Bringing down the pyramids
The time has come to return the capital to its real owners - the public, urges Nili Even-Hen of the Movement for Quality Government.
The problem of economic concentration was described in stark terms by Nili Even-Hen of the Movement for Quality Government in Israel: The people are being fooled all of the time.
People think that if they work hard, it will benefit them. They think the state's role is to represent and protect the citizen, she told the government committee on economic concentration last month. "Investors believe that their investments are protected and secure, that the economy is managed wisely and that companies act to maximize profits for investors." It's a fallacy, and it's all wrong, she says. And why? "Because of the existence of pyramids of control and cross-ownership."
Pyramidal business structures contravene the greater good, summed up Even-Hen.
A handful of business barons control more than a trillion shekels of the public's money, she told the committee, which is chaired by Eyal Gabbai, director general of the Prime Minister's Office, and Haim Shani, director general of the Finance Ministry. These barons distort the entire economy through cross-holdings, sweetheart relationships with the government and own media outlets that otherwise might be more critical of them. But the media doesn't tend to bite the hand that feeds it.
The only way for regulation to address the economy's structural failures is to break down the pyramids of control and prohibit cross-ownership of financial and non-financial assets, Even-Hen says.
The economic concentration panel is exploring the relationship between big money and government, and which pyramidal corporate structures are involved. Even-Hen is one of many to appear before the panel; others include representatives from the Arison Group (which owns banking and construction interests ), the Federation of Chambers of Commerce and the Israel Consumer Council.
A corporate pyramid has a holding company at the top that owns controlling stakes in other companies, which in turn own other companies. The owner at the top needs a mere controlling interest at each stage of the chain to gain effective control of all the companies in the pyramid.
He appoints the board and richly rewards management, gaining control.
Shareholder meetings are supposed to serve the interests of the investing public. But it's an empty shell, Even-Hen says. Minority shareholders rarely show up because of the inconvenience - and they sense they have virtually no influence on decisions.
Companies do not act to maximize these small investors' profits: Their aim is to maximize the major owner's gains, she says.Insider information
The problem of corporate pyramids exists among financial firms as well, including banks, pension funds and insurance companies. Israel is rife in cross-ownership, which avails the controlling shareholder of readily available financing and a hedge against business failure, Even-Hen says.
"When the controlling shareholder needs a loan, the bank he owns complies since the CEO and the directors owe their jobs and salaries to him. In addition, the cross-ownership serves as a source of information about other companies that do business with the bank," Even-Hen said. That's bad for competition, and such economic clout influences public officials.
The Federation of Chambers of Commerce favors competition. It submitted a position paper to the committee last month urging that enhancing competition would lower food prices, save businesses money and enable importers to slash prices of clothing and electrical appliances. "It would make the Israeli economy more advanced and competitive in global terms and improve the quality of products manufactured in Israel," the group wrote.
Chambers of Commerce President Uriel Lynn says the public discourse on economic concentration tends to focus on ownership structures, but to the business community, the problem of concentration stems largely from the fact that it closes the economy to competition from imports. Also, businesses (like the public ) have to pay the absolute monopolies through the nose.
Opening the market to competition would benefit both the consumer and companies, Lynn urges. Through free trade agreements, Israel has become part of globalization, lowering prices substantially, Lynn says. And Israeli industry has also become more efficient and competitive both locally and for export.You're paying 190% tax on imported beef
The Federation of Chambers of Commerce advocates expanding free trade agreements in Asia, particularly with China and India. Lynn says there are still many protective tariffs on food and agricultural products imported into Israel.
The tariff is 190% on beef, 140% on butter and 153% on other imported dairy products. Duties ranging from 105% to 180% are imposed on other imported foods such as fruits and vegetables, dates, tuna, olive oil and onions, so many food items are simply not imported to Israel because the prices for consumers would be prohibitive, the federation says. And lowering duties on food could drive down prices substantially.
Government-owned monopolies such as the Israel Electric Corporation, the port companies and Israel Railways also pose a problem, Lynn says. Despite reforms of these monopolies, they have not become more efficient. They remain controlled by workers' committees, he claims.
"The state provides essential services to the business sector and the public at large through monopolies it owns, while the public and the business sector have no option to get these services from another source," he explained.
Lynn also cited a 2008 state comptroller report terming 2005's port reforms a failure - because they remained monopolies.The families and their minions
"Most of the public's assets in Israel are controlled, absurd as it is, by a few families," Even-Hen says. "The control pyramids and cross-ownership create an undemocratic reality contrary to the public interest. A minority group of the rich sets the economic agenda, in practice controlling the economy in which the private investors are invested - controlling the media, banks and pension funds. And they do with them as they please."
