Economics should govern remuneration

Over the last many years, most companies have conveniently approached executive compensation with no reference to established economic fundamentals. Economics states that the nature of contribution and risk that a shareholder brings is different to that of the agent of the shareholder, namely professional manager, and which in turn is different to that of an ordinary employee. Hence, each of these resource providers needs to be compensated differentially.

The shareholder puts his capital to risk, and hence is justified to seek a return in excess of 20 per cent compound annual growth rate (CAGR). The market pays him his remuneration through multiples. The professional manager does not put to risk his net worth. He sells his ability, which is perishable in time, but is transferable to others with a very small deterioration, even in bad times, should it be in demand. If it is not in demand it has no worth or low worth.

The ordinary worker, who brings his technical ability and not the strategic ability, should normally be remunerated at best in line with 15 years CAGR inflation or one to two per cent more. The reason being that here thousands of people perform a broken down complex work, and hence the per-person work is simpler than that of the professional manager, who handles the complex job of decision making on resources allocation and carries the risk of destroying the shareholders' capital, the most precious resource. So this professional manager has a justification of being remunerated much higher than the 15 years CAGR inflation, even three to five per cent more than this benchmark. This is both a complexity premium and a demand-and-supply price premium.

If you put all this together, we will arrive at a number of about two per cent above 15 years CAGR inflation as the sustainable wage rise any economy can afford. That is why economists believe that over a 15-year period if compensation in any economy grows above five to seven per cent CAGR, it becomes an important contributor to inflation in the economy. This becomes a circular reference, one pushes the other. This also leads to certain industries which are reckless with compensation increases, becoming globally non-competitive. We have evidence of it in Japan and now in India.

Now let us examine the bogey that in India talent shortage is leading to the wage inflation. In a country of 1.25 billion people, where at least 60 per cent have more than 35 years of productive life, how can there be a talent shortage? This happens when the industry follows a clutch of ill-thought-out and lazy practices. The most ludicrous one is the presumption that readymade talent was available to any economy in the world at any stage. Every industry all over the world invested in creating vocational and professional training infrastructure along with the government to relieve itself off the burden of high wages, which arises out of a lopsided demand-supply situation.

The Indian industry has been irresponsible in killing the apprenticeship programme and loading all responsibility for delivering able employees on academic institutions. They also have put excessive weighting on academic qualification over vocational ability. This has resulted in the 'overqualified and under-skilled' phenomenon, which in turn leads to overpricing at all levels of jobs. Is it not laughable that the information technology industry uses engineers to code, the banking sector uses graduates to do tellers jobs, and the fast-moving consumer goods industry uses graduates to do first-level selling. The most mediocre person who has passed 12th class should not take more than 100 days to pick up these skills.

Add to this our MBA fixation. The world over, less than 25 per cent of the first-level management executives are B-school graduates. But in India 100 per cent are from this tribe, with a generous sprinkling of engineer MBAs. Even after this we complain about talent. If an organisation or industry is unable to source 90 per cent of its requirements at the base rate and without paying an acquisition premium, then they surely have poor-quality human resources managers. Their CEOs and boards should also be of poor quality for blessing such a poor strategy. Year after year paying an acquisition premium compounds the wage cost and inflation.

The most destructive part of wage inflation is the poor-quality governance in large parts of the industry, especially the multinational and promoter-controlled firms in India. In India it is possible to get any salary benchmarking report from a consultant for a right price. All it takes is to cleverly choose the comparator set. Then your top management's pay can be shown at as low a percentile as you desire. Add to this the specious practice of these consulting firms doing a survey with their clients or prospective clients on what the likely wage increase is going to be. They then do the cross-influencing and get out a number. In the last 10 years it has been upwards of 12 per cent. The press carries it. The HR head takes this to his board and thumps the table on how there will be a talent exodus if the wage rise is lower than this. Is it a surprise that we are trapped in a top management wage spiral? The ability of any of these consulting firms to verify the veracity of the data supplied by the participants in any salary survey is next to nothing. There is no authentic public data available. This leads to most of these surveys, both syndicated and the standalone ones, being seriously suspect.

A few responsible Indian organisations have had good-quality board governance. In these organisations you will see the 15-year CAGR wage rise around nine per cent for middle and junior staff and around 12 per cent for the senior and top management. Most Indian companies carried out two justifiable wage corrections to catch up with the world in late 90s and around mid-2000s. In these organisations the governance committee members have not fallen prey to the widely prevalent questionable practices on top management remuneration. But most organisations have impressionable and pliable governance committees, wherein the blackmail that the top talent will flight succeeds. In multinational firms their regional leadership in Singapore and Hong Kong do not have any meaningful bandwidth to exercise good governance.

The top management wage spiral has exacerbated the gap between them and the first-level employee. This is not tenable in the longer run. This will lead to militant trade unionism because it leads to gross inequity. In conclusion, the argument is not against using wages and increases as a lever to attract and retain talent. It is to anchor this on good economics and not on questionable or illogical premises.

K. Ramkumar is executive director of HR at ICICI Bank.