As the debate rages about compensation paid to executives of America's publicly traded companies, there seems to be a disconnect between the issue of excessive compensation and the bigger picture with regard to the performance of American businesses. While we grouse about the grotesque levels of wages and benefits paid to CEOs, we must not lose sight of the fact that this is also a symptom of a far greater problem that has come home to roost with damning consequences. I am speaking of the failure of boards of directors to do their jobs to protect investors.
First, we think about the public company in terms of a money making proposition: investment return. We are all getting a fast lesson in the flip side of that proposition as well: investment risk. From an investor's perspective, it is the responsibility of those that are in place to represent our interests - namely boards of directors - to manage the two aspects of our investments. As we have now learned, it is difficult for any of us to see whether directors are doing their jobs of managing risk on our behalf.
However, one symptomatic measure is how these same directors manage the compensation practices of their executives.
Compensation or Coronation?
The question then is whether directors, via the boards' compensation committees really set meaningful performance measures for their executives that will result in linking compensation to corporate performance. Sadly, in many cases, this is not done.
Let's take a look at the performance measures established by one company: Citigroup.
In its proxy statement filed in early 2008, the company devotes 39 pages to its discussion of executive compensation schemes. A quick glance suggests that the company's directors took steps to manage executive compensation in 2007. However, the company's proxy statement reveals two things.
First, the board has devoted considerable time to figuring out a truly arcane process for determining compensation paid to top executives. In addition, this new rigor applied to compensation confirms that the company's executives were being grossly overpaid.
Second, despite efforts to tweak up its compensation practices. the board got it wrong.
The Compensation Barometer
As noted in the proxy statement, executives were paid from three piles of money: "40 percent of the incentive award was payable under CAP (Capital Accumulation Plan), 30 percent was payable in cash, and 30 percent was payable in retention equity awards."
Roughly translated, this means that the executives got 30% of their pay in a form like the rest of us: a paycheck for showing up. Another 30% came from a bonus pool for doing a really great job and the balance or 40% was paid as an inducement for sticking around. To the credit of the board at Citigroup and its compensation committee, considerable thought was put into the process of granting compensation to the senior executives at the company. However, at the end of the day what ultimately matters is the outcome.
In this instance, the outcome isn't pretty from a shareholder's point of view.
On January 1, 2007, Citibank's shares were trading at $59.52 a share. On December 31st of that year, the share price had dropped to $27.83. During this period, shareholders witnessed a dramatic rearrangement of the deck chairs at Citibank.
The company's former CEO, Charles Prince, who earned a whopping $25 million in compensation in 2006 was replaced by Vikram Pandit, who's total package for a portion of 2007 was a relatively meager $6 million and change. However, one measure that didn't change was the compensation paid to Sallie Krawcheck, the company's senior executive who was promoted to CFO that year. From 2006 to 2007, Ms. Krawcheck's total compensation rose from $7,139,792 to $9,918,267.
Today, we witness Citigroup's shares trading around $3 and Mr. Pandit's basset hound stare at members of the House Banking Committee while giving up his base compensation (remember the figure 30%) and it compels us to pat him on the head like a mischievous puppy dog who just chewed up a pair of slippers.
So what does this tell us about Citigroup's board of directors?
Simply this. If executive compensation calculations are a measure of board competency, then shareholders have a real problem at Citigroup. Reality has a funny way of validating this theory.
As the share price of Citigroup stock dropped to 5% of its value two years ago, the marketplace proves this out. As we continue to watch the debate escalate around executive compensation, it's important to remember that executive remuneration is not only a measure (at least in theory) of executive performance but a measure of director performance as stewards of shareholders as well.