and the results reflect a strong alignment towards driving P&L performance across most organizations. At the CEO level, almost all companies have metrics on a combination of profit/ profitability and cost savings parameters, metrics around top line growth are prevalent in almost all companies as are non-financial metrics such as customer satisfaction or employee engagement. However, the interesting thing is that very few companies seem to drive metrics that reflect efficiency parameters e.g. Return on Capital, Return on Equity or Assets, etc., only 5% of respondents highlighted these as metrics in their CEO scorecard. The structure gets broadly replicated at the business head levels with profitability metrics and top line metrics appearing across all organizations, there is a higher prevalence of non-financial parameters. There seems almost no difference in the kind of metrics being used for business and function head positions across most organizations. While broadly the pattern around usage of metrics seemed to remain consistent across different industries, ownership buckets or organizational life stages, some facts do get validated. For instance, public listed companies seemed to have a significantly greater focus on profitability while private companies focused more on free cash flows. Although intuitive, early stage businesses show a far greater focus on input metrics such as service quality, etc. while having lesser focus on cash flow or profitability as compared to growth or mature businesses.

In Closing

The study captured some interesting insights on the thinking within companies with regard to executive pay levels. In line with some of the data that we have discussed in this note, we found organizations worrying less on fixed pay or benefits but being more concerned about aspects such as ensuring long-term incentive earning opportunities are appropriately structured or ensuring that performance metrics and targets are designed to ensure line of sight along with the impact of achievability, etc. We found organizations realizing and worrying about communicating the right value of long-term incentives to the executive team.

Executive compensation in India is still in a bull market phase and while there have been some moderations on account of a muted economic and business performance, the trend line remains intact. Also while organizations agree to the fact there are still some gaps that remain in the whole structure of executive pay when compared to global standards – the pressing need is to ensure that the governance of executive pay is more rapidly aligned to global standards.

We hope this report will help HR departments and remuneration committees take more informed decisions towards managing executive compensation in their organizations.

Data Sources

1. Business Standard Study, May 2012
2. Hindu Business Line

		Anandorup Ghose Director – Executive Compensation and Governance, Aon Hewitt, India For more information, please write to us at totalrewards@aonhewitt.com