Sunday, December 30, 2012

Narayana Murthy on CEO pay

How do we determine CEO pay? Narayana Murthy, writing in ET, suggests that the ration of the  highest to the lowest pay in a company should be of the order of 20-25. This is rather more liberal than what Peter Drucker, the management guru, had proposed many years ago: 5: 1. But even NRN's prescription is way below what obtains in the corporate world today. In India, I would imagine the ratio is as high as 300: 1 or even 500:1 in many companies. If we factor in perquisites and stock options, the differential escalates even more. It is only in the much-derided public sector that NRN's prescription comes close to being true- and, that too, when you exclude the market value of perquisites such as housing provided by the company.

NRN's argument that companies are bound to benchmark pay with global practices is not persuasive for the simple reason that overseas companies do not have very clear norms for setting CEO pay. Nor is one persuaded by the point about independent directors setting pay- all of us know how independent these directors and how generous they can be when they are looked after well by the company.

The way CEO pay is set is just another manifestation of the fundamentally inequitous nature of modern society- those at the top will simply get away with doing whatever suits them. The best we can ask for more comprehensive disclosure not just of the total pay packages at the top but of the norms used for setting pay. The latter is seldom made available to shareholders or the general public.

More broadly, the answer to reining in private sector pay is to have a public sector alternative that offers a different lifestyle- more security, more job satisfaction, linked to more modest pay. When people have that sort of a choice and many spurn private sector salaries, however attractive, in favour of something that is inherently more satisfying, that might contribute to limiting pay in the private sector. 

Thursday, December 20, 2012

Global economy more crucial to growth than reforms

India's growth prospects, it is generally agreed, should improve in the next year. That is because the global outlook has improved. One indication is the return of FII flows into India in a big way- net FII inflows this calendar year are over $20 bn, the same as in 2010. FII money fled India last year following the Eurozone crisis. The relatively stability in the Eurozone this year has prompted a return.

Note that FII flows did not return because of the burst of reforms. The bulk of the FII flows , $12 bn out of $20 bn, came into the country by August whereas the reform burst happened in September. This underlines an important point: what happens to the economy in the near future will be governed more by global conditions that any reform initiatives.

This proposition is borne out by the fact that India grew at 8-9% in 2004-08 without any serious reforms. Similarly, growth plummeted to 6.8% in 2008-09 at the peak of the global crisis. India's economy is far more integrated with the world economy than before through both trade and capital flows. Another reason the global economy matters is more is that private investment in infrastructure, which drove growth earlier, is hampered now by regulatory and legal issues and high leverage in infrastructure companies. We can't really expect domestic investment to drive growth in a big, given the difficulties in the big growth area, infrastructure.

As for reforms, the potential impact of these is constrained by two factors. One, the persistence of high inflation- this won't change in the next two to three years as domestic prices are gradually aligned with international prices. Two, the fiscal deficit will remain high upto 2014 if only for electoral reasons. Both these will mean a low rate of savings. High inflation will keep financial savings low as households prefer to park their savings in gold. A high fiscal deficit implies lower net savings. The fiscal deficit will decline substantially only when growth revives strongly on the back of a revival in global demand. It is unrealistic to expect that we can compress fiscal deficit to a level where interest rates fall, investment revives and growth accelerates.

Whichever way you look at it, the global outlook holds the key to India's return to the growth path of 8%. The Eurozone crisis will stretch out until at least 2014-15. That implies that India will have to wait at least until then before it gets to seeing growth of 8%.

More in my ET column, Slow return to 8% growth.

Reservation in promotions

The reservation in promotions for SC/STs Bill has been passed in the Rajya Sabha. Its passage in the Lok Sabha is awaited. Many of those who favour reservation for SC/STs at the point of entry are opposed to extending the principle to promotions. The merits of the Bill can be debated but the crucial thing to note is that the Bill will have to withstand any challenge in the  Supreme Court. The Hindu today carries an article that brings out the constitutional aspects very well.

