The StressTest column appears every Thursday on Fool.com. Check back weekly and follow @TMFStressTest.
"Pay for performance" has become something of a magical mantra for investors. Some company boards seem to have the idea that they can jam through any old pay plan as long as they slap that phrase in front of it. Citigroup (NYSE:C) and its awarding of "performance share units" may be a perfect example of this.
In determining the level of performance units that Citi awards its executives, the bank plans to use two metrics: average return on assets and relative shareholder return. I'll focus here on the latter.
For starters, total shareholder return is a lousy way to benchmark a company's executives. Consider Bank of America (NYSE:BAC). Its stock doubled in 2012, giving it the best return of major global banks. (Barclays (NYSE:BCS) was second with a 62% return, and Citi followed in third.) Was that a credit to Brian Moynihan's leadership? To some extent, perhaps, but it probably had a lot more to do with the fact that the stock closed 2011 with a price-to-book value of 0.27.
But it's not just the advisability of using shareholder return for compensation calculations that's at issue here. Executives at Citi are awarded 100% under that metric if the bank "achieves" the 50th percentile. Yes, you read that correctly, the full award is given for being perfectly average. Above-average results boost the award to greater than 100%.
Most people, myself included, associate words like "bonus" and "performance" with results that are above and beyond the average, not dead-on average.
The stock is also spring-loaded to help executives meet that very mediocre target. Currently, Citi shares trade at one of the lowest valuations among the major global banks.
So to some extent, if executives do anything short of the jaw-droppingly stupid -- think, acquiring Countrywide Financial -- they'll benefit from the valuation creeping back up to a level closer to its comps.
I have no bone to pick with the idea of paying Mike Corbat or any other worth-their-salt bank CEO well. At Citi, Corbat is running a multi-national bank with $1.9 trillion in assets and more than 250,000 employees. For (facetious) perspective, a hedge-fund manager with that level of assets under management would want $37 billion in fees regardless of performance. Corbat was paid just over $12 million in 2012.
The problem is the silly notion that achieving a middle-of-the-road result is somehow rewarding "performance." Either just give them the award outright, or set up a system that's rewarding real performance. But either way, be honest with shareholders.