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August 30, 2007

PM’s call and CEO salaries

Filed under: economics — odrf @ 8:40 am

 T Ram Mohan writes in Economic Times on Rising trend of  salaries of Indian CEOs….

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Many in the corporate world and the media have been dismissive of Prime Minister Manmohan Singh’s impassioned call for restraint on executive pay in his speech at the CII last week. The PM did not hector, he merely appealed to industry’s good sense. That good sense is not showing. Executive pay, we are told blandly, must be market-determined. Whether the market does a good job of determining pay is controversial everywhere. Without getting into this controversy here, this much can be safely said: the prime minister’s plea for moderation is not as outlandish as some would have us believe. For at least four reasons.

First, leaving aside the United States and, perhaps the UK, executive pay tends to be modest in most parts of the world. The knee-jerk response to this statement often is: that’s why the US is a lot more dynamic than other economies. Well, there’s a lot more to the dynamism of the US economy than big pay packets for executives — vibrant financial markets and huge subsidies for research coming out of defence budgets, for instance. Besides, prosperity is not confined to the US and there is no dearth of successful firms in, say, France, Germany, Scandinavia, Switzerland and Japan. Clearly, economic success is not just about outsized pay for top executives. There is the danger that the Indian elite’s admiration for things American may be leading to too close an emulation of the US economic model.

Secondly, the sharp rise in executive pay in the US has to do with a large variable component in the form of stock options. The argument for stock options is that by giving executives a long-term stake in their firms, it aligns incentives closely with performance. This is fine in a context in which firms, especially large firms, are run by professional managers.

But the Indian corporate landscape is very different. It is dominated by family-managed businesses and public sector firms. CEOs in family-managed businesses and often others at the top are from the family. They have large equity stakes in their companies. They receive substantial dividends that are not taxed in the recipient’s hands. Why would they need to pay themselves huge salaries? True, there are professionals as well at the top who need to be taken care of. But, even in the US, it is the CEOs who are incentivised the most. There is a chasm that separates the CEO’s package from those of other executives.
 

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