The Governance of Remuneration in Indian MFIs: Lessons from The Indian Experience

Ramesh S Arunachalam
Rural Finance Practitioner

As we move through the current crisis in Indian micro-finance, there are several
important lessons for me and the first of these relate to Governance in Indian MFIs and I
articulate the same in a series of posts, for readability and also segregating the key issues. The
first post is on the governance of remuneration and here is some food for thought and I am
sure this applies to other countries and their micro-finance contexts as well…

Some of the compensation practices that I have come across in Indian micro-finance include the
following: Irrational and unusually high compensation of senior management, founder/other
directors and much of this seems to be similar to that observed in financial services companies
during the sub-prime and global financial crisis. Further, adhoc bonuses, pay raises (followed by
sudden termination), the grant of shares when options have been sanctioned, the non-
transparent pricing of options, provision of (huge) loans to enable founders and board members
to buy their own company shares are some of the key compensation/remuneration issues in
Indian micro-finance. Much of this practice is observable during the last 4/5 years, although the
seeds were sown much earlier.

While the above provides a brief summary of the various existing practices, here are the lessons
that I learnt from the Indian micro-finance experience:

Lack of Arms Length Decisions and Negotiations: The governance of remuneration and

incentive systems seems to have (apparently) failed in some Indian MFIs because decisions
and negotiations (carried out) have not been at arm’s length. Conflicts of interest at various
levels have aided such improper decision-making and negotiation and much of this is applicable
to remuneration and incentive systems for a range of senior management personnel and not
just the CEO or Managing Director or Chairman of the Board. There are several examples from
the Indian micro-finance context but I have decided to refrain from naming organisations and
people because of the sensitivities involved…

Inordinate Level of Influence of Senior Management in Establishing Remuneration

Schemes: In the several cases that I have personally seen, senior management generally
appears to have far too much influence over the level and conditions (including measures) set
for performance based remuneration. On the other hand, boards are often unable to or
sometimes, even incapable of exercising objective, independent judgement. Here again, there
are serious conflicts of interest, which certainly exacerbate this whole issue – in fact, this has
been one of the most important reasons for inaction by the board against inappropriate
remuneration proposals of senior management in MFIs

Medium and Long Terms Risks are Not Taken Into Account: In some cases that I have
closely observed, the relationship between performance and remuneration is rather tenuous and
sometimes, even difficult to establish, especially, given the nature of micro-finance operations. A
very critical aspect here is that medium as well as long term risks and possibility of adversarial
political action are rarely factored into the whole process – something that should have been
done, given the nature of micro-finance and given what has happened in Andhra Pradesh
recently
Complicated and Opaque Remuneration Schemes: Some of the MFI remuneration schemes
are fairly complicated and also opaque in terms of shrouding actual conditions in the operation
of scheme and the consequences. What I am saying is that these (operational conditions and
terms) are perhaps not clear and obvious to the naked eye of an unassuming observer. These
conditions also tend to encourage excessive and mindless (growth and) risk taking…

Mere Disclosure is Not Transparency: While transparency (in some cases) may exist in terms
of disclosure, several MFIs couch the main characteristics of their performance related
remuneration programs in verbose technical language and thereby make it very difficult for
comprehension to the normal reader. Very rarely do we get information on the following: a) The
total cost of the remuneration program to the MFI; b) The specific performance criteria and
measures along with their conceptual and operational definitions; and c) The manner in which
remuneration has been adjusted for relevant risks – especially, medium and long term risks as
well as risk of political action (which is so relevant today). Without question, MFIs will surely
need to have remuneration and incentive systems that focus and encourage at least on the
medium term, if not long-term performance. This, in turn, means that MFIs must choose to
reward their senior management after some actual performance has been realised and that has
not usually been the case – a good example is a recent high front loaded one-time bonus paid
to a senior management executive of a large MFI

Overall, remuneration does not seem to have been established through an explicit governance
process where the roles and responsibilities of all stakeholders involved, including committee
members, consultants, risk managers and others, are clearly defined and separated (without
conflict of interest). The roles given to non-executive independent board members in the
process - although they may seem somewhat appropriate - again appears to be laden with
serious conflicts of interest. And finally, while remuneration policies are sometimes submitted to
the annual meeting and subject to shareholder approval, much of this seems to be a routine
matter, with minimal (informed) discussion…because of aspects mentioned earlier…