There are two criteria of the Supreme Court that are relevant to any provision for reservation in promotions for SC/STs. One, such reservation must not come into conflict with requirements of efficiency. Two, the government must demonstrate lack of representation of the SC/STs by providing appropriate data. The article points that as part of the negotiation with the BJP, the UPA government agreed to drop an earlier provision in the Bill that would have allowed it to ignore concerns about efficiency. However, the present draft contends that the government need not demonstrate under-representation. The author writes:

The draft of the 117th Constitution Amendment Bill has a rather short-sighted response to the Supreme Court’s demand that the inadequacy of representation of the SCs/STs must be demonstrated on the basis of each cadre. In essence, the Supreme Court’s position is that if the state wants to provide quotas in promotions for clerks, it should demonstrate inadequate representation of the SCs/STs among clerks . The response of the 117th Constitution Amendment Bill is to remove any reference to the requirement of demonstrating inadequacy of representation. The Supreme Court’s demand that the cadre must be the basis for demonstrating inadequacy of representation is far from ideal. A cadre-based determination of inadequacy of representation of the SC/STs would not result in an accurate picture of representation of the SC/STs in public employment as a whole. The 117th Constitution Amendment Bill should have clarified that a cadre-based determination of inadequacy of representation was not required by the Constitution and that it would be sufficient for the State to demonstrate inadequacy of representation in public employment as a whole. Instead, the Bill that has been passed in the Rajya Sabha goes to the other extreme and no longer requires the state to demonstrate any sort of inadequacy of representation. 

I am not clear as to how quotas on promotions will work. Are we to suppose that there will be 22.5% reservation for SC/STs at each level- joint secretary, additional secretary, secretary- in the government? Or will governments settle for, say, representation in the office cadres as a whole? If SC/STs are adequately represented at the joint secretary and additional secretary level and in the services a whole but there are not enough of them at the secretary level, would this call for government intervention?

The implications of having 22.5% quota at every level should be evident. Promotion would become virtually independent of performance or any comparative evaluation of merit. However, if we don't have enough SC/STs at the senior levels, that could be construed as violative of the intent of the amendment proposed. A compromise would be settle for some rough indicators- at least 5-10% of SC/STs for all posts at senior levels in the aggregate. But, then, an argument could erupt about the numbers; some would say that anything short of 22.5% is discrimination.

I'm sympathetic to the idea of quotas in promotions but I'm afraid I can't see how quotas in promotions will operate or can be operated. Any suggestions?

Friday, December 14, 2012

Basel III complacency

Basel III is supposed to be a tough answer to Basel II- better quality capital and more capital for banks. Banks have resisted the higher requirements saying it they will affect loan growth. It is sobering to be reminded, therefore, that equity to total capital at banks, following Basel III, will be a mere 3%- that is, a leverage of 33! The reminder comes from the Vice Chairman of America's Federal Deposit Insurance Corporation:
Despite the promise of higher capital levels and better quality capital, Basel’s new minimum leverage ratio requirement is only 3 per cent, about the same as that of the largest US banks when the global crisis erupted. Basel III offers more complexity and, therefore, new opportunities to circumvent the system. But it does not offer any more certainty that banks will be well capitalised when the next crisis hits.

What is the answer? Go for a simple leverage ratio that is reasonably high:
We can establish a simple but stronger capital base by replacing the unmanageably complex Basel risk-weighted standards with a tangible equity capital ratio of around 10 per cent, and use a simplified risk-weighted measure as a check against excessive off-balance sheet assets or other factors that might influence banks’ safety. If the financial industry had had tangible equity capital approaching this level in 2008, we might still have had a crisis. But it would have been far less severe and far less costly to the public.

Thursday, December 13, 2012

Interview on Narendra Modi

I found's interview with Gunvant Shah perceptive. The interview is about Modi- his strengths and weaknesses. Shah makes no bones about either. He condemns the Gujarat riots as a blot on the state but does not hold Modi personally responsible:
So you think he should not apologise.
Not at all! You are talking nonsense. When there is rioting and provocation of this dimension, do you think there won't be any reaction from the majority community? You conveniently forget that in 1984, Sikhs were killed by Hindu Congressmen. Not a single non-Sikh was killed. You can call it a pogrom. Here in Modi's Gujarat, 218 Hindus were killed in police firing... And do you know even Congressmen came to fight Muslims on that day?
It is good to see the media talking to people on the ground in  Gujarat. Rediff's coverage of the elections has been excellent.

