Limiting Bankers' Pay Won't Cure Israel's Wage Gap Ills

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Bank Leumi in Tel Aviv.
Bank Leumi in Tel Aviv. Credit: Bloomberg

Before its last recess, the Knesset approved a bill to cap executive pay at banks and other financial institutions.

In proposing the legislation, Finance Minister Moshe Kahlon’s stated goal was to reduce wage gaps. It seems like a populist goal, in the negative sense of the word, but it is in fact a right and healthy move for the economy. The problem is not the intention, but rather the way in which the finance minister chose to achieve it. The version of the law that was approved is shortsighted and harmful.

Wage gaps in Israel are among the highest in the Western world: The ratio between the highest and lowest wage earners is 12.5 to 1. Among Organization for Economic Cooperation and Development member states, only Chile, Mexico, Turkey and the United States have higher wage inequality. Yawning wage gaps reflect a problem in the labor market, but focusing on the salaries of a few dozen top executives diverts attention from the real problem, which is the low salaries of hundreds of thousands of other employees at the bottom of the wage ladder.

According to the Bank of Israel, about 25% of Israeli bank employees earn a gross monthly salary of 7,000 shekels ($1,868), and 10% earn minimum wage. This is very low compared to their colleagues abroad. In Britain, the starting salary of a bank clerk is the equivalent of about 14,000 shekels per month, much more than the British minimum wage. A department manager makes 80,000 shekels per month.

Finance Minister Moshe Kahlon at the annual conference of the Antitrust Authority, Airport City, January 26, 2016.Credit: Ofer Vaknin

And what about senior banking executives? The annual cost of salary for Bank Leumi CEO Rakefet Russak-Aminoach is about $2 million. If she were the director of a medium-sized bank in the United States, she would be at the bottom of the wage ladder.

The law that passed is shortsighted in that it treats the symptom instead of the real problem. Shareholders — that is, mainly us — set the CEO’s salary. If shareholders are forced to set the CEO’s salary instead of the board of directors, which is supposed to represent them, then the system tying together shareholders and management — corporate governance — isn’t functioning.

Corporate governance is supposed to prevent incidents of fraud, favoritism in issuing loans and the forgiveness of debts, to name a few examples of benefiting cronies at the expense of shareholders. The financial damage caused to each of us as a result of such decisions is immeasurably greater than the CEO’s salary.

Bank Leumi paid a fine of 1.1 billion shekels to U.S. and New York tax authorities, damages that were 100 times more costly than the CEO’s salary.

Bank Hapoalim forgave loans to cronies and businessmen in sums that surpassed even these amounts.

The danger in being shortsighted about treating the CEO salary symptom is in neglecting the real disease of managing the banks: the “private club” method of corporate governance that flourishes in Israel.

From an economic perspective, the law to cap executive salaries in financial institutions actually undermines the finance minister’s aspirations of narrowing the wage gaps. The money that will be deprived to top bankers will not go to customers or be used to reduce bank fees or to improve service. Capping salaries by law will move the rest of the salary from corporate workers to shareholders.

Thus, the finance minster requires the banks to transfer about one-fifth of the wage bill for executives at Bank Hapoalim and Union Bank of Israel (Bank Igud) to the holding companies of Shari Arison and Shlomo Eliahu, respectively, their respective controlling shareholders. Almost a third of the salaries at Mizrahi Tefahot will go to the holding company of the Ofer brothers, which owns the biggest block of shares in the bank.

Instead of increasing the wealth of millionaires, Kahlon will be padding the accounts of billionaires. He would do better by addressing the disease — the low salary of the majority of Israeli workers — rather than the most visible symptoms, the high salaries of a few dozen executives.

The author is an assistant professor of strategy and entrepreneurship at London Business School.