Compensation trends in India

Compensation trends in India

India’s transition to a market driven economy began in 1991 with the introduction of liberalization (pro-market economic reforms). Prior to 1991, the Government was (and still is) the biggest employer and job creator, accounting for over 85% of post-matriculation (High School) jobs. Pay was largely determined by high-level agreements between employee unions and the Government and was largely guaranteed in nature. A similar situation was prevalent in the private sector, where Government pay scales were often used as a benchmark in fixing and revising pay. Compensation packages were low on cash and high on fringe benefits such as accommodation, cars, and subsidized loans. Variable pay was largely restricted to top and senior management in few private sector enterprises. Grading systems were largely industry-wide and salary progression was purely determined by length of service.

Current trends

Productivity gains (4% in 2003-04), fast growth in real wages (40% over the last 5 years), a booming but extremely competitive economy (GDP growth of 6%), simplification of tax rules and emergence of knowledge-based industries such as Information Technology & Outsourcing Services, Healthcare etc are key factors that have influenced compensation in India post liberalization. Compensation is now characterized by a Total Cost of Employment approach, a rapid movement to flexible benefits, and increasing levels of variable pay (variable pay now forms about 7% - 35% of fixed pay). Grade structures have become organization specific and salary progression is driven by market forces and individual performance. Average salary increases over 2003-04 ranged from 5% - 20%. The average increase was 11%. While most organizations benchmark compensation nationally within a select group of competitors, a few organizations are beginning to benchmark themselves internationally at senior management levels. India has the fastest compensation increase rate in the Asian region at 11.7% and it also has the highest labour turnover in the region.

Different compensation plans - how do they affect your financial results

With the introduction of FRS 102 Share-based Payment, companies are required to recognize the expenses of employee equity compensation schemes with effect from 1 January 2005. This article highlights the major implications to the financial results of the three most common equity compensation schemes, namely share option scheme, performance shares scheme, and Share Appreciation Rights (SAR, also known as phantom share scheme).

Key CharacteristicsThe key characteristics of each scheme are as follows:

Share option scheme

The company grants employees the right to subscribe for new shares in the company at a fixed price.

Employees are required to pay the company the exercise price in consideration for the shares.

Employees can generally only exercise the right after remaining in service with the company for a period of time and/or after meeting certain performance targets.

The right would generally expire after a period of 5 to 10 years from the date of the grant.

Performance share scheme

The company grants employees shares in the company.

Employees will generally receive the shares, at no cost, after remaining in service with the company for a period of time and/or after meeting certain performance targets.

Share Appreciation Rights

Similar to the share option scheme except that:Upon exercise of the option, the employees do not pay the exercise price to the company nor receive the shares; instead, they are paid the difference between the exercise price and the market price of the shares in cash.

While all three schemes require the use of fair values of the share options or shares for the recognition of the compensation expense over the vesting period, the impact on the company’s financial position and financial results is different.

Impact on net assets

The three schemes have a different effect on the net asset values of companies. Under FRS 102, share option scheme and performance share scheme are considered “equity-settled”. This means that in recognizing an expense for the compensation costs, a corresponding increase in shareholders’ equity is recognized. Hence, the net asset position of the company is unchanged. In contrast, obligations under SAR schemes are considered liabilities of the company, as there would be a cash settlement when the right is exercised. The recognition of the compensation cost under SAR results in a decrease in the net asset of the company.