Just before he set out to battle the top brass at the Tel Aviv Stock Exchange, Israel Securities Authority Chairman Prof. Shmuel Hauser issued the last word in Israeli capital market regulation. This is Amendment 20, a completely original Israeli creation aimed at curbing the rise of executive pay at publicly owned corporations. At the very least, it aspires to inject some rationality into executive pay by requiring companies to substantiate and justify how their managers are rewarded.
Three slides stood out in Hauser's presentation on the subject several months ago . Two of them exemplified the absurdity of executive pay in Israel. One graph compared the 65% increase in the market value of TA-100 index companies (not including dual-listed companies) from 2003 to 2012, compared with the 100% increase in pay for those same companies’ top executives during the period. In the final year the companies’ aggregate market capitalization rose 40%, while executive pay jumped 127%. In any case, it is clear that executive compensation in Israel has soared over the last years without any connection to performance. It was a cut-and-dry case of executive extravagance.
Another slide, showed an even more absurd discrepancy, by comparing executive pay in 2008 in Israel with the pay in a sampling of other countries. In absolute terms, Israel ranked 12th among the 13 surveyed: The U.S. led with an average pay equivalent to NIS 21.6 million against NIS 6.6 million in Israel. But when comparing executive pay at similar-sized companies the distortion became clear: Salaries for the top executives at Israeli listed companies ranked second in the developed world, after Spain. Compensation in Israel was triple what American executives of the same-sized companies were getting.
So there you have it: The figures show that management pay at public companies became detached from reality sometime during the last decade and became the most bloated in the world. Of course, nobody suspects that Israeli managers are better than their counterparts in the U.S., Germany, Britain, or Sweden to justify their extra pay. In fact, there is no way to explain why Israeli executives earn more than their peers elsewhere in the world except for those in Spain (which, based on its current economic condition, isn't such a great example) except by pointing at a market failure in approving executive pay.
This is precisely why Amendment 20 came about -- to intervene in the judgment calls being made by Israeli boards of directors when they are determining executive compensation and compel them to meet guidelines. From now on pay will depend on the company’s long-term performance using quantitative measures that take risk into account. Bonuses will have to be returned if heavy losses occur, with ceilings are set on bonuses and more. The goal is to establish a clear link between executive pay and the company's long-term objectives to ensure that managers act to promote their companies' long-term success.
The big question is whether Amendment 20, which is only now going into effect is actually likely to achieve this goal.
Will it make a difference?
Actually, the question that could and should be asked is which, if any, of the three goals Amendment 20 is likely to achieve: curbing the dizzying rise in executive pay in Israel, creating a link between pay and performance or, most importantly, improving management by providing executives with the right incentives.
Success in realizing the first goal – reining in the rise of executive pay packages – is questionable, according to the third slide of Hauser's presentation. This slide analyzed the results of Amendment 16, which was similar to Amendment 20 except that it applied to shareholders owning a controlling stake in the company. Amendment 20 applies to hired executives. According to the Securities Authority, the percentage of pay proposals rejected in general shareholders' meetings votes was a mere 3.6% before Amendment 16 took effect, but it doubled to 7% afterwards. So there was an improvement, but it wasn't terribly significant.
The ISA qualifies this finding by pointing out that no figures are available on the number of pay proposals altered before being submitted for shareholder approval in the context of early negotiations between the company and its minority shareholders. Without such figures it is hard to fathom the actual effect of Amendment 16 on the pay of controlling shareholders, but it isn't believed to have been significant.
Controlling shareholders who get greedy with compensation packages amounting to tens of millions of shekels will likely catch hell from shareholders. The average package, which according to the Securities Authority is between NIS 3.2 million to NIS 3.7 million a year, has already become the norm. Even the traditional gatekeepers of shareholder value – the institutional investors – award their executives similar levels of compensation, so it's hard to expect this norm to undergo any substantial change.
But the drafters of Amendment 20 didn't at all intend to cause a drop in the average pay of public company executives per se. Their goal was to link pay to performance. The likelihood of achieving this is higher, as can be seen from the compensation plan at Mizrahi -Tefahot Bank, one of the first companies to release a compensation plan. This includes three clearly defined measures for determining the CEO's pay: return on capital, share performance compared with the performance of shares of other banks and operational efficiency metrics. These are three important measures, but it should be noted that in two of them the bank is already performing in the center of the range that was set. In other words, all the CEO needs to do to be eligible for a bonus is to maintain the bank's current position (which, it should be pointed out, is a relatively strong position).
This raises a question about the third goal: Can detailed compensation plans actually be expected to ultimately bring about a qualitative improvement in management by providing executives with incentives for achieving long-term objectives? This is the billion dollar question. Amir Raskin and Keren Shaked of the strategic consulting firm B-Pro warn that it won't. They point to studies conducted at Harvard University by two of the world's top business strategy researchers, Robert Kaplan and David Norton, who concluded that there was no substantial link between achieving financial objectives and strategic goals.
Raskin and Shaked bring up the example of Israel's cellular phone operators, which generated spectacular results in increasing revenues for a decade – until the 11th year, when the market opened up to competition and their business performance collapsed.
"In most organizations the compensation package objectives are a big mixture of indices that aren't rooted to anything," say Raskin and Shaked. "Meeting objectives doesn't ensure future success unless ensconced within a clear strategic plan. That's why Israeli management is so terrible – because there isn't a clear strategy and there are no incentives for following strategy."
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