Managerial Remuneration in Loss-Making Companies: Decoding the Governance Paradox

When a company incurs heavy losses, faces cash-flow crunches, or delays debt servicing to lenders, high executive compensation frequently triggers public and investor scrutiny. However, paying crore-plus salaries to top management during loss-making years is not inherently illegal under Indian corporate law.

Understanding how this occurs—and how to spot it in annual reports—requires navigating the statutory provisions and governance nuances of the Companies Act, 2013.

1. The Legal Framework: How CEOs Get Paid Despite Losses

Under Section 197 of the Companies Act, 2013, standard managerial remuneration for public companies is capped at 11% of net profits for all managerial personnel combined. However, when a company has no profits or inadequate profits, special provisions kick in:

A. Schedule V Limits (Absence or Inadequacy of Profit)

Companies in a loss-making scenario can pay executive directors based on their Effective Capital (share capital + reserves – investments/losses). The statutory limits under Schedule V, Part II are structured into tiered slabs:

B. The Special Resolution Bypass

If a company wishes to pay its Key Managerial Personnel (KMP) an amount exceeding these Schedule V limits, it can legally do so by:

1. Obtaining approval from the Nomination and Remuneration Committee (NRC) and the Board of Directors.

2. Passing a Special Resolution at a shareholder meeting (requiring at least 75% majority vote).

3. Securing prior approval from lenders/banks/financial institutions if the company has defaulted on its debt obligations.

2. How Companies “Bend” or Navigate the Rules

While statutory provisions provide flexibility, governance concerns arise when companies manipulate disclosures or bypass investor intent:

• Fixed Salary vs. Performance Incentives: Companies often structure executive pay with high fixed components (base salary, perquisites, allowances) that remain untouched regardless of operational losses.

• Redefining “Special Approvals”: Passing special resolutions during periods of weak retail investor turnout allows promoter-heavy boards to approve remuneration above statutory limits.

• Excess Remuneration Refunds: If a company pays remuneration in excess of the legal limits without prior approval, the director holds that excess money in trust for the company and is legally bound to refund it unless shareholders explicitly waive the recovery via a special resolution.

3. Red Flags: Where to Find This in the Annual Report

To evaluate whether executive pay is aligned with company performance, investors should examine specific sections of the Annual Report:

I. Board’s Report & Annexures

• Extract of Annual Return / Remuneration Disclosures: Search for the ratio of the remuneration of each director to the median remuneration of the employees. A widening gap during loss-making years indicates poor alignment.

• Details of Managerial Remuneration: Look for explicit notes indicating whether remuneration paid was within the limits of Section 197 read with Schedule V.

II. Corporate Governance Report

• Check the Nomination and Remuneration Committee (NRC) section to see the criteria used to determine executive compensation during distressed periods.

• Look for disclosures regarding shareholder resolutions passed to approve excess compensation.

III. Financial Statements & Auditor’s Report

• Notes to Accounts (Related Party Transactions): Check the exact breakdown of short-term employee benefits, post-employment benefits, and stock options granted to Key Managerial Personnel (KMP).

• Statutory Auditor’s Report: The auditor is required to report under Section 197(16) whether the remuneration paid to directors is in accordance with the law and whether any excess pay was drawn. Search for words like “excess remuneration,” “pending approval,” or “held in trust.”