This article is written by Nishish Mishra Rajnish, pursuing Diploma in Companies Act, Corporate Governance and SEBI Regulations from LawSikho.
Remuneration paid to the management is often the bone of contention between the shareholders and the management because the shareholders don’t really get to see the performance of the company until the financial statements are placed before them at the annual general meeting and it is at that very meeting that they are supposed to review and approve the remuneration to be paid to managing directors or managers.
Remuneration is also an above the line item in the profit and loss account, reducing the available profits for distribution to the shareholders. Hence, they want to ensure that the managerial personnel are being paid appropriately and commensurate with their performance.
In this article, we will briefly discuss which companies are required to constitute a Nominations and Remuneration Committee, its scope, functions and duties in detail.
Which companies are required to constitute a Nomination and Remuneration Committee?
Section 178 of the Companies Act, 2013 talks about the Nomination and Remuneration Committee. The following classes of companies are to constitute a Nomination and Remuneration Committee of the Board:
- Listed companies;
- All public companies with a paid-up capital of ten crore rupees or more;
- All public companies having a turnover of one hundred crore rupees or more;
- All public companies, having in aggregate, outstanding loans or borrowings or debentures or deposits exceeding fifty crore rupees or more.
Scope of the Committee
The scope of the Nomination and Remuneration Committee (“the Committee”) would inter alia include:
- To identify persons who are qualified to become Directors and who may be appointed in senior management in accordance with the criteria laid down, recommend to the Board their appointment and/or removal.
- To carry out the evaluation of every Director’s performance.
- To formulate the criteria for determining qualifications, positive attributes and independence of a director.
- To recommend to the Board a policy, relating to the remuneration for the Directors, Key Managerial Personnel and other employees. Such Remuneration policy shall be disclosed in the Annual Report of the Company.
- To review and recommend, subject to the Shareholders’ approval, the remuneration of the Managing Director and other Whole-time/Executive Directors.
Composition of the committee
The Committee will consist of at least three members who shall be appointed by the Board. The members of the Committee shall be Non-Executive Directors and of which not less than one-half shall be Independent Directors.
The Chairman of the said Committee shall be an Independent Director. If the Chairman of the Committee is not present at a meeting of the Committee, the members present may elect another Independent Director to act as Chairman for that meeting. The Chairman shall not have a casting vote on any matter in the event of any equality of votes. In such a case the matter will be presented to the board for approval.
The company secretary shall act as Secretary to the Committee.
The quorum of meetings of the Committee shall be a minimum of two independent members.
What do Nomination and Remuneration Committees actually do?
Board composition and evaluation
Any additions to the board of directors will be discussed by the nomination and remuneration committee and recommendations to the board will be made accordingly. The committee will consider the composition of the board of directors and ensure that it not only meets the requirements of the legislation but is also commensurate with the size and business of the company. Further, there has to be an ideal representation of skills on the board and diversity to enable discussion of strategic matters from all viewpoints. Though many corporates in India look at having founders and their friends/relatives/ support group/existing directors’ recommendations on the board, often management is willing to consider recommendations for induction of external individuals who have a high degree of expertise in matters relevant to the business of the company or a network which can be beneficial.
The committee shall review and recommend to the Board the size and composition of the Board, including the review of Board succession plans and the succession of the Chairman and CEO, having regard to that the Board comprises directors with a broad range of skills, expertise and experience from a broad range of backgrounds, including gender. The committee will also ensure that there is appropriate induction carried out for the different types of directors.
The committee will also play an important role in developing an evaluation mechanism for the board; the criteria for all aspects of the board functioning and the method of measurement will all be planned out.
The nomination and remuneration committee can review the criteria adopted by the Board for assessing the independence of the directors and provide recommendations to the Board on evaluating the independence. There can be an apparent conflict here since there are independent directors themselves on the committee, however, it may be remembered that the decision has to be ultimately taken by the board as a whole and the concerned director would not participate in the discussion on his independence.
