As I See It

Israel's High Court Gives a Nod to Social Reforms

Justices who refused to strike down the law imposing pay caps on financial sector executives made it clear they will not intervene when lawmakers assert social values.

Lawmakers meeting over the pay law earlier this year.
Emil Salman

Israel’s bankers and insurers are starting the Jewish Year 5777 with some introspection. They have three months to think about what they really want: Money? Influence? Power? The next challenge? The thing is, they have three months – until the start of 2017 – to decide whether to take their money and run, or continue to work under substantially inferior conditions.

Last week the High Court of Justice gave its approval to the enactment of a law capping executive pay in the financial system. It may not exceed 35 times the lowest salary in the company. Assuming that’s the minimum wage, then an executive may not gross more than 2.5 million shekels a year ($660,000).

Constraining executive pay at the banks and insurance companies is a blow to the freedom of occupation and freedom of competition and of contracts, but a constitutionally permissible one, wrote Supreme Court President Miriam Naor. The blow, she concluded, was not harsh enough to warrant invalidation of the law. Her opinion was backed by the entire panel, including justices Elyakim Rubinstein, Yoram Danziger, Salim Joubran, Hanan Meltzer and Zvi Zylbertal.

The point of the law, Naor summed up, is to narrow wage gaps by capping top pay at the finance companies, and also to protect the public’s money that is managed by these finance companies: Worthy causes indeed, she wrote.

The High Court has no economic policy as such, Naor pointed out. The banks argued that pay for talent shouldn’t be constrained, while the legislator aimed to narrow inequality; she for one didn’t feel it the court’s job to prioritize these conflicting views – that’s the legislator’s job, and the court found the resultant law to be constitutional.

However, a whiff of very moderate capitalist dogma could be read in Meltzer’s words. “These days, the constitutional right to property is sometimes entwined with values of human dignity,” he wrote. People should be assured of minimal financing, education and healthcare throughout their lives, from birth through employment or unemployment through retirement, he asserted, “without the property right, on the other hand, necessarily protecting the possessions of the wealthy.”

The court ruling has an important statement for proponents of social change and equality in allocation. Anybody who manages to legislate a reform that could change the way the socioeconomic pie in Israel is shared will find a friend in the Supreme Court, even if the reform gnaws at the constitutional rights of specific groups.

Past rights remain problematic

The main problem the court faced was whether the pay-cap law should apply to contracts agreed on in the past and that come into force in the future. Retroactive application is one area where the justices leaned toward the financiers.

Naor’s position sets forth guidelines for the law’s interpretation: The law shall not be applied to rights acquired in exchange for work the employee has done before the end of the “adjustment period,” and if the rights were laid down in a contract signed before the law came into force. That adjustment period had been scheduled (by the law) for October 12, but the justices put it off to January 1, 2017.

The stated purpose of the law is to contend with over-the-top pay in banking and insurance circles. Was it meant to lower executive pay in general in Israel? Danziger for one doesn’t see it achieving that, arguing that taking aim at such a small group won’t lead to change.

The truth is that the court has no tools to assess the law’s chances of success. That is a problem, because when a law damages constitutional rights, one has to see whether the cause is worth it, and whether the law is effective.

The bankers and  insurers suggested other options that might have achieved the same ends that the Knesset wanted, without setting rigid pay caps, Naor wrote, and admitted that the court doesn’t have the tools to see whether the pay caps would: If anything, the shareholders might just rake in even more money as the hired help earns less.

If that’s true, then the law achieved the opposite of its aim. But if the state manages, in the long run, to change the system in which banks and insurance companies have controlling groups, and make them all like Bank Leumi and Israel Discount Bank (which have no controlling shareholder), then the investing public would be sharing in the savings.

Thus, the law’s chances of narrowing wage gaps in Israel depends on efforts to change the structure of ownership over public bodies in Israel, not that any such efforts are being made.

Bankers and insurers wail that the new law will lead their colleagues to quit en masse, taking their well-gotten gains with them. Zion Kenan, CEO of the biggest bank, Bank Hapoalim, has already quit, as has the deputy CEO at the No. 2 bank, Bank Leumi, Danny Tsiddon.

Elyakim Rubinstein doesn’t think Israelis should lose sleep over the threatened tsunami of rueful resignations, pointing out, in writing, that the “cemeteries are full of people who thought they were irreplaceable.”

Nor do the justices seem to buy the extremist economic tenet that profit and loss are the main drivers of mankind.

A sentence that attracted public attention in this context is Naor’s criticism of the opinion submitted by Prof. Moshe Zviran, dean of the School of Management at Tel Aviv University, who warned that senior executives would abandon ship if the law remained in force.

Naor wrote that Zviran’s opinion was based on a hidden assumption that the decisive consideration in a person’s choosing their professional path is maximizing income. “It is possible that another approach takes into account that people choose a workplace based on other considerations, such as a professional challenge, the desire for self-fulfillment, satisfaction and the aspiration to influence and do good. As for the matter of the extent of departures, this is a scenario that predicts the future. The court has no tools to evaluate the effects of the law on the actions of the employees of financial corporations,” wrote Naor.

The question of whether the limitations of executive wages in the financial industry would affect other business sectors too was not discussed directly in the ruling, but was clearly implied in the intensive discussion of the unique characteristics of the financial sector.

Naor accepted as almost completely obvious the differences between the banks and insurance companies, and other publicly-traded companies. She said that because these institutions manage the public’s money, it justifies the special treatment the legislature has imposed. 

Naor accepted the government’s claim that in times of crisis, it was highly likely that the government would be forced to rescue these institutions too.  This is what has happened in the United States, for example. Naor mentioned the limitations on executive salaries for companies that participated in the U.S. federal rescue plan, TARP, after the 2008 global financial crisis.

The High Court, as well as the government, went out of their way to isolate the banks and other financial firms from all the other public companies. Senior executives in other industries can breathe a bit easier, at least for now.

After the passage of the salary cap law, some politicians warned that the law would be expanded into other sectors if executives did not internalize the message on their own, but the present ruling will make it more difficult. After the wide range of justification to isolate financial firms from the rest of the business sector, it will be hard to impose further limitations outside the financial industry – even if many of these justifications also apply to other firms, which are to a great extent heavily leveraged through the use of the public’s long-term and retirement savings.

Almost all the justices criticized the negligent way the law was formulated. Naor said it would have been better if the legislature had given thought to the limitations placed on the parties involved because of existing contractual obligations. Naor said she did not have the impression that this issue received proper discussion in the Knesset.   

Danziger also commented that the public expects legislators, especially concerning laws with significant ethical aspects, to carefully consider the law and its implications. Danziger said it was worrying that some of the sections of the law were passed with unimaginable haste, and seemingly without properly dealing with all the implications they might have. Given the circumstances this is not enough for legal intervention by the court, but such a situation is far from being desirable, he said.

Finance Minister Moshe Kahlon’s political instincts told him the law implementing the salary cap would not have been passed if it had been debated in the long process of a full hearing in the Knesset committees. Such processes are held captive by powerful interest groups, lobbyists and other advisers. The salary cap law could only have been passed in such a hasty move. 

In their book “Solomon’s Knot: How Law Can End the Poverty of Nations,” professors of law and economics Robert Cooter and Hans-Bernd Shafer write about how to overcome such powerful interest groups that object to major reforms. One method is to pass such reforms using confusion and surprise against the opponents. The heads of the banks and other financial institutions in Israel, and everywhere around the world, are such an interest group. It is not surprising they have succeeded in heading off such salary limitations just about everywhere, and only during the TARP process did any such limited moves succeed in the United States.