In the last minutes of 2015, the Finance Ministry granted the IDB group an extension to reach an agreement to sell its Clal Insurance subsidiary to a Chinese investor group, Macrolink.
The extension – given by Dorit Salinger, the ministry’s commissioner of capital markets and insurance – wasn’t so that IDB could get a better price or find a different buyer. At this stage, IDB is only being allowed to negotiate with Macrolink, while the price – 2.6 billion shekels ($664 million) for a 55% stake in Israel’s second-largest insurance company – has long been settled. That price is 50% higher than the company’s stock market valuation. But other than the buyer and seller, no one really likes the pending transaction. The regulators don’t, the stock market doesn’t and the analysts don’t, either.
Why? Because control by one person, family or group of people of a publicly traded company that manages the savings of the public – which, generally speaking, doesn’t closely follow what’s happening with its money – is always problematic. The reason is that such a company’s controlling shareholders have an interest in exploiting minority shareholders. Minority shareholders are at times actually a majority of shareholders, because control can be exerted by holding a relatively small stake, through a corporate pyramid or chain of subsidiaries.
It’s a well-known phenomenon. Entire sections of corporate law are dedicated to trying to minimize the risk that this poses – for example, by requiring the appointment of directors who report to the public, and with regulations dealing with executive compensation and transactions involving parties with vested interests.
The issue is not confined to the Tel Aviv Stock Exchange. The relations among controlling shareholder groups, the public and corporate management have been the subject of a lot of academic research, mostly in the United States. The research recognizes the basic fact that corporate executives cannot be replaced by public shareholders, because they were hired by controlling shareholders working to further the controlling shareholders’ interests and act to the detriment of the public.
Prof. Asher Blass published a number of articles on the subject 10 years ago. He tells TheMarker that when there isn’t a controlling shareholder group, the manager can be replaced if the company doesn’t maximize shareholder profits. “While in the United States most major corporations don’t have a controlling shareholder group, it’s not like that in Israel. Even Bank Leumi, whose shares are held by the public, doesn’t exactly lack a controlling shareholder – because even if the public wanted to change management, it can’t exactly do it,” he says.
“It’s only when there is no controlling shareholder group that such a deterrent exists. And, of course, there are also no transactions involving parties with vested interests, because there are no such parties. American capital markets don’t like controlling shareholder groups, and what’s interesting is that when Israeli companies issue shares in the United States, there is also no controlling shareholder group – for example, at Teva Pharmaceuticals, Nice Systems and high-tech firms whose shares are dispersed among entrepreneurs, initial investors and the public.”
Even worse is the situation involving shareholder groups that are structured as pyramids, such as IDB, with holding companies controlling firms further down the pyramid – which in IDB’s case includes Super-Sol, Cellcom Israel and Property and Building Corporation.
IDB’s former controlling shareholder, Nochi Dankner, exploited his control for his own personal ends. Just a few weeks ago, it was in evidence again as IDB’s new controlling shareholder, Eduardo Elsztain, made the scandalous decision to award incoming CEO Gil Sharon a financial package worth 71 million shekels over five years (it has since been reduced to 59 million shekels). Research shows that corporate pyramids make it easy for controlling shareholders to shift profits to their own pockets, at the public’s expense.
It was precisely these matters that were considered by the government panel on business concentration that Prime Minister Benjamin Netanyahu convened when the issue was still on his radar. Blass, by the way, believes that the panel didn’t do the one vital thing necessary to eliminate the pyramids – impose a tax on dividends paid among companies in the same pyramid. This would levy a double tax on companies, and it’s precisely what has prevented the formation of pyramids in the United States. At this point, the United States and Britain have almost no publicly traded pyramids or holding companies like IDB or Israel Corporation.
If a controlling group in a public company is a bad idea, and if a controlling group in a pyramid is a very bad idea, then a controlling group in a financial services company that manages the public’s savings is the very worst possible idea. Why? It’s simple: In addition to the conflict of interests that exist between controlling shareholders and other shareholders, the controlling shareholders also face a huge temptation to make use of the public’s deposits (in the case of banks), and savings and pension funds (in the case of insurance companies), to serve their private interests.
