Citigroup shareholders’ loud and clear message on ‘say on pay’

WHEN CONGRESS first considered allowing shareholders to cast a nonbinding vote on executive compensation — “say on pay” — three years ago, we were skeptical. One of our concerns was that the votes would be meaningless if they were truly nonbinding. The other concern was that “say on pay” might prove harmful if it empowered inexpert shareholders motivated by desire for short-term profits.

But Congress made “say on pay” part of the 2010 Dodd-Frank financial reform law; and on Tuesday, 55 percent of Citigroup’s shareholders voted against a 2011 compensation plan that awarded CEO Vikram Pandit $14.9 million. Citigroup was the first big bank and the largest company, by market capitalization, to get a thumbs down. As such, the vote debunked some of our original worries and confirmed others.

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The broad goals of “say on pay” are to invigorate shareholder participation in corporate governance, to rein in unjustified and excessive CEO pay and to help reduce executives’ incentives to chase short-term profits. On balance, “say on pay” does appear to be jump-starting a much-needed conversation between corporate boards and their shareholders. The fact that the votes are nonbinding is less important than the fact that they take place at all, because few companies can afford the negative publicity of a “no” vote, even if, legally, they may ignore it. Knowing that they will be heeded, institutional investors now employ compensation analysts to advise them on how to vote, which puts them on an equal footing, information-wise, with boards.

The net result is that prudent companies must invest in communication with their shareholders and their compensation analysts, thus enriching the data upon which they ultimately base their decisions, and making the companies more likely to satisfy investors. The fact that only 41 out of the Russell 3000 companies suffered “no” votes last year suggests that the system is working.

Citigroup’s mistake was to try to pay Mr. Pandit and others more than could be justified by the company’s recent performance. A raise was understandable, since Mr. Pandit had agreed to work for $1 a year in 2009 and 2010. But the fact remains that Citi flunked the Federal Reserve’s most recent bank stress test, and its total shareholder return was down 44 percent over the last year. The new pay plan offered top Citi execs millions in bonuses for meeting only modest profit targets.

Nevertheless, the jury is out on whether “say on pay” reduces CEO incentives to take risks in pursuit of short-term profits — the major threat that high pay might pose to the financial system. Shareholders, and the analysts they rely on, continue to emphasize companies’ stock prices as a benchmark of executive performance. A leading advisory firm, ISS, evaluates executive compensation against total shareholder returns over a one- to three-year period, though it recently tweaked that to add a somewhat longer-term metric.

Meanwhile, another unintended consequence of “say on pay” has been lawsuits against companies that exercised their statutory right to enact pay plans despite “no” votes. Most of those suits failed; but they cost money to defend, and at least one settled out of court for more than $1.75 million.

More experience with the rule should help both boards and shareholders work out the bugs in the system. So far, though, “say on pay” appears to be promoting better corporate governance.