Last week the country saw one of the fruits of the Dodd-Frank financial reform bill. The bill requires that major corporations offer their shareholders the opportunity to vote on the pay package for their chief executive. The shareholders of Citigroup voted down the $14.9 million pay package for CEO Vikram Pandit by a margin of 55-45 percent.
The vote was non-binding (a very serious problem), but it was nonetheless a huge slap in the face for Pandit and Citigroup’s top management and directors. It is extremely difficult to organize shareholders for this sort of vote. Management controls the flow of information to shareholders in a way that would make incumbent members of Congress green with envy.
When shareholders see a poorly run company, it is far easier for even large investors to just dump their shares rather than try to gain the support needed to change the way the company is managed. That is why this vote was so striking in a huge corporation like Citigroup.
Of course the law is still tilted so much in management’s favor, that even when the shareholders — the actual owners of the company — vote down a pay package, it is still only an advisory vote which the board and top management is free to ignore. But this vote is still a big step forward.
The first question that people should ask is how Pandit managed to get a compensation package that was so out of line with his performance. The fact that executive pay packages bear little relationship to performance is well documented in Lucian Bebchuck and Jesse Fried’s excellent book Pay Without Performance.
The issue that Bebchuck and Fried examine is not whether CEO pay is too high in some abstract sense, but more specifically whether it can be justified by the extent to which CEOs increase a company’s profits and share price. They cite study after study showing the big bucks CEOs rake in has little to do with their performance.
For example, one study examined random events that led to an increase in profits and share prices, such as a jump in world oil prices. While a jump in oil prices will lead to a surge in oil company profits, oil company CEOs do not deserve credit for higher world oil prices. Nonetheless, the compensation packages of oil company CEOs routinely soar when oil prices go up.
This is usually the result of the fact much of their pay is in the form of company stock or options. When the stock price jumps for any reason, CEO compensation soars along with it, even if the CEO’s actions had little to do with the rise in stock prices. Lee Raymond, the chairman of Exxon, was able to retire from his position in 2006 with close to $400 million because rising oil prices had sent the price of Exxon stock through the roof.
There is an easy way to avoid such unearned gains by top executives. The stock awards granted to executives just have to be indexed to the performance of the industry as a whole. This means that if Exxon’s stock goes up by 150 percent, but the stock of all other oil companies also goes up by 150 percent, then the CEO doesn’t get any bonus pay out of the deal. The same can be done for any other industry.
This seems so simple and obvious it is difficult to understand why every major company doesn’t structure its compensation packages this way. At least it’s difficult to understand until we look at who is on the board of directors that decides CEO compensation.
If we look at Citigroup’s board the name that immediately jumps out is Vikram Pandit. Yes, that would be the same Vikram Pandit who is Citigroup’s CEO. While I’m sure Vikram Pandit does not vote directly on his own compensation, the fact that he sits on the board of the directors is suggestive of the loyalties of this group.
The board is supposed to serve the shareholders, but they typically are friends and/or business associates of the top management of the company. They get paid very generous fees (at $250,000 a year in the case of Citigroup directors) for what is likely no more than a few days’ worth of work. Such generous stipends can go far to secure loyalty to top management among those who might otherwise be tempted to take their responsibilities to shareholders seriously.
The issue of CEO pay goes beyond just the ripoff of shareholders. The outlandish pay packages of top executives set a pattern that gets emulated throughout the economy. When top executives of even mid-size companies can pull down $5-10 million a year it creates an environment in which top executives in other sectors, government, universities, even charities feel they are sacrificing when they get high six-figure or even low seven-figure paychecks.
The decision of Citigroup shareholders to just say “no” should be the opening shot in the battle to restore sanity to CEO pay. We need many more “no” votes on CEO pay. More importantly, people should pressure board members — who are often prominent figures, such as university presidents, academics, retired politicians, and even ministers — to take their responsibilities to shareholders seriously.
Can the members of Citigroup’s board say with a straight face that they represented shareholders’ interests when they approved Pandit’s $14.9 million pay package? Can they say they earned the $250,000 the company paid them this year?
The board members of every major company should be forced to answer this question about the CEO pay packages they approve. It’s time to put an end to crony capitalism.
Dean Baker is author of the new book, “Plunder and Blunder: The Rise and Fall of the Bubble Economy,” PoliPoint Press, LLC. This piece was first published on the Center for Economic and Policy Research’s Jobs Byte. CEPR’s Jobs Byte is published each month upon release of the Bureau of Labor Statistics’ employment report. For more information or to subscribe by fax or email contact CEPR at 202-293-5380 ext. 102 or chinku@CEPR.net.
This post originally appeared on the Center for Economic and Policy Research.