One of the more gratifying moments so far this year – at least in the realm of high finance – was the decision last week by shareholders of Citigroup to reject a $15 million pay package for CEO Vikram Pandit. The shareholders vetoed the award since they believed there was too big a disconnect between Pandit’s pay and performance. As my colleague Christopher Matthews pointed out, Citi shares have plunged 80% under Pandit’s leadership. In 2011, Citi’s stock sunk 20% while the S&P 500 index jumped 6%. Now does that sound like a track record worthy of $15 million? The rebuke, though, is much more than comeuppance for another entitled CEO – more even than a blow to rampant corporate greed and excess in America. The revolt at Citi is a victory for capitalism, and a signal that, hopefully, more capitalism is on the way.
What am I talking about? In the great debate that has followed the Great Recession over how to fix the current capitalist system, there have been two main streams of thought. One is that capitalists are inherently incorrigible, forever too greedy and self-interested to ever be trusted with the greater good of society. The only way to prevent crises like the 2008 Wall Street meltdown is for some counterbalancing power — the government — to step in and control their dangerous ways. That spirit led to the heavier regulation of the Dodd-Frank bank reform. The other view is that the solution to capitalism’s problems is, ironically, more capitalism. The market has to be freed to decide winners and losers, and the self-regulating systems of capitalism have to be strengthened so capitalists can better police themselves.The shareholder uprising at Citi is proof that the latter course may be the right one.
(MORE: Are We Paying Our CEOs Enough?)
Capitalism, at least the way I learned about it, is not meant to be a free-for-fall in which a few elite with their hands on the levers of financial power gorge themselves at the expense of everyone else. A well-functioning capitalist system possesses built-in checks and balances that, in theory at least, rein in excess and risk and prevent crises. The many agents of capitalism are supposed to monitor each other. Shareholders and board directors watch over corporate management and protect the interests of the firm. Auditors and credit rating agencies watch the books and assess risk. Capitalism is also supposed to be a meritocracy, where the smart and hard-working succeed, and those who make bad choices and fail to perform suffer. Capitalism, in other words, is not a system where a CEO gets paid $15 million after his firm loses 80% of its market value.
Sadly, though, the form of capitalism we have today is something very different. The policemen of capitalism have been asleep on the job. Shareholders and the boards they elect have been about as tough on hotshot CEOs as compliant concubines. Even more, the relentless demands of shareholders for ever-higher quarterly profits have egged on corporate managers to take on higher levels of risk. Rating agencies, rather than calling out financial firms on the unsound nature of subprime mortgage securities, were effectively complicit in the efforts to market them. Rather than linking CEO pay to performance, managers were given massive paydays apparently for doing no more than showing up at work. It is here where we can discover the real reason we’ve suffered a global financial crisis – the monitors within the capitalist system who are tasked with properly managing that system failed abysmally to fulfill their very important responsibilities.
(PHOTOS: The Global Financial Crisis)
That’s why the fact that shareholders at Citi stood up for themselves is so crucial for the future of capitalism. If more shareholders did their jobs as owners – protecting the long-term interests of the company, ensuring pay matches performance – then we would achieve tremendous progress towards making capitalism a more secure and more equitable system. Doing their jobs properly, however, means more than just cracking down on CEOs. Shareholders, too, must act more responsibly by having more realistic expectations of corporate performance and returns. Here’s how the Financial Times put it in an editorial:
Investors, however, will have to make sacrifices too. They were guilty in the pre-crisis era of encouraging banks to unsustainable levels of profitability, by turning a blind eye to risk. If executives have to be more modest in their demands, shareholders need to rein in expectations on returns. That is in the long-term interests of investors, the banks and the financial system as a whole.
Just to muddle the picture a bit, it is important to note that the shareholders at Citi were better able to stand up to Pandit’s pay package because of new regulation. The Dodd-Frank bank reform bill mandated such shareholder votes on executive pay. Over at Fortune Stephen Gandel points out that Dodd-Frank has been successful in controlling the excesses of corporate pay through this mechanism. So even though Dodd-Frank is hated by many who believe more government regulation is always bad, sometimes regulation is necessary to help capitalism solve its own problems. Based on the Citi case, perhaps the way to fix capitalism is to better empower the capitalists to fix themselves.