Therefore, given the above, in my opinion, a key question that stakeholders always need to ask
is whether the compensation approaches being pursued are indeed consistent with the
institutions (MFIs) ethical values of creating value for clients and its objectives, strategy and
control environment as well as that of the overall industry? This aspect on compensation is
nicely summarized by Mr Jan Postmus in his paper {Cited from Arunachalam, Ramesh S
(2010)} and reproduced in Box below:

Executive remuneration: Issues to

consider when placing people in Africa
FEATURE ARTICLES | CLAUDE HARDING | SEPTEMBER 19, 2010 AT 13:27

The global financial crisis, which severely battered international economies, brought executive
remuneration into the spotlight. However, structuring of executive remuneration for organisations
employing executives in Africa, adds another layer of complexity to this contentious subject.
Karen Crous, associate director: Executive Reward for PricewaterhouseCoopers (PwC) says, “The lack of
skills available in Africa often requires organisations to employ or redeploy senior expatriates to run the
business division in the respective country. There are a variety of issues organisations need to consider
when placing senior people in African countries, particularly in terms of executive remuneration and the
structuring thereof.”
Developments in corporate governance brought complexity and additional requirements to remuneration
practices, forcing organisations to amend their executive compensation processes. In addition, insufficient
credible data in the war of talent in Africa makes it difficult to decide what to pay executives.
Crous continues, “Unlike South Africa and other western countries, where access to a company’s
financial reports are freely available, detailed executive compensation information is not as easily
accessible in certain African countries. As a result there is a dire need for independent remuneration
committees to oversee the compensation process and report to the board on any relevant issues.”
Setting pay levels
To overcome the lack of reliable benchmarking data in Africa, multinationals should split pay levels into
three categories:
Local employees: These are usually citizens of the country and operate at junior levels as they don’t yet
have globally marketable skills.
Expatriate employees: These are more senior employees assigned to the host country for their skills. In
many cases these employees are globally mobile and are not permanently placed in the country making
the structure of their compensation a little trickier. The salary and benefit expectations of these employees
are more complex when a wide range of benefits is expected.
Global employees: These are senior people who have globally marketable skills, generally paid in
Dollars or Euros. One of the most significant factors to consider here is that these employees’ salaries
must be adjusted for local cost of living and currency of the country in which they reside.
When companies conduct benchmarking to gauge salaries, they compare themselves to similar
companies or a peer group which considers the number of employees, market capital, turnover and profit
after tax. While the benchmarking is being conducted it is vitally important to consider the three categories
of employees.
Crous concludes, “When placing employees into positions in other African countries it is also important to
understand the country’s tax systems and exchange control legislation which further adds complexity.”
Executive Remuneration
In recent years, executive remuneration has been the focus of considerable attention
from the public, media, academics and policy makers alike. It is a quintessential
corporate governance issue about which there are many different views and opinions.
In this section of the ECGI website, we set out some of the arguments and provide
links to academic and other material that can shed light on the debate, notably
proprietary research that examines the international system of senior management
remuneration, from a  regulatory and corporate governance perspective. 

At the European level, regulation aims to harmonise disclosure. Member states have transposed this EU
regulation to different extents. The US and European approaches portrait several divergences in regulation
and practice, but also similar and common initiatives that aim to create a global best practice
environment.

The debate on executive remuneration can be approached from various angles: as optimal pay structure
for aligning pay with performance in order to reduce agency costs; as a regulatory issue with the objective
of remedying any system flaws; and as a public policy concern. The debate is also multi-jurisdictional,
reflecting the changing dynamics of remuneration, regulation and corporate efficiency in different
governance systems.

The objective of this topic page is to share ideas, highlight issues, put forward opinions and raise debates
for further reforms in the light of current business practice. The ECGI itself does not take a position on
these matters. Rather, the purpose of the Institute is to generate research, stimulate debate and
disseminate best practice. In these pages therefore, you will find links to proprietary ECGI research and
other references to material on this important topic. They are continuously developed as new information
becomes available.

The Editor of this topic page is Maria-Cristina Ungureanu, a Researcher at the University of Genoa, to
whom any comments and suggestions should be sent (MariaCristina.Ungureanu@unige.it). See:

The EU context

Member states’ perspective

ECGI research and debate

ECGI Working Papers

ECGI Research members

Remuneration is another term for employee pay. There are a number of ways a company might
recompense an employee for work beyond a standard wage or salary. These methods of paying include
offering benefit packages, health insurance, stock options, time off of work, among many others.

Basic remuneration is the employee's salary or wage, which may be computed in several different ways.
The employee may receive an hourly wage, and gets paid specifically for hours worked. Other employees
get a salary or set amount of pay per month, twice monthly, bi-weekly or per year, no matter how many
hours they work. Many sales employees work on a commission basis and may only make money if they
sell products and/or services. Others have a base salary they draw, in addition to added commission
based on their sales.

