In the Money Breakin' Up Corporate Control Pyramids Is Hard to Do

Pyramids are a corporate structure which allows holding companies to control subsidiaries with relatively little investment.

Of the dozens of recommendations made by the committee examining economic concentration in Israel, two were left out. The committee did not recommend breaking up the large holding companies (control pyramids ), and essentially did not even say that corporate pyramids limit competition. In addition, it did not recommend limiting the size of pyramids and blocking them from expanding further.

Pyramids are a corporate structure which allows holding companies to control subsidiaries with relatively little investment.

kids - Bloomberg - September 21 2011
The concentration committee forgot to stop the tycoons from building their pyramids even higher.Bloomberg

The only size limits in the recommendations involve investments by large corporations in financial companies, or the whole issue of financial/non-financial holdings. The committee did choose to limit these holdings, such that Nochi Dankner's IDB group, Yizhak Tshuva's Delek group and Zadik Bino will have to choose between their non-financial holdings and their banks or insurance companies.

Size limits do not affect any other aspect of corporate pyramids. From now on, they will not be able to buy banks, insurance companies or brokerages, but they can buy any other companies to their hearts' content, with no limits.

Thus, if the IDB group chooses to buy the Azrieli group tomorrow - this is just an example; as far as we know, the Azrieli group is not for sale - no one will be able to block it, even if the post-merger company will be a giant mass of economic concentration with far-reaching influence.

This description is a little off, because there will be some limits on corporate pyramid expansion. For instance, if the IDB group were to want to buy the Haifa Oil Refineries from the Israel Corporation, it probably couldn't. This is because the committee is recommending making critical infrastructure companies more subject to competition considerations, and the Haifa refinery is clearly such a company. The pyramids will be blocked from buying government assets or critical infrastructure, but any other acquisition, from real estate companies to retailers, large industrial plants and food manufacturers, would still be allowed.

Then how will the committee's recommendations help limit economic concentration if they don't block the large groups from expanding? The answer is a matter of debate. Some people were indeed disappointed by the committee, and believe that its recommendations won't stop the few from controlling the many.

Others believe that taken together, the collection of recommendations will indeed block the groups' expansion. This argument holds that the recommendations will break up the groups, even though the committee did not call for this explicitly.

For instance, the recommendations discriminate against the groups when it comes to granting credit. They're already largely blocked from receiving bank credit, due to credit limits. In the capital market, however, the limits were very loose, and they did not effectively stop the groups from borrowing growing sums. One of the committee's recommendations is to apply the Bank of Israel's limits on the capital market as well. The exact limits have not yet been set, but it's quite possible that they will significantly limit the capital available to pyramids.

If the limits set by the capital markets commissioner are effective, then the groups' ability to grow will be very much limited.

In addition, it will become more difficult for pyramids to expand by buying new companies, since they will no longer be able to buy just enough shares to control the company; instead, they'll have to buy all the company's shares, including those held by the public. This could double the cost of acquisition, imposing yet another limit on expansion.

Another limit is a recommendation to let regulators force pyramids to sell off companies should the minority shareholders want this.

Yet all these recommendations are little more than nuisances compared to the two central recommendations. The first one is that all major business decisions - acquisition of control, raising capital, etc. - must receive the approval of minority shareholders. This is a very problematic recommendation, since it neuters the company's management: If the CEO cannot make crucial decisions regarding his company, then he is no longer a CEO. It's unlikely that pyramids could go on existing if these were the rules.

Just imagine the implications of these recommendations: A company seeking to take out a bank loan will not only have to receive approval from minority shareholders, but will also have trouble getting the loan itself due to a lack of securities. It will be less able to offer shares in a subsidiary as security if the minority shareholders can demand that it sell off the subsidiary at any moment.

The biggest obstacle is hidden in the second recommendation, of course, which is also the most controversial: Doing away with the pyramid's outsize control over subsidiaries when the top of the pyramid does not actually own a controlling share. Currently, if a person owns 51% of company A, and company A owns 51% of company B, then this is enough to give the person control over company B - even though in practice, he only owns 26% of company B.

This recommendation would mean that the people at the top of the pyramids would lose their control over subsidiaries of subsidiaries, and would thus cancel the advantages of the pyramid structure - the ability to control lots of companies with very little capital. Why bother with a pyramid if you don't control all the companies under it?

If these last two recommendations are indeed adopted, then the committee apparently will have succeeded in breaking up the country's corporate pyramids. All we can do is wait and see how daring the committee and the Knesset will be when it comes to adopting the recommendations.