Potential Implications Of Citigroup's Pay Debacle

May. 6.12 | About: Citigroup Inc. (C)

Citigroup (NYSE:C) has a big decision to make following the "say on pay" vote that recently took place.

The big question on the minds of Citigroup stockholders is what the company will do next. This follows a vote by shareholders who rejected the bank's executive compensation package. This is the first example of shareholders taking a stand against high CEO payouts in the banking industry. Although the vote, which is part of the "say on pay" provision of the Dodd-Frank Act, is only advisory, it still represents a big problem for Citigroup.

As I see it the company has two options. It can either choose to completely ignore the vote, or it can make adjustments of some kind to management's pay. This decision may seem easy, but it actually places Citigroup in a very difficult position.

Obviously, the company does not want to be seen giving in easily, but the ramifications of not adjusting management pay are far-reaching. Let's have a look at what is likely to happen if Citigroup ignores the vote.

For one, the company will face an enormous public relations scandal if it does not revise the pay packages, and this is something that should not surprise it in the least. When chief executive Vikram S. Pandit received a payout of $15 million last year, Institutional Shareholder Services recommended to shareholders that they vote against it because it was "not based on Citigroup's financial performance, Citigroup stock had declined by more than 90% in the last five years and Mr. Pandit's pay package was not in alignment with that of his peers". Although the company defended its decision, it still reeks as its reported by the media.

Citigroup now looks greedy, and, in the current economic climate, that is far from being the ideal image to portray. In light of this, shareholders as well as the public, are likely to force the company to make adjustments to management pay, even if the company chooses to ignore the vote.

In addition, Citigroup may come under increased scrutiny by federal regulators and even face litigation. It is now compulsory for federal regulators to ensure that banks do not engage in activities, such as paying excessively large salaries to its executives, which could be seen as risky financially speaking. And Citigroup is unlikely to avoid a lawsuit, as it is such a big and juicy target for regulators. Although the outcome of other such cases, involving companies like Cincinnati Bell (NYSE:CBB) and Beazer Homes USA (NYSE:BZH), have not yielded results that allow for definitive predictions on the outcome of a lawsuit against Citigroup, any lawsuit will generate bad press for a company of this size.

To me, it seems unlikely that Citigroup will ignore the vote considering what is likely to happen if it does. However, the question remains regarding what exactly it plans do about Pandit's paycheck. If the company decides to implement a retroactive pay cut, Pandit will have to agree. If going forward it will reduce his salary, he will have to agree to that too. I feel that Citigroup will have a hard time responding adequately to the many demands that shareholders currently have, and I feel that the outcome of this situation may be the most important indicator of the direction Citigroup stock will take this year.

In slightly more positive news, some expect the banking market to outperform expectations, listing Citigroup as one of the substantially undervalued companies.

And so, although the news is not all bad, stockholders have to ask themselves if they are willing to stay on board to find out what happens next. It's certainly been a bit of a rollercoaster with Citigroup stock, and I don't expect that to end anytime soon.

It appears that a trend has started whereby shareholders are taking matters into their own hands in terms of executive pay. Credit Suisse Group as well as Barclays (NYSE:BCS) shareholders voted against proposed management pay packages. What was once a rare occurrence is becoming quite a noticeable trend. Now, we are just left to wonder which companies will experience the wrath of its stockholders next.

Citigroup is not the only company facing pressure in the changing banking landscape. HSBC Holdings (HBC) recently elected to cut more than 2,200 UK jobs. Middle management is the main target of these cuts. The idea behind the cuts is too boost the bank's profitability to account for the huge economic changes the country is currently experiencing. If HSBC can escape stockholder doubt that comes with these cuts, look for it to invest the new cash wisely.

Bank of America (NYSE:BAC), a Citigroup competitor, may or may not be a good option for investors. This is one of the most volatile stock currently being traded, as we can all see by the sharp rises and falls it experiences. Recently, for example, the Bank of America was listed as one of the companies that far outperformed its market. However, huge increases like this are just as common as major declines, making it a sketchy option, at best, to back. It is a stock that warrants close monitoring, as does its competitive drive against Citigroup.

Not all banks are creating bad names for themselves at the moment. JPMorgan Chase (NYSE:JPM) was recently voted Corporate Donor of the Year by the Food Bank of Delaware at the organization's Annual Awards Dinner. The bank essentially works towards ensuring that as many people living in Delaware as possible receive the food that they need in order to survive. The company has a long history of supporting the food bank. The banking industry could use all the goodwill stories it can find, and JPMorgan may use the leverage to its advantage.

It's up to you whether the bad press that banking giants get will sway you away. It's not going to stop anytime in the near future. But there's money to be made with these companies. Citigroup, however, may be too mired in its own troubles right now to flock toward. Look to see how it settles down the anger of its stockholders and listen closely to how it plans to move on.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.