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In addition to salary or wages, many companies offer additional types of remuneration, especially to full-
time employees. One type is to give a certain amount of paid vacation or sick days per year. Some
countries mandate that employees receive a specific amount of time off, and other countries don’t have
such mandates but still have many employers who give this time to employees each year. Amount of
time, when not mandated, may vary and often increases the longer an employee stays working for a
specific employer.

Another form of remuneration is health insurance, which is not offered by all companies and varies as to
quality and cost. Companies typically pay part of the insurance premium. Health insurance may or may
not extend to immediate family members like spouses and minor children. Dental and life insurance could
also be offered as part of a remuneration package.

Other types of benefits that are part of remuneration could include ability to invest in company stock, or to
create 401ks where the company matches some of the employee’s contribution. This can help increase
the employee's ability to save money, though companies usually have a matching limit such as three or
five percent. Company stock investment can be good or badremuneration — if the company is not yet
public but plans to go public, being able to buy stock early, should the company be successful, can be a
wealth building strategy. Strong public companies with rising stock values may prove to be a good
investment.

There may be additional forms of remuneration that are frequently classed as fringe benefits. Employees
might have education costs reimbursed, they could have access to company owned vacation spots, or be
given a company credit card. With the exception of education programs, luxury benefits are usually only
available to executive employees.

Remuneration
 
Remuneration Compensation
 
Employee Remuneration
 
Remuneration Plan
 
Salary Remuneration
 
Pay Remuneration
 
Remuneration Rate

An employee can determine total pay plus benefits by adding together all things the employer pays with
salary. By adding insurance contributions, matching 401ks, funds paid for education, vacation days and
so on, an employee can calculate total remuneration paid per year by their employer.

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The Governance of Remuneration in Indian MFIs: Lessons from

The Indian Experience
Ramesh S Arunachalam

Rural Finance Practitioner

As we move through the current crisis in Indian micro-finance, there are several important
lessons for me and the first of these relate to Governance in Indian MFIs and I articulate the same in a
series of posts, for readability and also segregating the key issues. The first post is on the governance of
remuneration and here is some food for thought and I am sure this applies to other countries and
their micro-finance contexts as well…

Some of the compensation practices that I have come across in Indian micro-finance include the
following: Irrational and unusually high compensation of senior management, founder/other directors and
much of this seems to be similar to that observed in financial services companies during the sub-prime
and global financial crisis. Further, adhoc bonuses, pay raises (followed by sudden termination), the grant
of shares when options have been sanctioned, the non-transparent pricing of options, provision of (huge)
loans to enable founders and board members to buy their own company shares are some of the key
compensation/remuneration issues in Indian micro-finance. Much of this practice is observable during the
last 4/5 years, although the seeds were sown much earlier.

While the above provides a brief summary of the various existing practices, here are the lessons that I
learnt from the Indian micro-finance experience:

Lack of Arms Length Decisions and Negotiations: The governance of remuneration and incentive
systems seems to have (apparently) failed in some Indian MFIs because decisions and negotiations
(carried out) have not been at arm’s length. Conflicts of interest at various levels have aided such
improper decision-making and negotiation and much of this is applicable to remuneration and incentive
systems for a range of senior management personnel and not just the CEO or Managing Director or
Chairman of the Board. There are several examples from the Indian micro-finance context but I have
decided to refrain from naming organisations and people because of the sensitivities involved…

Inordinate Level of Influence of Senior Management in Establishing Remuneration Schemes: In the

several cases that I have personally seen, senior management generally appears to have far too much
influence over the level and conditions (including measures) set for performance based remuneration. On
the other hand, boards are often unable to or sometimes, even incapable of exercising objective,
independent judgement. Here again, there are serious conflicts of interest, which certainly exacerbate this
whole issue – in fact, this has been one of the most important reasons for inaction by the board against
inappropriate remuneration proposals of senior management in MFIs

Medium and Long Terms Risks are Not Taken Into Account: In some cases that I have closely
observed, the relationship between performance and remuneration is rather tenuous and sometimes,
even difficult to establish, especially, given the nature of micro-finance operations. A very critical aspect
here is that medium as well as long term risks and possibility of adversarial political action are rarely
factored into the whole process – something that should have been done, given the nature of micro-
finance and given what has happened in Andhra Pradesh recently

