Private equity investors are known to enter into side agreements/ compensation agreements with key management personnel, directors or promoters of listed companies whereby the former would share with the latter a portion of the proceeds at the time of their exit, based on satisfaction of performance criteria and / or the gains made. SEBI has recently issued a consultation paper titled “Corporate Governance Issues in Compensation Agreements” wherein it proposes to regulate this practice.
Such arrangements act as an incentive for top personnel to improve the performance of the investee company. While it may be argued that such arrangements are beneficial to all shareholders, the top management’s focus on short term goals of meeting performance targets at the cost of long term growth and sustainability remains a concern. In its consultation paper, SEBI observes that such practices are not desirable and proposes to introduce a provision within the Listing Regulations whereby such agreements for additional compensation or profit sharing will require prior approval from SEBI as well as the shareholders of the investee company (ordinary resolution). Further, it has been proposed that all existing agreements shall be discontinued unless the approval of the shareholders of the investee company is received.
The corporate governance issues due to such agreements are evident and may result in a situation where the independence of the board of directors of the investee company is in question. However, requiring prior approval from SEBI may lead to delays in obtaining PE funding and prior approval from shareholders will simply increase compliance costs while adding minimal benefits. Alternatively, such agreements can be made subject to approval by a committee of independent directors of the investee company along with a disclosure to the shareholders.