India: Regulation Of Compensation Agreements By SEBI

Last Updated: 13 February 2017
Article by Rohan Shrivastava

Compensation Agreement or Upside Sharing Agreement or Reward Agreement:

Compensation Agreement or Upside Sharing Agreement or Reward Agreement is entered into by private equity firms quite often in the form of a side agreement with top personnel and key managerial personnel of the listed companies wherein:

  1. investor agrees to share a certain portion of the gains above a certain threshold limit made by them at the time of selling the shares, with such top personnel and key managerial personnel; or
  2. in the event the listed investee company achieves certain performance criteria and the employee continues with the company for a certain period, such employees shall be eligible for sharing of the gains with the investor.

In simpler terms, a compensation agreement (synonymously known as upside sharing agreement or reward agreement) is an agreement between the private equity investor and the management of the listed companies wherein the parties agree to share the profits/ returns which may arise at the time of sale of investment by the private equity investor or upon fulfilment of certain conditions in terms of the agreement. Such agreements are incentive instruments for the employees and/or management of the listed companies. It is pertinent to note that it is the private equity investor who is willing to part with some share of their profits to motivate employees to perform better.

For instance, the private equity investor may agree with the top personnel and key managerial personnel of the listed investee company that if it gets a return of more than 50% on its investment in the listed investee company, then any portion over and above the 50% of the return shall be shared in certain proportion between the private equity investor and the top personnel and key managerial personnel as a reward for the performance of the management of the listed investee companies. 

The Securities and Exchange Board of India ("SEBI") in its meeting held on November 23, 2016 deliberated on the corporate governance concerns relating to unfair practices in relation to compensation agreements incentivizing employees, promoters, directors and key managerial personnel of listed companies. Recently, SEBI, on January 4, 2017, notified the Securities Exchange Board of India (Listing Obligations and Disclosure Requirements) (Third Amendment) Regulations, 2016 ("Amendment Regulation") to amend Regulation 26 of Securities Exchange Board of India (Listing Obligations and Disclosure Requirements), 2015 ("LODR Regulation") to address the concern of unfair practice and ensure high standards of corporate governance.

SEBI, vide Amendment Regulation, made two changes which can be accessed here

Analysis of the Amendment Regulation

Regulation 26(6) of LODR Regulation:

Few of the contentious issues, in the opinion of the author, which were introduced in the Amendment Regulation are highlighted herein below:

  1. Any employee including key managerial personnel or director or promoter: SEBI mandates "any employee including key managerial personnel or director or promoter" of the listed companies to comply with the terms of the Regulation 26(6) of LODR. Usually, such compensation agreements are executed to incentivize the management of the listed company. However, SEBI has attempted to encapsulate all employees who may not be a part of the management of the listed company. Not only employees, SEBI intends to regulate all direct as well as indirect arrangements by usage of the term "for himself or on behalf of any other person". This has further widened the ambit of the persons who could get covered by the scope of Regulation 26(6).
  2. Compensation or profit sharing in connection with the dealings in securities or otherwise: SEBI contemplates two specific rewards under the sub-regulation 6. The investor may agree on the specific condition wherein the payment of the reward may get triggered when the investor sells its shareholding in the listed company and makes profit, over and above a pre-determined threshold. Generally it is observed that these arrangements are usually linked with the internal rate of return that the investor may make at the time of exit from the listed company. Alternatively, the investor may also reward the employee of the listed company by stipulating a fixed amount of compensation which gets triggered upon fulfilment of certain condition under the agreement. For example, the parties to compensation agreement may agree that upon achievement of certain level of turnover or net worth or profit, the investor shall compensate the employee with fixed compensation. It is clear that SEBI intends to cover all types of arrangement, whether security based or otherwise.
  3. Approval of board of directors and shareholders of listed company: SEBI mandates that employees of a listed company should obtain a prior approval of the board of directors as well as public shareholders by way of ordinary resolution for execution of any agreement between the investor or third party and the employees which relates to compensation or profit sharing in connection with dealings in securities of the listed company.

    The sub-regulation also requires that all agreements (including expired agreements) entered during preceding three years ought to be disclosed to the stock exchanges. SEBI further mandates that all the subsisting agreements between the employees and the investor shall be approved by the board of director of the investee in their forthcoming board meeting. Upon receipt of approval from board of directors, the same shall be placed before the public shareholders for approval by any ordinary resolution.

    The third proviso of Regulation 26(6) creates an ambiguity for the subsisting agreements. It has not been specified as to what is the consequence to follow in case either the board or the shareholders do not approve any subsisting agreement. If the intent is that the employees should not receive the compensation in such cases, it seems a little unfair as the compensation to the employee is not sourced from either the company or the public shareholders but only the private equity investors.
  4. Interested Persons: Lastly, the sub-regulation provides that the interested persons, involved in the transaction, shall abstain from voting in the general meeting. The ambit of 'interested person' is very wide which effectively makes only the public shareholders of the investee entitled to vote and approve such compensation agreement.


The primary purpose of an investor executing a compensation agreement is to enhance the value of the investment by incentivizing the employees or management. This in turn enhances the value of the investments made by the public shareholders as well. One perspective could be that the purpose of executing such an agreement is to motivate the employees for further growth of the investee company.

In the past, there have been instances of private equity investors voluntarily rewarding the employees of unlisted investee companies at the time of exit without the existence of a contractual obligation.

The author is of the view that such a regulation by SEBI is a far reaching attempt at regulation. The listed companies are usually not a party to such compensation agreement and such agreements are normally executed between the investor and the employees. Such agreements, may be executed either at the time of allotment of shares to the investor or any time after the allotment of shares to the investor. Further, the intent behind the agreement is not to depreciate the value of the shareholding of the public shareholders. The compensation or reward which is paid by the investor is neither from the account of the listed company or from the shareholders of such listed companies. Moreover, the same does not fall under the ambit of related party transactions.

The only concern which the public shareholders or SEBI may have are the governance issues which could financially affect the shareholders of the listed company. Therefore regulation of compensation agreement may be justified only from the perspective of corporate governance. The shareholder of a listed company are made aware of the  fact that the employees may be inclined to work in the interests of the investors in order to reap the benefits of such compensation. Such disclosures may act as a check and balance to ensure that interests of various stake holders are balanced.

It is not clear as to why SEBI is seeking disclosure of expired and subsisting agreements of this nature. Further, it will be interesting to see the number of such arrangements coming out in public and SEBI's reaction to such disclosures.

© 2016, Vaish Associates Advocates,
All rights reserved
Advocates, 1st & 11th Floors, Mohan Dev Building 13, Tolstoy Marg New Delhi-110001 (India).

The content of this article is intended to provide a general guide to the subject matter. Specialist professional advice should be sought about your specific circumstances. The views expressed in this article are solely of the authors of this article.

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Rohan Shrivastava
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