04/23/2012 06:04 pm ET Updated Jun 23, 2012

'No' Vote on Citigroup's Pay Should Spark CEO Compensation Reform

This week's vote by 55 percent of Citigroup shareholders to oppose CEO Vikram Pandit's $15 million pay package should sound a death knell for outdated methods of determining executive compensation.

The shareholders used their prerogative granted under the Dodd-Frank Wall Street and Consumer Protection Act to weigh in on the pay package of Citigroup CEO Vikram Pandit. The so-called "Say on Pay" vote is only advisory, but it marks the first time a majority of shareholders of a major U.S. bank have voted "no."

Time will tell if shareholders were merely frustrated at the rejection earlier this year of a bump in the dividend, are still reeling from the depressed share price -- down 80% since the financial crisis, are feeling the pain of the "99%", or all three. Would the outcome have been different if the Board kept the package at least a shade under Pandit's peers at Goldman and Morgan Stanley? Hard to know. The message from the shareholder vote, however, is pretty clear: shareholders are paying attention to not only how much compensation is earned, but also what it's rewarding.

Getting pay right is more art than science. And it's vitally important to get it right. What can we learn from Citi's fate?

First, shareholders now have the means to really focus in on pay. So-called "Say on Pay" lets shareholders send a warning shot over the bow when pay is out of whack with public sentiment. "No" votes have been rare since the right went into effect, and only the Board knows all the factors that came to bear on the structure of the package. But the vote this week should be a loud wake-up call for pay consultants who heretofore have been free to ignore common sense and the larger debate about fairness.

I appreciate that Mr. Pandit wasn't running the company when the music stopped, that he accepted a dollar a year while the taxpayers owned the risk and has worked hard to bring about change in both attitudes and results. But the vote signals concern over returning to business as usual. It could even mean that the Lake Wobegon affect of constantly ratcheting up pay for "competitive" reasons is finally under real scrutiny. If so, that is a very good thing.

We also know that well-compensated business executives, like the rest of us, are motivated to do a good job for a complex set of reasons -- pay is not the prime motivator and never has been. That doesn't mean that shareholders want a vow of poverty from executives, far from it. But it's time to bring some common sense to the table. With the country still reeling from recession and with pensions under water, pay must make sense in a larger context than among a tiny Wall Street peer group.

Second, in spite of the resounding "no" vote, we are reminded that not all shareholders are the same. The day-traders want different things than the long-term investors; when they agree, the result is a powerful, but it hides significant differences among the constituents. For example, Ann Simpson, the Director of Corporate Governance at the nation's largest state pension fund, CalPERS, told the New York Times that their "no" vote reflects concern that pay be linked to sustainable, long-term goals.

Finally, plenty of research and guidance exists to help boards structure pay to reward the executive team for the long-term and to instill healthy incentives that stand the test of time. Getting the banking sector working again is critical to our future. Citigroup is heading in the right direction and it's great that the board is confident in Mr. Pandit and his team. What a great time to get creative in rewarding pay, and to be discerning about the nature and source of profits that we hope will again begin to flow from Citi and other institutions of its ilk.

What would pay look like if pay packages emphasized investment in the real economy over short term profits that emanate from the non-productive activity that got us into trouble in the first place?

Citi might be a great place to experiment.