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Citi Shareholders Do Capitalism a Very Great Service

Irwin M. Stelzer

Good news for those of us who know that only a reformed version of market capitalism can survive the current unhappiness with its performance.

Citigroup’s shareholders have told their executive employees, and most especially chief executive Vikram Pandit, that they are the owners of the business, and if these employees want to make big bucks, they had better deliver stellar performance.

So a majority of shareholders turned down a plan that paid Pandit almost $US15 million last year, and promised to pay him millions more this year despite less-than-stellar performance.

This is important because of discontent with capitalism.

True or not, there is a perception inequality of income and wealth is increasing, and that it is due not to great performance by executives but to the fact the game is somehow rigged against the ordinary worker.

The US President is building his re-election campaign around the theme of socking it to the rich, whom he says are not paying their fair share of taxes, and several nervous politicians in other countries, unable to deliver economic growth, are blaming “fat-cat bankers.”

If Citi’s shareholder uprising is a harbinger, the fat cats might have to become accustomed to a diet of skimmed milk.

But we must be careful not to lapse into the vulgar populism of the campaign trail because the issue is not that some people make a lot of money.

Nobody begrudged Steve Jobs his income, or is outraged at the billions made by Warren Buffett, Bill Gates, Mark Zuckerberg and others who have been successful investors or built a better mousetrap. Their compensation was in return for performance that benefitted shareholders, created jobs and contributed to growth.

Now that the Dodd-Frank law requires shareholders to have a “say on pay,” demands for reform, that compensation be performance related, are becoming more common at shareholder meetings.

Hewlett-Packard, Janus Capital Group, gaming-machine maker IGT, regional bank First Merit and industrial products maker Actuant are among companies to have had executive pay plans rejected by shareholders because pay and performance were inadequately linked.

To be sure, these rejections are advisory only: directors are free to overrule the shareholders.

But that seems unlikely, at least in the case of Citi, where departing chairman Richard Parsons called the shareholder vote “a serious matter.”

Directors will meet shareholder representatives to bring the compensation packages more in line with investors’ demands, as General Electric and Lockheed Martin did in advance of their shareholder meetings, and as Barclays has done with Bob Diamond’s pay package to head off a shareholder uprising at its annual meeting this week.

Which brings us to the question of just who these shareholders are.

In 1932, scholars Adolf Berle and Gardiner Means pointed out that the widely dispersed ownership of shares in big companies in essence turned over control of those companies to their managers.

The result was a self-perpetuating management team that often selected the slates of directors to put before investors, creating a corporate governance system with unchallenged access to the corporate treasury until Michael Milken and the so-called predators took over the greatest abusers and ended perk parties.

That era of hostile takeovers petered out, leaving the corporate governance system in the condition Berle and Means had described.

But in proof of its ability to self-generate reform, to create institutions that periodically repair democratic market capitalism, three events occurred.

First, a financial crisis resulted in legislation that introduced shareholder “say on pay” and required that directors be truly independent of the chief executive and other executives. It is now more difficult for chief executives to create a board of directors from the membership lists of their country clubs.

Second, institutional investors, among them the state-employee pension fund that controls the bulk of Citi stock, shed their passivity in favour of activism.

They decided that to protect their members’ pensions, they would gather sufficient shareholder votes to express discontent with packages that dole out bonuses to underperforming executives.

Third, new legislation and attitudes accelerated the growth of a new set of institutions. Compensation consulting firms joined proxy advisers and governance advisory firms in telling shareholders to just vote “no” when compensation schemes do not seem aligned with shareholders’ interests.

The battle by owners to regain control of their investments is far from over, not least because it is easier to call for pay related to performance than to develop performance standards that measure an executive’s contribution to his company’s success, especially now when an economic recovery will raise all boats regardless of who is at their helms.

The usual solution is to compare a company with its peers, and to reward only performance that exceeds the peers’ average, which makes it important to select an appropriate peer group, rather than laggards that are easy to beat.

The importance of this battle transcends the issue of executive pay.

There is a perception that market capitalism has seen better days, and that China’s state-run economy is the model best equipped to produce growth in a globalised world.

A “Beijing consensus” is said to be replacing the “Washington, Anglo-Saxon consensus” that saw so many countries choose democratic capitalism as the alternative to the failed centralised economic management imposed on them by the now-defunct Soviet Union.

Citi’s shareholders have done capitalism a great service by reminding directors of their obligation to see that executives, like all company employees, perform for their pay.

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