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Shareholders of the World, Unite

You have nothing to lose...

12:00 AM, Apr 21, 2012 • By IRWIN M. STELZER
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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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