Santa Claus Directors

Generosity is easy when somebody else pays

Over at Bank Hapoalim (TASE: POLI), they are proud of the executive pay packages brought before the shareholders' assembly in November 2005.

They are proud of their long-term policy of performance-based rewards, and from time to time raise the bar of performance.

The last update was in November 2005. It determined that the managers - chairman Shlomo Nehama, deputy chairman Danny Dankner, and apparently CEO Zvi Ziv (whose terms are linked to Nehama's) - will get bonuses only if the bank's return on equity passes 12%, and if its return on balance sheet assets is greater than 1%.

That refers to accrued bonus, meaning one bonus is paid for return on equity and another for the return on the balance sheet. There is no link between the two.

By raising the bar of performance by progress, the bank hopes to deliver a message of being a serious institution that cares about motivating the management. But the reality is otherwise. That 12% return on equity bar was set months after Bank Hapoalim had sold Signature Bank of New York and everybody and their auntie knew the bank would achieve RoE far above 12%.

The same is true regarding the bonus depending on return on assets, which tracks the return on equity. In practice the bank doubled the bonuses it paid the talent without any material change in performance.

All gain, no pain

The incentive bonuses approved in November 2005 therefore had nothing to do with motivation. The year 2005 was all but over, leaving them little time to "improve performance" in order to "win a bonus" by merit. All the bank did was give them nicely-wrapped presents, which had been assured in advance. In the case of Nehama and Ziv, the amount in question was NIS 19 million and for Dankner, NIS 12 million.

We can expect them to get more presents this year. The economic boom in Israel and the banks (under pressure) selling their provident and mutual funds promises more beautiful profits in 2006, and Bank Hapoalim will easily achieve more than 12% return on equity (and more than 1% return on assets). Again the managers will be taking home tens of millions of shekels.

Nowhere in the proposal to "incentivize" the management did anybody mention what would happen if profits dip, only the 12% return on equity.

The result is asymmetric remuneration. If the bank's return on equity is greater than 12%, the managers get tens of millions of shekels. If it is lower, no matter how much below that threshold, they get nothing, or rather just their base salary of NIS 1.7 million a year. Put otherwise, for the Bank Hapoalim management, working at the bank confers no risk. The ceiling is sky-high and the floor is NIS 1.7 million a year.

That is, at least NIS 1.7 million. Also, they are not required to return bonuses granted in the past. There is no danger of their being fired. There is no risk. That is completely asymmetrical: all they have to do is let time pass and they get their money, nicely shrink-wrapped in the guise of "motivation".

If it were genuine incentive, the managers would have to share some risk through their decisions. If it were genuine incentive, the managers would have to be judged on a long-term basis, not share in profits one year and be exempt from sharing losses in another year.

But it is not incentive, it is a present, a clever one but still just a gift of the type that almost all the top managers in Israel get. They share in corporate profits without risking a thing if profits disappear and losses start to mount.

And the boards approve these gifts with no serious discussion, no hard questions, never questioning whether these good people are indeed worthy of such generosity, or whether they could reduce their pay, or find equally talented people at a fraction of the price. It is easy to be a Santa Claus director and hand out presents, as long as somebody else is paying the bill: the workers, the shareholders and the customers.