Irwin M. Stelzer writes for The Weekly Standard.
Good news for those of us who know that only a reformed version of market capitalism can survive current unhappiness with its performance. Citigroup's shareholders have told their executive employees, and most especially CEO Vikram Pandit, that it is the owners of the business, not their hired hands, who run the show. And that if these employees want to make the big bucks, they had better deliver stellar performance. So a majority of the shareholders turned down a plan that paid Mr. Pandit almost $15 million last year, and promised to pay him millions more this year despite less-than-stellar performance.
This is important because it addresses one of the discontents with capitalism. True or not, there is a perception that inequality of income and wealth is increasing, that the rise is due not to great performance by executives but to the fact that game is somehow rigged against the ordinary worker. And the president of the United States is building his reelection campaign around the theme of socking it to the rich whom he says are not paying their fair share of taxes, while several nervous politicians in other countries, unable to deliver economic growth, are blaming "fat cat bankers." In Britain one of that hated breed has been de-ennobled, his peerage rescinded, and his seat in the House of Lords snatched from him.
Well, if the uprising of Citigroup's shareholders is a harbinger, the so-called fat cats might have to justify their pay checks or become accustomed to a diet of skim milk. We must be careful here not to lapse into the vulgar populism of the campaign trail. The issue is not that some people make a lot of money. No one begrudged Steve Jobs his income, or is outraged at the millions pocketed by Warren Buffett, Bill Gates, Mark Zuckerberg, or others who have been successful investors or built the better mousetraps that benefit consumers and contribute to economic growth. Their compensation was in return for performance that benefited shareholders, created jobs and contributed to growth. The problem at Citi was best stated by the Wall Street Journal, "Instead of tying pay-outs to long-term share appreciation, the [Citi] plan set a low earnings bar that conveniently didn't count the parts of Citi that aren't expected to thrive."
The Dodd-Frank law — much derided by conservatives, with reason, given some but not all of its provisions — requires that shareholders have a "say on pay." So demands that compensation be performance-related are becoming more common at shareholder meetings. Hewlett-Packard, Janus Capital Group, IGT (gaming equipment), FirstMerit Corp. (regional bank), and Actuant (industrial products) are among more than 40 companies that have had executive pay plans disapproved by shareholders because pay and performance were inadequately linked. To be sure, these rejections are advisory only: directors are free to over-rule the shareholders.
But that does not seem likely, at least in the case of Citi. Richard Parsons, departing chairman of the board, called the shareholder vote "a serious matter," and has announced that the directors will meet with shareholder representatives, with a view towards bringing the compensation packages more in line with what shareholders deem reasonably related to performance, as General Electric and Lockheed Martin did in advance of their shareholder meetings, and as Britain's Barclay's Bank announced yesterday it intends to do.
Parsons has had a distinguished career in politics as a protege of Nelson Rockefeller, and in business as a protege of Laurance Rockefeller, who helped him become CEO of Time Warner, where he presided over the unfortunate merger with AOL. Nevertheless, his reputation remained sufficiently intact for him to become chairman of Citi, and he is not likely to risk it by being seen as ignoring the wishes of Citi's shareholders, whose interests he has a fiduciary obligation to protect.
Which brings us to the question of just who these shareholders are, and what powers they have. In 1932, two scholars, Adolf Berle and Gardiner Means, pointed out that the widely dispersed ownership of shares in large corporations turned effective control of the operation of those companies over to their managers. The result was a self-perpetuating management team that often selected the slates of directors to put before shareholders, creating a corporate governance system in which executives had unchallenged access to the corporate treasury — until Mike Milken and the so-called "predators" and "raiders" fought for and won control of the greatest abusers, and ended the perk parties.
That era of successful hostile takeovers petered out, in part because incumbent managements became more proficient at erecting defenses, 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 both introduced shareholder "say on pay," and required that directors be independent, truly independent, of the CEO and other corporate executives. It is now more difficult for CEOs 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 favor of activism. They decided that to protect the pensions of their members, they would gather sufficient shareholder votes to express discontent with compensation packages that dole out bonuses to under-performing executives.
Third, the market filled the need for controls on executive pay by stimulating the growth of and creating a new set of institutions. Compensation consulting firms such as Semler, Bossey and Pearl Meyers & Partners joined proxy advisers and governance advisory firms such as Glass Lewis and Institutional Shareholder Services (ISS) in advising 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 the 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 easy to out-perform.
The importance of this battle transcends the issue of the manner in which executive compensation is determined. There is a perception that market capitalism has seen its better days, and that China's state-run economy is the model best equipped to produce growth in a globalized world. A "Beijing consensus" is said to be replacing the "Washington consensus" that saw so many countries choose democratic capitalism as the alternative to the failed centralized 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 company employees at all levels, get paid for performance.
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