Complicated and Opaque Remuneration Schemes: Some of the MFI remuneration schemes are fairly
complicated and also opaque in terms of shrouding actual conditions in the operation of scheme and the
consequences. What I am saying is that these (operational conditions and terms) are perhaps not clear
and obvious to the naked eye of an unassuming observer. These conditions also tend to encourage
excessive and mindless (growth and) risk taking…

Mere Disclosure is Not Transparency: While transparency (in some cases) may exist in terms of
disclosure, several MFIs couch the main characteristics of their performance related remuneration
programs in verbose technical language and thereby make it very difficult for comprehension to the
normal reader. Very rarely do we get information on the following: a) The total cost of the remuneration
program to the MFI; b) The specific performance criteria and measures along with their conceptual and
operational definitions; and c) The manner in which remuneration has been adjusted for relevant risks –
especially, medium and long term risks as well as risk of political action (which is so relevant today).
Without question, MFIs will surely need to have remuneration and incentive systems that focus and
encourage at least on the medium term, if not long-term performance. This, in turn, means that MFIs must
choose to reward their senior management after some actual performance has been realised and that has
not usually been the case – a good example is a recent high front loaded one-time bonus paid to a senior
management executive of a large MFI

Overall, remuneration does not seem to have been established through an explicit governance process
where the roles and responsibilities of all stakeholders involved, including committee members,
consultants, risk managers and others, are clearly defined and separated (without conflict of interest). The
roles given to non-executive independent board members in the process - although they may seem
somewhat appropriate - again appears to be laden with serious conflicts of interest. And finally, while
remuneration policies are sometimes submitted to the annual meeting and subject to shareholder
approval, much of this seems to be a routine matter, with minimal (informed) discussion…because of
aspects mentioned earlier…

Therefore, given the above, in my opinion, a key question that stakeholders always need to ask is
whether the compensation approaches being pursued are indeed consistent with the institutions (MFIs)
ethical values of creating value for clients and its objectives, strategy and control environment as well as
that of the overall industry? This aspect on compensation is nicely summarized by Mr Jan Postmus in his
paper {Cited from Arunachalam, Ramesh S (2010)} and reproduced in Box below:

Box: Creating Value for Clients is the Raison d’ être of an MFI[i]

“The second lesson from the financial crisis deals with the huge bonuses that fuelled the crisis. The Dutch
book ‘de Prooi’ (‘the Pray’)[ii] concludes that the excessive remunerations in the banking and financial
sector failed. Especially the investment bankers took too many risks in their hunt for excessive bonuses.
One of the main and important conclusions of this book is that banks need to become reliable, sound and
maybe a bit ‘dull’ again with the core focus on the client and share value becomes as stable as an
‘government bond with a little extra’. This lesson is utmost valid for the microfinance sector where the
clients consist of mainly illiterate clients.[iii] The MFI needs to be responsible for its clients in the first
place and not for its investors. Both the MFI and the investors in microfinance need to be fully aware of
the fact that the client always stays central. High expectations from investors about returns on their equity
investment by creating increased share value for personal gains (which is happening frequently
nowadays) needs to banned from the microfinance sector. We need to make sure that greed and
excessive self enrichment, which is the root cause of the financial crisis, does not get a hold on
microfinance. We know by now that this will become the downfall of the microfinance sector. If banks now
want to become reliable, stable and ‘dull’ again and return to conventional banking, why should
microfinance want to continue to measure itself with the investment bankers in the capital markets?
Microfinance is not about creating personal gains rooted in greed. An MFI needs to be focused on
creating maximum value for its clients. That is the raison d’ être of an MFI.”

To summarise, “Compensation…is one factor among many that contributed to the financial crisis that
began in 2007. Official action to address unsound compensation systems must therefore be embedded in
the broader financial regulatory reform program, built around a substantially stronger and more resilient
global capital and liquidity framework. Action …must be speedy, determined and coherent. Urgency is
particularly important to prevent a return to the compensation practices that contributed to the crisis.”[iv] I
hope that the RBI sub-committee focuses on this aspect as part of its Micro-finance regulatory exercise…

[i] Jan, Postmus (2010), “Micro-finance at Cross Roads”, Unpublished Working Paper

[ii] De Prooi (‘the Prey’), about the rise and fall of ABN AMRO, a fascinating book written by J.Smit, 2008,
recently translated in English

[iii] Jan Postmus, Lessons for Microfinance (based on ‘the Prey’), 2009 at http://www.microfinance.nl/en-
GB/Content.aspx?type=news&id=196

[iv] Quoted from BIS paper on Compensation and Corporate Governance, 2010

Posted by Ramesh S Arunachalam at 9:22 AM   

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