Accountant General Michal Abadi-Boiangiu’s decision, announced last week, to set into motion measures to protect the state's rights as 6 percent shareholder in Bank Leumi has been very fruitful.
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As a result, the Bank of Israel and the Justice Ministry made it clear they'll torpedo attempts by publicly-owned companies to distribute bonuses that aren’t derived from measurable performance. The central bank also said it will keep bonuses to banking system executives in line with the accepted practice in Europe. The tens of millions to be saved annually will be used by the banks for paying dividends to shareholders or granting credit to the public.
But the combined move - by the Finance Ministry, which sounded the alarm; the Justice Ministry, which is examining the legal aspects of the compensation plans; and the Bank of Israel, which imposed limits on the banks - has only underlined the flimsiness of Israel's regulatory framework when it comes to protecting the rights of shareholders in public corporations.
The state, as a minority shareholder in the bank, prevented Bank Leumi last week from taking part in the pay frenzy indulged in by management at most large companies. But the state only examined the compensation plan at Bank Leumi, since that is where it holds shares. Nothing was done at all the hundreds of other companies where executives party at the expense of the public.
Pension savers' trap
High pay for top executives isn't a problem in itself. Appropriate, generous compensation can help companies attract the most talented managers and spur them to maximize company profits. The problem is that a good number of the compensation plans presented lately are distorted: They allow executives to rake in millions of shekels in salary, bonuses and shares just for showing up to work, almost regardless of their contribution to the company or its shareholders.
It would seem none of the state's business to intervene in disputes between minority shareholders and public corporations. Shareholders have the right to oppose proposed transactions, and if they're approved anyway they can simply sell their shares and invest in companies run in a more honest manner. This would be true if we were talking about a free market, but the capital market in Israel isn't entirely free. The mandatory pension insurance law that took effect in 2008 requires all salaried workers to contribute each month to a pension or provident fund, which invests these funds in publicly traded companies.
While employees are required to pay into these funds, the funds are not obligated to provide a minimal return. The return provided by the capital market is the return the retiree will receive, minus the management fees charged by the fund.
Last year the Bank of Israel found a great similarity among between 77% and 90% of the pension fund investment portfolios. This means most pension funds invest in the same channels and the same companies, so their expectations for returns are similar. If you add the fact that competition between pension funds is negligible and that the five largest pension insurers control more than 95% of the public's funds, then no pension fund has any incentive to take measures to protect the rights of their members. This is a classic case of the phenomenon known as "other people's money."
In this situation – the state requires salaried employees to invest in the stock market, putting a steady stream of NIS 20 billion a year into the capital market – the state must also provide the public with protection: Either the Finance Ministry’s capital markets, insurance and savings division must tighten its supervision of pension funds or the Israel Securities Authority must ensure corporate compliance with the law.
Without strict government regulation of the conduct of public corporations, the compulsory pension insurance law could turn into a law requiring salaried employees to fund the executive feeding frenzy at those companies.
The gatekeepers who fell asleep
Had the ISA and the capital markets division, both of which answer to the finance minister, been effective in protecting the rights of minority shareholders in public corporations, Abadi-Boiangiu would have been spared from the battle she launched last week.
In other words, if the supervisory division had done its job, had it forced the pension funds to effectively oversee the companies in which they invested the public’s money, the finance and justice ministries would not have needed to intervene in Leumi's executive compensation plan. The treasury’s intervention demonstrates the market failure of the pension funds in protecting their members’ rights.
In addition, the flaws found by the Justice Ministry in Leumi's compensation plan invite the question of what the ISA was doing. After all, its job is to insure that investors receive due disclosure about the compensation policies of public corporations, in accordance with the law. After studying Leumi’s executive compensation plan, at the Finance Ministry’s request, Deputy Attorney General Avi Licht, found it to be partly in violation of the law, in that it permitted executives to receive shares without having to prove the performance of genuine, measurable objectives. It is the job of the securities agency, not the Justice Ministry – which in this case was merely advising the treasury - to identify these shortcomings.
In the absence of intervention by the ISA, and in light of the support provided by Entropy Consultants, it is reasonable to assume that the pension funds would have approved Bank Leumi's compensation plan, and one more distorted salary and bonus distribution would have gotten under way. Until now the Israel Securities Authority hasn't expressed its stand on the issue, which raises the question of how many more distorted compensation plans are now on the table without anyone having examined them.
The ISA spokeswoman responded: "The authority puts great importance on establishing a connection between compensation paid to public corporation officials and their companies' performance and the contribution by the compensated official to the company's results. Amendment 20 to the Companies Law is expected to strengthen this connection and thereby improve the corporate governance norms at companies."