Executive appointments and remuneration
It is the nomination and remuneration committee (NRC) that will determine whether or not there exists a need to appoint executives for specific positions unless of course, there is a statutory requirement to do so. The NRC shall also establish the profile of personnel to be appointed to these positions and reach out to the executive placement consultants accordingly. NRC will be reviewing the selection procedures and shortlisting candidates based on the established criteria.
The NRC will make recommendations to the Board for the appointment of the shortlisted candidates and also the remuneration and appointment terms to be offered to them based on the candidate profile, nature of work and size and complexity of the business.
One of the very important functions of the NRC is to manage the ESOP or ESOS plan of the company. It is the NRC that will make recommendations to the Board as to the pool of the stock options, the criteria for the grant, vesting schedule and conditions, strike price etc.
As far as the board and executive performance are concerned, it is the NRC that will ensure that the Board and the top management are appropriately incentivised to ensure performance. Many executive employment contracts have a significant degree of the variable or performance-linked payment mechanisms. The NRC will ensure that the key performance indicators for each of the executives are appropriately set and that these are appropriately communicated to them.
While there seems to be an apparent conflict where the board is evaluating its own performance, it must be noted that the performance of the board is evaluated as a whole i.e. it is not based on individual performances. Board evaluation criteria can involve questionnaires with questions as to whether Board has achieved the strategic objectives over 3-5 years, how efficiently are board meetings conducted, how is the quality of the information to the board, how are the relationships of the board with different stakeholders, how each director rates his own contribution to the board etc. There can be a rating mechanism for each question.
Policy formulation and implementation
The NRC is responsible to ensure that there are suitable policies in relation to remuneration prevalent within the company. Remuneration policies can be formulated with the following objectives:
- To ensure that the company’s remuneration structures are equitable and aligned with the long-term interests of the company and its shareholders and having regard to relevant company policies;
- To attract and retain skilled executives;
- To structure short and long-term incentives that are challenging and linked to the creation of sustainable shareholder returns; and
- To ensure any termination benefits are justified and appropriate.
- In the discharge of the Committee’s responsibilities, no director or executive should be directly involved in determining their own remuneration.
Duties, rights and responsibilities
- The Committee is authorised to review the following:
- Elements of the remuneration package i.e. salary, perquisites, retirement benefits, pension, separation compensation, and the structure of the remuneration package viz., the proportion of fixed and variable component, annual/mid-term increments, merit rewards, special payments, etc., of the Managing / Executive Director and that of the Key Managerial Personnel.
- Changes to remuneration package, terms of appointment, notice period, severance fees, recruitment, retention and termination policies and procedures.
- To recommend the shortlisted candidates who are qualified to become directors and who may be appointed in senior management and recommend to the Board their appointment and/or removal.
- The Committee shall review the succession plans, if any, for both executive and non-executive Directors.
- The Committee is authorized to seek any information it requires about any employee and the management is directed to cooperate with any request made by the Committee.
- The Committee may obtain outside legal or other independent professional advice with regard to issues pertaining to remuneration, incentives etc. Pertaining to industry practices as and when required.
- The Chairman of the Committee could be present at the Annual General Meeting to answer shareholders’ queries.
How can Nomination and Remuneration Committees effectively contribute to creating shareholder value?
The board of directors have certain fiduciary duties. Where the remuneration levels prevalent for the board or the top executives are not adequate and commensurate with responsibilities and payments from peer companies, they may feel a need to place personal interest before the company interest and therefore, benefit in some way from the company transactions. However, where the board and executives are adequately remunerated and suitably incentivised for performance, they will consistently contribute towards the growth of the company and increase its wealth, thus increasing the shareholder value in turn.
NRCS also play an active part in the executive appointment as well as exit terms. NRCS can ensure that inappropriate exit terms and payments are not offered to executives, where the retained earnings can take a hit.
We conclude that the role of the Nominations and Remuneration Committee is crucial and a committee like this is engaged in performing important activities such as policy formulation and implementation, executive appointments and remuneration, Board composition and evaluation and performance management. We also understand that the Nomination and Remuneration Committee can effectively contribute to creating shareholder value.
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