Two leading financial figures dropped a bombshell last week. David Zaken, the Bank of Israel’s banks supervisor, and Dorit Salinger, director of insurance, capital markets and savings at the Finance Ministry, said they would be placing limitations on the salaries that corporate board bosses at companies under their supervision – including banks, insurance firms and institutional investors – could be paid, ensuring it couldn’t be linked to the firm’s financial performance.
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The aim of the change is to curb chairmen and women from encouraging workers to take undue business risks in pursuit of more profit, and enable boardrooms to better oversee management and its work. Zaken and Salinger expect their directive to lead to a limitation on chairpersons’ salaries and create compensation norms that will permeate other levels of corporate management. Really?
Many believe the social-justice protests of summer 2011 were a one-time flicker of public activism, one that quickly waned without affecting our lives. After all, the cost of living remains high. Home prices continue to climb. The value-added tax rate has increased by two percentage points, and the defense budget – which sucks up every available shekel – continues to be a burden on the state budget, leaving too little for spending on social welfare. But that’s far from accurate.
The protesters camping on Tel Aviv’s Rothschild Boulevard may have long packed their tents and left, and a few of the movement’s leaders can now be found serving as Knesset members. And the prime minister back in 2011 is still in office.
But there are several sectors in which there has been change. It hasn’t been huge, but it has had an effect. And that includes corporate executives’ salaries.
After many years of steep salary hikes way beyond wage increases elsewhere in the economy, executive pay has actually declined recently. Data compiled by Keren Kibovich, of the corporate governance department at BDO, reveals that the average annual salary of senior executives at Israel’s top 100 blue-chip firms in 2014 was 3.22 million shekels ($838,000). The comparable figure in 2010 was 4.55 million shekels, the year when the figure peaked. Then it declined 29% in four years. Even between 2013 and 2014, the drop was 7%. The data are based on the salaries of 350 senior corporate management.
Role of the social-justice protesters
Executive pay wasn’t the focus of the social-justice protests. If we’d asked the protesters to state their demands at the time, it’s reasonable to assume the issue wouldn’t have topped their list. But the ballooning of executive salaries over the past two decades reflects something fundamental that was the basis for the protests: the sense that something here hasn’t been fair; that the cost of living is too high; that salaries in general are too low; that the disparities between rich and poor are widening; and that social solidarity has disappeared. This ferment also triggered several political changes, including the emergence of former Finance Minister Yair Lapid’s Yesh Atid party and current Finance Minister Moshe Kahlon’s Kulanu. It also, for a short time, resulted in Shelly Yacimovich leading the Labor Party.
Yacimovich deserves some credit for the drop in executive pay. A bill she sponsored with then-MK Marina Solodkin (Kadima) and current Social Affairs Minister Haim Katz in 2010 brought about a series of developments that ultimately helped lead to the salary decline. Their bill sought to link executive and lower-level workers’ salaries, and required that the highest salary at a company not exceed 50 times that of the lowest.
At the time, it was perceived as a radical proposal and crude intervention in the free market. In fact, a concerned Benjamin Netanyahu ordered the establishment of a committee, headed by then-Justice Minister Yaakov Neeman, to examine limits on executive pay.
The panel’s work led to the passage of an amendment to the Companies Law, which imposed some order on approval of executive salaries and required long-term compensation policies linking salaries to corporate performance, as well as taking minority shareholder interests into account (high salaries are often a way of avoiding dividends payments).
During the tenure of former Finance Minister Lapid, that amendment led to another proposed law, which has yet to pass: this would virtually limit executive pay at financial firms to 3.5 million shekels a year. If firms were to exceed that amount, their salary outlays wouldn’t be recognized as tax-deductible expenses. Current Finance Minister Kahlon intends to push the bill through the Knesset and maybe even make it more stringent.
Another factor keeping top pay down is the financial crisis at several of the country’s corporate consortiums, particularly the IDB group. In the heyday of these corporate pyramids, the companies paid out huge salaries and bonuses. However, the collapse of some of them – along with the debt rescheduling agreements and haircuts to creditors that had to be worked out – forced these companies’ executives to keep their employment terms to what was more appropriate to their new reality.
It’s hard to know which of these initiatives has been or will be most effective in reining in executive pay. But it’s clear every step increases the pressure and pushes salaries down at publicly traded companies. But that’s not the only influence the protesters had on salaries. Another, not inconsiderable, one involves the cost of living: We see it in management salaries at the cellphone service providers, after sector reforms increased competition and curbed profits. It can also be seen in food retailing, where competition increased following the protests. Without real competitive pressures in these sectors, we wouldn’t have seen a drop in executive salaries.
While Yacimovich’s bill would have linked executive pay to wages paid to lower-level employees, reform programs and increased competition created a different kind of linkage between management salaries and the cost of living. They created a symmetry of sorts between the extent to which the consumer is provided with a free market (when it comes to price, service and the ability to switch from one provider to another) and the level of the free market that executives face in their ability to command high salaries.
These developments complement one another, each addressing a different problem. Limiting executive pay should work toward narrowing income disparities in the country (a particular problem here). On the other hand, competition-related reforms work to improve the situation for the consumer, and create a balance among all interested parties in a firm: shareholders, workers, executives and consumers.
In the capital market, there are still many firms where this balance doesn’t exist, where the firms’ financial performance doesn’t justify high executive pay – firms whose contribution to the increase in inequality is still too high. So we shouldn’t get overly excited about the recent downward trend. Instead, it’s important to ensure that the process continues and isn’t a limited or accidental phenomenon.
P.S. In limiting their focus to executive salaries at financial firms, the Finance Ministry and Bank of Israel are sending an important signal about the status of the financial sector compared to other industries. Many bank and insurance firm executives would have preferred that we consider their firms as private companies that operate within the free market under competitive conditions. But that’s not true. Banks, insurance companies and investment firms manage the public’s money and raise public capital. And when they collapse, the taxpayers are the ones who rescue them – as we saw in the United States and Europe in 2008, and in Israel in the 1980s. Many parts of the financial system suffer from a lack of competition, whether that’s due to the structure of the system, or regulation that prevents real competition. As a result, it’s difficult to claim that it’s a real free market from the consumer’s perspective.
There’s an additional reason for starting in the financial sector when it comes to limiting salaries. Banks, insurance companies and institutional investors are providers of capital. Consequently, they have a major influence over the approval of companies’ business plans and on votes at shareholder meetings where compensation at publicly traded companies is up for consideration. If we inject more rationality into the salaries of those at the top of the financial pyramid, it might just trickle into the other public companies.