The gatekeepers - the legislature, the media and institutional entities - should prevent such distortions and protect the investing public's interests, she says. "In practice, the existence of pyramids of control and cross-ownership negate the ability of the many gatekeepers to act effectively against the interests of the business barons."
Take the acquisition of land by Danny Dankner's Salt Industries from the Israel Lands Administration. The land was bought relatively cheaply and the deal completed without setting off regulatory alarm bells, Even-Hen says. That transaction provided the collateral necessary for the Dankner family to buy Bank Hapoalim (later sold to the Arison Group ).
Nor do external entities that are supposed to assist regulatory agencies always do the job, Even-Hen says. If a controlling shareholder is dissatisfied with a credit rating agency, he can switch to another company, which is what Shari Arison of the Arison Group did in moving from Ma'alot to Midroog, Even-Hen notes.
In her appearance before the committee, Even-Hen also cited the example of corporate credit and investment committees entrusted to decide where funds should be placed in a professional, objective manner. In practice, committee members are appointed by the controlling shareholders and are beholden to them, she said.
"It would be hard to find a single example of a credit or investment committee coming to a decision that was contrary to the interest of the controlling shareholder," she adds.
"The situation is similar among appraisal firms. Here, too, it's known that holders of capital can practically buy the appraisal that meets their needs, whether it is realistic or not."
The Movement for Quality Government cites Israir Airlines as an example, claiming that Nochi Dankner received an unrealistic appraisal of the company. That high valuation helped him get approval for his publicly traded company IDB to buy Israir's parent company Ganden Tourism, allowing him to dispense with personal guarantees he had provided.
When Israir's real, lower value was revealed it was too late, and the company's chronic losses, NIS 61 million in 2010 alone, were borne by IDB shareholders, the movement asserted.
The appraisal firm in this case got NIS 800,000 in fees, and even after its valuation was discredited, Dankner's IDB Group continued to use it, the organization claimed.
What is the role of auditors in this picture? "In a small country like Israel, the elite accountants, a very few firms, serve a mix of the tycoons and the institutional and public entities that are supposed to be monitoring the tycoons," said Even-Hen. "When everyone works with everyone, the interest that is harmed is of course that of the public at large, especially when payment for the oversight comes from the target of that oversight itself, and there is no outside party overseeing things."
Independent research institutes are supposed to supply objective opinions. But that costs money, Quality Government says. Who foots the bill? Often enough, big business, which makes it tough for such institutes to report heavy-handed conduct by big business. Again, it's the public that loses.
Nor have the politicians and press come to the rescue. "Knesset members, government workers and public servants sometimes maintain warm friendships with big business. It's hard to maintain a friendship with someone and at the same time impose sanctions or castigate him for improper conduct," the group says.
"Relationships aren't the whole story. Big business deploy lobbyists and public relations people constantly working on the decision-makers. The case of natural gas royalties and the Sheshinski Committee [which made recommendations to increase the government's share of natural gas exploration revenues] is a clear example of how the doors of publicly elected officials are open to holders of capital and how receptive the officials are to contact from them, in a way the simple citizen can only dream of."Big business owns the media
According to Even-Hen, "A healthy and independent media sector should be an integral part of governance in a democratic country, protecting the public interest. In practice, most media outlets in Israel are controlled and funded in many instances by big business. There's not a single employee who would severely criticize the person paying his salary."
Regulation cannot overcome these problems, due to pyramids of control, therefore change has to be structural, systemic and drastic, Even-Hen says. "The time has come to return the capital to its real owners - the public. Pyramidal ownership structures and cross-ownership must be eliminated. The benefits - economic, public, and social - from such a step are unimaginable. It will require the public's courage and faith in the correctness of the democratic system .... The solution is within reach, but will the decision-makers have the courage?"
One way to eliminate control pyramids is to allow shareholders to own 100% of a company, or 30% or less - nothing in between.
Investors would not be able to hold a 5% stake in a corporation in the lowest rung in an ownership chain but exert control over the company, the group suggested.
"There would be no more appointments by controlling shareholders of key people, no more directors obligated to 10 companies and jumping from one conference room to another to satisfy everyone. The director's position would become a full-time profession, with an obligation to the company paying his salary," the Movement for Quality Government proposes. "In this way, the public would benefit from professional managers who effectively steer the company for the good of the company, maximizing its profits and the investors' profits."
Companies should be required to issue reader-friendly reports accessible to amateur investors, the organization contends. Accessible information would help investors make educated decisions. The movement even suggested allowing real-time Internet-based voting at shareholder meetings. This would make the meetings truly democratic gatherings rather than a sop for appearances' sake.