Tuesday, December 11, 2012

Financial Times and Economist up for sale?

Well, there is certainly speculation on this account. FT is said to be losing money. The report does not say anything about the finances of the Economist. As somebody who is addicted to both periodicals, I sincerely hope that they don't lose their character if they are acquired. I wonder why Rupert Murdoch is not interested- could it be because of the troubles he has had to face in the UK? Whatever his failings, Murdoch will be gratefully remembered by journalists as the man who has helped preserve two of the greatest titles in journalism, The Times of London and the Wall Street Journal.

I have only one other thought. The FT and the Economist do not lack commentators who advise policy-makers and businessmen on how to get their policies and strategies right. FT has a whole section on Management. The redoubtable Schumpeter of Economist dissects corporate strategies all the time. Are we to believe that the pundits at these journals do not merit attention within their own publishing house? I do remember that some years back, the Economist flew Michael Porter in for a strategy session.  The cynical could say that that doesn't mean much: after all, Porter's own consulting firm, Monitor, is in the doldrums.

Economic growth can't be left to the market

After the financial crisis, the case for regulation of the financial sector has grown stronger; most people believe that leaving things too much to the market was part of the reason for the crisis. Still, not many would argue for a role of the state in promoting economic growth. The wider view is that the state should take care of law and order, infrastructure and efficient financial markets and leave the rest to entrepreneurs.

Chinese economist and former World Bank chief economist, Justin Lin argues otherwise in his recent book, The Quest for Prosperity. He makes the point that nations have seen sustained and strong growth all owe it to strong support from the state- very often, support for particular sectors. The proposition is not new. Robert Wade and others have pointed out that the East Asian miracle was pretty much state-led. But, the earlier thesis was that the state should generally support firms that were in competitive businesses, especially those that were trying to win in export markets. Lin goes further. He wants the state to target particular sectors and guide private investment into those areas.

This is really a strong form of what used to be called 'industrial policy'. Lin shows that this sort of thing is not unique to East Asia. It happened to all the advanced economies of the west earlier. What is more, the advanced economies practise this even today, although sometimes in not so obvious ways.

More in my ET column, How the state can boost growth.

J S Verma on SC judgement on Vodafone

I return to my blog after a fairly long time- preoccupied on many fronts in recent weeks.

I wanted to flag Justice JS Verma's comments on the Supreme Court verdict on Vodafone. There has been much criticism of the government's attempt at changing the tax law retrospectively in the Vodafone case. Many have differed, however, with the SC's views in this particular case and it is interesting that Justice Verma is one of them.

Justice Verma gives two reasons for his difference of opinion with the SC judgement. One, he believes that "the three-judge judgment in Vodafone bypasses a five-judge constitution bench judgment in the McDowell matter in 1985. The McDowell judgment in substance said that in this context what you have to see is the substance of the transaction to determine the tax liability and not merely the form of the transaction." Justice Verma points out that a three-judge bench cannot bypass the view of the larger five-judge bench in the McDowell case.

The bigger reason, according to Justice Verma, is as follows (all quotes here are from the report in the Indian Express):
Judges need to be committed to constitutional philosophy and not the philosophy of the ruling party. The constitutional philosophy in this case as laid out in Articles 38 and 39. The effect of benefiting a corporate is to cast a higher tax burden on the common man and when you uphold an illegal tax avoidance, then you cast a higher tax burden on the honest tax payer. According to me the Vodafone judgment has all these implications.

Justice Verma believes the Vodafone judgement is to be clubbed with two other SC judgements- those in the habeas corpus case during the emergency and the JMM bribery case as judgements “which are best forgotten or allowed to pass”. In the habeas corpus case, the SC had ruled that the right to habeas corpus stands suspended during an Emergency- this was subsequently changed by parliament through a constitutional amendment. In the JMM bribery case, the SC ruling was that the MPs who were accused of taking a bribe to vote in a particular way had committed no crime that the legal system could act on as they enjoyed immunity granted to members of parliament.