Controlling shareholders can do this in a variety of ways. Dankner, for example, had Clal Insurance invest in funds managed by the Swiss bank Credit Suisse – the bank that was at the same time providing him with personal loans. A controlling shareholder, by selecting corporate management, directors and investment committee members, can steer investment decision-making when it comes to how the funds of members of the public are invested. You have a friend who needs help refinancing debt and who will repay the favor one way or another? No problem. Members of the public with funds being managed by your insurance company will see their funds invested in his bonds. Of course, controlling shareholders do face government regulators who are supposed to prevent such behavior. In most cases, though, they have chosen not to intervene in the investment decision of financial firms.
What the Chinese stand to gain
This brings us back to the sale of Clal Insurance to Chinese firm Macrolink. At the end of 2014, Clal Insurance was managing 159 billion shekels in pension funds and managers’ insurance. Of all the possible options involving a change in corporate control of a financial firm, the sale of an insurance company to such a foreign entity is certainly the worst idea.
In such a case, not only is there a controlling shareholder who is tempted to make use of the public’s money, but it is a Chinese company – and China is not known for its outstanding corporate transparency. China’s corporate governance is different from that accepted in the West; its executives occasionally disappear. It’s also not clear what commitment Macrolink would have toward Israeli government regulators and Israeli oversight.
And these are not the only questions raised by the transaction. There’s also the price tag. The Chinese are prepared to pay a control premium of more than 50% over the company’s current stock value, yet no one understands why. How do the Chinese intend to turn a profit on this investment after paying such a high price? Can the public feel comfortable when their money, in a sector that gets another 80 billion shekels to manage every year, is in foreign hands?
Analysts and businesspeople say that when an asset changes hands for a price that appears irrational, something bad will often be in the offing. One experienced financial analyst told us over the weekend that the Clal Insurance sale reminded him of transactions carried out a number of years ago by Russian-Israeli oligarch Arcadi Gaydamak.
“No professional understands the price the Chinese are willing to pay,” says the analyst. “And the fact the share price [of Clal Insurance] has not changed since the deal was set proves that investors among members of the public don’t believe the company is worth so much money, either.”
What government regulators need to do
But don’t the regulators know this? Are they unaware of the temptations that controlling shareholders have to use the public’s savings? Are they not doubly concerned when the buyer of an insurance company is a foreign investor, from a country where transparency is not a strong point?
Of course they know, but they can’t do a thing about it. Dorit Salinger cannot disqualify a potential purchaser because it is Chinese. Despite the concerns, such a decision is politically unacceptable and also would run counter to the international agreements Israel has entered into with China (likewise the sale of Israel’s Phoenix insurance company to China’s Fosun International). Regulators hope these two transactions don’t come to fruition. They hope the buyers get cold feet and that somehow the problem will disappear on its own.
But the problem is not that the buyers and controlling shareholders might be Chinese, American or from a wealthy Israeli family. All such buyers and controlling shareholder groups are problematic because their interests are not in keeping with those of minority shareholders and the members of the public whose money they are managing. That’s why Salinger, Finance Minister Moshe Kahlon and the government as a whole must do something else: convene a public committee that can quickly propose a mechanism that will drive the holders of major capital from control of this country’s financial firms. It really doesn’t matter which country the investors are from.
Financial firms, by virtue of the fact that they manage the public’s savings, need to be public entities without a controlling shareholder group and where the public appoints the management. Then the public can also dismiss management if it thinks it is not performing in the public’s interest.
After all, these are special kinds of companies. Their executives need to be public trustees, they need to have a system of rewards and punishments in place, and they need to be closely supervised.
It’s true there are also management challenges at companies that don’t have a controlling shareholder group and the possibility that management will serve its own interests. We’ve already seen how banks and insurance companies elsewhere in the world make horrible decisions, like the ones that triggered the global financial crisis in 2008. But when it comes to weighing risks, temptations and the potential for competition and oversight, financial firms without a controlling shareholder group are a better alternative for the Israeli public and Israeli capital markets.
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