Imagine interviewing for a job, landing it, closing on the pay terms, but then getting a call from human resources a few days later telling you sorry, there is a problem and you’ll only earn half as much. What would you do? Most employees would probably let loose a curse – and look elsewhere.
That is what happens when there is a free market, with supply and demand for workers. The price is set at the intersection between the supply and demand curves, as is taught in the first economics lesson.
But the free market doesn’t always work. Gil Sharon, until recently Pelephone CEO and now moving to the same job at the holding company Discount Investment Corporation, proved this last week.
The scenario described above happened to Sharon. He agreed with his new employer, the Argentinean tycoon Eduardo Elsztain, on a package worth 71 million shekels ($18.2 million) over five years. But other shareholders objected to the deal — not just once but twice. Sharon settled for 59 million shekels and may have to make do with even less after shareholders yesterday voted against the revised package.
Sharon thus proved that, contrary to the assertion of many senior executives, when it comes to top managers in large publicly traded companies market forces don’t work. It is not a free market. It is certainly not a sophisticated market. It has a fundamental flaw requiring regulatory intervention. What’s the problem? We’ll get to that.
Sharon is not the only executive in a publicly traded company who’s run up against objections to bloated compensation. Over a year ago, Phoenix Insurance CEO Eyal Lapidot asked for a salary package of 10 million shekels annually, which the board of directors approved. However, a “problem” then arose. Then Finance Minister Yair Lapid, and the treasury’s supervisor of capital markets, Dorit Salinger, thought this pay package was completely over the top and didn’t think it was an isolated phenomenon either. The two got a law passed that would not recognize for tax purposes salaries over 3.5 million shekels annually and would require agreement by a majority of minority shareholders.
“Everything that is sick and unethical in the Israeli economy and society is expressed in this attempt to pay Phoenix CEO Eyal Lapidot the exorbitant amount of 10 million shekels,” Lapid said at the time. “We need to confront this as a society. It is not capitalism and it is not a free market but just unbridled greed.”
And what was Lapidot’s response? He, too, probably cursed, but did he resign? Did he take a job abroad, as many executives threaten to do when anyone questions their salary? Did he slam the door and open a private company without regulatory intervention? No. After a series of discussions, Phoenix approved Lapdot an annual salary of 5.2 million shekels, about 50% of the value of the original package – and he stayed exactly in the same job he has been doing for several years.
A free market of executives? There is no such thing, and the readiness of executives to reduce their salary by tens of percentage points and remain in their jobs is proof of market failure. If the market were truly free, these executives, who are not working in the name of heaven or public service, would switch to a new employer.
And what is the failure – why is the labor market, which works in a relatively sophisticated way in most private professions, absolutely failing when it comes to executives at large cap corporations? The answer is simple: It’s someone else’s money?
What do they care?
Phoenix, for example, is 53%-owned by Yitzhak Tshuva’s Delek Group, of which Tshuva himself holds 63%. The rest of the shares are dispersed among pension funds and public investment portfolios. The significance is that only a small part of Lapidot’s salary comes out of Tshuva’s pocket, so it does not cost him much to approve salaries for his executives far in excess of what the free market would award them.
Sharon’s case is identical, but several degrees more severe. A substantial part of his salary is to be derived from shares he will be awarded in companies like Cellcom and Supersol, above which in the pyramid are Discount Investment and IDB Development Corporation, above which there is a pyramid of several foreign companies – all held by a South American investment fund made up of 20 investors. In practice, the controlling shareholder Eduardo Elsztain, is only the manager put in charge by these South American investors, in a manner that allows one to conclude that not one shekel of Sharon’s salary comes out of their personal pockets. Under these conditions, what does Elsztain care if he approves 71 million shekels in compensation for Sharon? Indeed, the ones who will foot the bill are all the others, mainly the Israeli public holding IDB, Discount Investments and the other companies in the pyramid.
Enabling control of the executives
From the perspective of the controlling shareholder, who does not have to pay out of pocket, the decision is rational and in his personal interest. Through this imaginary salary, controlling owners guarantee their executives’ absolute loyalty, including – and perhaps mainly – for situations in which the executives will have to decide between what’s best for the company, as they are obliged to do according to the Companies Law, and what’s best for the controlling owner’s own interests.
We saw an example of this when not a single executive or company director of Discount Investment opposed Nochi Dankner’s decision to acquire the money-losing Maariv newspaper – a decision that Judge Ofer Grosskopf described as hard to understand and which led him to approve a lawsuit against the board of directors.
“Maariv was presented as a new piece of clothing needed for the group to make it attractive to its customers,” Grosskopf wrote. “Very regretfully, there was no one on the board who shouted or even whispered ‘but the emperor has nothing at all on.’” It was clear. Why would directors shout when they all earn millions of shekels annually and the act of opposing the deal would lead to their dismissal and remove their hands from the coffers of Discount Investment and its subsidiaries?
And there are more reasons. Through the gigantic salary, controlling shareholders also send a message to regulators and government officials that they better act nice because one fine day the company might hire one of them – exactly as Tshuva, Elsztain (and Dankner before him), Idan Ofer of The Israel Corporation and the other tycoons whose businssses depend on regulation tend to do.
Regulation? Of course. It is no coincidence that high salary packages are paid precisely to executives in companies whose business depends on regulators, including banks, insurance companies, telecoms, gas and natural resource companies as well as in those that are monopolies or in a non-competitive market.
Indeed, a controlling shareholder wouldn’t be signaling to the regulator who’s supervising him what riches to expect in the future if he simply paid his executives the ordinary market price for their work, i.e., the price that many other companies are prepared to pay if they were to hire the same official.
Because the executive-employment market in these companies is not free, it requires regulatory intervention. This is what happened in the case of Lapidot, when the finance minister and the supervisor of capital markets decided to cap his salary by law. It is also what happened to Sharon, when this time the “regulators” were shareholders from among the public, private investors and institutional bodies.
The painful thing is that the real regulator, the most efficient one, did not act in either of these two instances – and it is also unclear if it will ever act. That of course is the public as regulator, which should operate through public norms. Indeed, if the public understood how and why the salaries of Lapidot and Sharon were set and who is paying the price, it would dictate a public norm that does not allow such things.
In the end, both Lapidot and Sharon are social creatures. Today they are mainly the object of admiration and envy, but they would not be prepared to walk down the street if they knew that people would look at them disdainfully and point at them like thieves of the public coffers – even for millions of shekels a year.