cards - Ayala Tal - 18072011
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One of the better-known stories in "Liar's Poker: Rising Through the Wreckage on Wall Street" by Michael Lewis (Penguin, October 1, 1990 ) - the best book ever written on securities traders - goes like this:

Two men were sitting together and telling each other how the world really works.

One was Michael Milken, a genius at bond trading. He'd become one of the world's richest men, before crashing and going to jail.

The other was an Israeli-American businessman named Meshulam Riklis, owner of a firm called Rapid-American Corporation (also famous for selling Carnival Cruise to Ted Arison for $1; helping Ariel Sharon build the Sycamore Ranch; and marrying singer Pia Zadora ). Rapid American, explained Milken to Riklis, belongs to Drexel (the bank at which Milken worked at the time ) and to its customers - not to Riklis.

"How can that be when I own 40% of the stock?" asked Riklis.

"We own one hundred million dollars of your bonds," Milken answered him in Lewis' book. "And if you miss one payment, we'll take the company away."

A person can finance a company in one of two ways - by investment in its share capital or by borrowing. Shareholders receive control, dividends and any capital gains achieved by selling their shares. Bondholders get their money back - the principal they invested plus interest payments.

That arrangement works as long as all is well and debts are paid on time. But when a company stumbles into trouble and has difficulty repaying its debts, the priorities get turned upside down. The shareholders become an inferior creditor and the debt-holders receive priority in the case of the company's liquidation, further management, sale, or any other major decision involving its fate.

In practice, any major loan brings a new partner into the business, whose strength grows as a function of the size of the loan relative to the company's ability to repay. Anybody with a big mortgage on his property knows this well. The bank has a caveat registered on its behalf at the Land Registry, property insurance and life insurance on the borrower; priority in getting its money back when the property is sold; and even the right to foreclose and take possession if the borrower defaults on payment.

And that's how it works with companies too: A company borrowing money signs a contract stating the terms of repayment, limitations and obligations on management and, mainly, stating what will happen if the money isn't repaid.

Ownership of the company and decisions pass to the lender, usually a bank, as soon as the company stops servicing the loan. In the United States and the West, that principle is sacrosanct. The business world demands that when a company gets into trouble, the creditor takes possession. The creditor may decide whether to sell the company, manage it itself, or liquidate it. The shareholders failed in its management, therefore their role is over and they get nothing.

That is how it has to be. Otherwise, the shareholders would have no incentive to repay loans, and no lender would lend to somebody with no incentive.

All depends on the institutionals

But the obvious doesn't always work in Israel, mainly when it comes to the tycoons. When a company owned by a tycoon stumbles, another procedure kicks in: The public that lent money to the enterprise is required to accept a complicated debt arrangement often including loss of part of the loan (the "haircut" ) - and the tycoon retains control.

The law and agreements are much the same in Israel as elsewhere. Here, too, default grants the lenders the right to succor in court, to exercise their right to manage the company as they see fit. But it doesn't happen.

Here, corporate debts to companies are managed by banks and institutional investors, which are in turn managed by people with relationships and business ties with the tycoons. They go to the same parties and sit on the same boards. Their incentive is to leave things as they are. They don't want liquidation, ownership transfers or conflicts with the kings of the Israeli business world.

It doesn't have to stay that way.

To whom, for instance, does Tao Tsuot belong? The public holds the bonds issued by Tao, which said last week that it would have difficulty meetings its liabilities and thus wanted a complex debt arrangement. As Milken told Riklis in Liar's Poker, the bondholders could simply tell Ilan Ben-Dov and his head manager, Yossi Arad: We don't want your troubles. Pay up in full or on time, or we'll take your company.

Moreover, in practice, before anything happens, Tao already isn't fully owned by Ben-Dov. Already, its real owners are savers at Clal Insurance, Phoenix, Excellence and others. What is ownership and what is management if not the ability to make decisions about the company's fate, including whether to seek succor in court and liquidate it?

Here is a message to the bondholders of Tao: You are the company's new owners, not Ben-Dov. From now, the main issue is which interests stand paramount in the eyes of the people at the institutional investors managing your money. Will they see the big picture, and clarify to one and all how a proper capital market is run? Or, will they choose the interests of the tycoons and their own personal good?