The Executive Pay Conspiracy Theory

Now that financial service bosses, including the managers of big instutitonal investors, are facing big salary cuts, are they going to make their nonfinancial peers do the same?

Finance Minister Moshe Kahlon at the annual conference of the Antitrust Authority, Airport City, January 26, 2016.
Ofer Vaknin

The capital markets, the government and, most notably, top executives at the country’s financial firms are still up in arms over steps taken by the Finance Ministry and Knesset to limit executive pay at financial firms to 2.5 million shekels ($646,000) a year.

Deputy Attorney General Avi Licht tried to address the millions that top financial firm executives have also been earning in pension payments and severance pay, but he got skittish and shifted the issue to the Knesset to decide. At the Knesset, no one has been in a hurry to deal with the issue, while the Association of Banks in Israel has asked the High Court of Justice to rule that the new law limiting executive pay should not be interpreted to apply retroactively.

But in the markets themselves, the controversy continues to rage. Some people say the law is crazy and will hurt the economy while others contend that the law is justified in light of the exorbitant salaries that had been paid at the top without any relationship to the recipients’ abilities or performance.

The major question being asked in the capital markets, however, is how institutional investors will now view other publicly traded companies where there are no salary caps, in light of the steeply curtailed compensation now being paid the top brass at the financial firms.

The story goes like this: The salary caps only apply to top executives at financial firms and institutional entities — banks, insurance firms and investment firms, but not at the hundreds of other publicly traded companies, even though there, too, executives are earning millions of shekels a year. At a few dozen of these companies, the pay is even higher than at the banks.

But the executives at the institutional firms, whose salaries have now been cut substantially, are precisely the ones who have the ability to object to what the CEOs at the other publicly traded companies are getting. In the past the institutional firms weren’t in the habit of protesting the salaries being paid (other than in the most egregious cases). That raises the question of whether now the financial executives will act to rein in salaries at other firms not subject to the caps, but which they can still influence as major investors in those firms.

Sources in recent weeks are telling us yes, and that’s due to frustration and anger and the chance to do to others what has been done to them, in some instances doing what they have wanted to do all along but couldn’t under the circumstances that had prevailed at the top.

Pay test

“At some of the institutional investment firms, they’re now saying if I can’t get millions in salary, then they won’t either,” a senior capital market source says.

Against the backdrop of the controversy, capital market sources predict that the coming months will serve as a test regarding senior executive pay. The question will be whether the institutional investment firms will dispatch their representatives to vote against high salaries at publicly traded companies where the financial firms have an investment.

“There are several companies, for example Victory [supermarkets] and Housing & Construction Limited, where discussion and a vote will be held in the near future regarding executive salaries. These cases will serve as a test of expectations regarding the increased involvement of the institutional investors in the corporate governance of the public companies,” the source said.

If that’s what happens, and the institutional investors, who manage the public’s savings, finally demonstrate power vis-a-vis the publicly traded companies, rein in executive salaries and tighten corporate governance, that would be an additional success for the new law that on its surface relates only to financial firms.

In all of the commentary and analysis on the importance of the law, including remarks by Finance Minster Moshe Kahlon, it has been claimed that limiting top salaries at banks and other financial firms would send a message to other corporate executives as well. But we have learned from experience that the message is highly abstract and doesn’t always affect reality.

In the past, a whole series of rules were established to limit senior executives’ salaries. These include an amendment that requires the issuance of an explanation regarding pay packages, linkage to performance and another decision from 30 years ago requiring that senior executive salaries appear in the companies’ annual reports. Although these measures were also supposed to send a message, executive pay just continued to balloon.

Among the reactions to the most recent law, we have also heard an additional, almost conspiracy-related explanation for the militancy of the financial institutional executives towards their corporate counterparts, saying that the financial executives are committed to battle the other companies’ high compensation packages. The conspiracy has it that the executives at the institutional investors intend to create a major commotion at the meetings of the boards of directors of the companies to make the Finance Ministry and the Knesset understand that the current executive salary cap legislation targeting financial firms hurts the economy — so it gets repealed.

How could such a thing work? For example, if the institutional firms’ militancy against the executive pay causes companies like Teva Pharmaceutical Industries or Israel Chemicals or Nice Systems or Ormat Technologies to buy back their shares and delist from the stock exchange, as Nestles’ firm Osem recently did, one can assume that a number of regulators would call for the law to be changed.

There is little doubt that the heads of the Tel Aviv Stock Exchange, the Israel Securities Authority and the Association of Publicly Traded Companies would go to Jerusalem demanding of Kahlon and the Knesset that the law be either rescinded or softened, for example by raising the annual salary cap at the financial firms from 2.5 million shekels. And that, of course, is exactly what the senior executives at the financial firms want.

The outcome of such a step would depend on the reaction from the publicly traded companies themselves. If the companies decide to comply with the message that the law is designed to convey to them, and produce senior salary contracts that are smaller than what has been accepted in recent years, they would be spared a war between themselves and the institutional firms.

‘Winning approach’

On the other hand, if the nonfinancial companies continue with their current “winning” approach, in which they first produce scandalously high salary contracts as a bargaining chip, in the knowledge that the institutional firms will object and the executive pay will then be reduced a bit, it is entirely possible that in the near future, we will be seeing some interesting headlines, some of which may contain a whiff of hypocrisy.

Such as what? For example, a representative from a financial firm could object to a CEO at a non-financial company drawing a salary that has no connection to performance while the CEO at his own financial firm had been receiving comparable pay until the new law went into effect, and which also had no connection to how the company was doing. Another possible prospect could be headlines in which the CEO at the non-financial firm could accuse the financial firms of sour grapes, saying that no one objected when the executive pay at the financial firms was just as high.

So how well-founded could the conspiracy theory be? It’s hard to imagine that there is more than a small clutch of dreamers who really think that such a ploy on the part of the institutional financial firms could really result in a repeal of the current salary cap. After all, there are two sides to everything. If such an attack is carried out, there are those who will actually see it as a sign of the law’s success, in that after years of apathy and inaction, the law has involved the financial firms in the management of publicly traded companies, thereby protecting the interests of their own investors from among members of the general public.

In the interim, the very fact that there is a controversy and public debate on the consequences of the salary caps at the financial firms means that the law is bearing fruit, and apparently is also making the executives more cautious in the future salary demands. That is a success, small as it may be, in the long battle to reduce inequalities, expand social solidarity and to adopt a new public corporate management culture in Israel.