How to Get the Wrong Man for the Job

Last week Bank Leumi published its financial statement for the third quarter. The bank said it netted NIS 534 million.

The speed at which Israel's banks returned to profitability reflects not only their low exposure to the global economic crisis, but also the sheer resilience of Israel's financial sector.

Just as important as Leumi's profits is the fact that it achieved the best results of all Israel's banks in the last quarter.

Leumi falls among banks that face little competition and receive high monopolistic income.

Hapoalim and Leumi, the two biggest banks, get the highest monopolistic income, but the two institutions aren't comparable. Hapoalim was privatized 12 years ago and is considered the "younger," more dynamic bank. Leumi remains owned by the state.

How has Hapoalim's privatization been expressed? That is an interesting question with a lot of possible answers, and one particularly simple one.

The December issue of TheMarker Magazine (Hebrew), published this week, lists the 20 Israeli companies that generated the most value for shareholders in the last decade. Readers may be astonished to see boring, staid Leumi high on the list, with annual returns of 9.6% a year.

More astonishing is that privatized, dynamic Hapoalim achieved inflation-adjusted returns of 5.3% a year, which is less than the benchmark.

So how has Hapoalim's privatization been demonstrated exactly? In executive pay, perhaps.

In the last five years, the wage cost of Hapoalim's chief executive and chairman total NIS 110 million. At Leumi the comparable figure is NIS 52 million.

You may find that surprising. Henry Mintzberg, a world expert on management, wouldn't twitch an eyebrow. He would probably regale you with similar tales, far more egregious in fact, in the United States, the world center for extreme executive bonuses.

Mintzberg, who has written many books on management, leadership and strategy, made waves in American financial circles last week with his solution for the problem of remuneration on Wall Street.

Since the financial crisis erupted, throughout the West, academics have been pondering how to rebuild the capital markets, and mainly, how to create a remuneration mechanism that would better reflect performance, thus deterring managers from taking crazy risks. Remuneration experts on Wall Street, and academics at Harvard, suggest long-term remuneration systems, adjusted to the market. But last week Mintzberg suggested something completely new: Abolish bonuses.

If he'd suggested that a year ago, he'd have been considered nutty as a fruitcake. For decades the players have been told that bonuses are the most important economic driver.

Now Mintzberg's suggestion is not only being voiced, but heard, not just because of the global economic crisis, but mainly because Americans discovered to their shock and disgust that returns on stocks in their country, over 10, 20 or 30 years, are no better (or worse) than returns they could have gotten on risk-free assets.

In other words, for decades Americans had assumed it paid for them to give managers giant bonuses, stock options and golden parachutes. Now they learn that they didn't get much for their money.

No less surprising than Mintzberg's theory is the newspaper he published it in: The Wall Street Journal, one of the most extreme in its support for free-market theory and rewards for management. The Journal is read by the richest people in the United States, some of whom probably didn't appreciate Mintzberg's views.

Most managers who receive bonuses are described as "leaders." But in practice many are pure gamblers in a fixed game.

They are gambling with other people's money, that of their shareholders and employees, who could lose their jobs if the gamble goes sour.

They get their bonuses not only when they "win," but also when it only seems that they're winning - when the share price rises, for instance, or when their bonuses are tied to accounting criteria.

They also get their money when they lose the game. That's what the golden parachute is all about.

Some even get their bonuses before the game has even begun; for example, when they sign a merger agreement (and most mergers fail).

And there are executives who get bonuses just for deigning to stay at the table.

None of that is new. The interesting part of Mintzberg's theory is what he calls fundamental fallacies of strategic planning - wrong assumptions, if you will, on which the entire world of executive bonuses is based. The bonuses not only fail to reflect executive performance, argues Mintzberg, they can ruin companies and create anti-management feeling.

Most bonus plans assume that the company's health can be represented purely by financial parameters, or share price.

Mintzberg says that's silly. Companies are a lot more complicated than that. Their real health is reflected in what accountants call "goodwill": the quality of their brands, their reputation, the depth of their management culture, and the managers and employees' commitment to their company.

More importantly, the fallacy that executive performance can be measured by financial parameters destroys management. Focusing on financial parameters is very convenient for detached managers who don't understand their business and have no real management depth.

Moreover, Mintzberg, who's been studying executives at big companies for decades, says that impatient managers abuse financial parameters. They will ruin a company's goodwill by cutting operating costs and customer service, replacing experienced, veteran workers with cheaper, inexperienced ones, who will ruin the company's most valuable brands. Costs may drop, but so will the company.

A second assumption underlying usual remuneration plans is that operational parameters, whether for the short or long term, reflect the company's strength.

Not so, says Mintzberg. Even financial results over years can't be clearly correlated with management quality.

Is 10 years long enough to reach conclusions? How many years of bad management did it take to reduce the mighty General Motors to bankruptcy? Does a rising share price say anything about a company's current manager, or perhaps attest to qualities of his predecessor?

The third assumption Mintzberg attacks is a favorite in management echelons: that the CEO bears most of the responsibility for a company's performance.

And what if the CEO happened to reach a company at a fortuitous time? What matters, Mintzberg says, in looking at a company's performance is its history, management culture and the markets.

In any case, how can success over a few short years be ascribed to a single person? What about all that "our people are our best asset"?

Mintzberg's conclusions are even more provocative. He mocks the adage that without paying bonuses, a company can't recruit the right people. "If you do pay bonuses, you get the wrong person," he writes. At worst you'll wind up with a self-involved narcissist at the helm and at best, somebody comfortable being detached from the team by virtue of his bonuses. That isn't how to create teamwork and a sense of community.

He believes you can get good people in management without big bonuses because good people look for other things in the job anyway: prestige, the pleasure of leading a big company, and the opportunity to influence an organization they care about.

Mintzberg's views are provocative and extreme. Not in all sectors are bonuses divorced from value creation for shareholders.

But in an era when people's pensions are invested in the capital markets, when social gaps are widening at a frightening pace around the world, it's right to challenge entrenched views and boardroom axioms.

During the last decade, Israel joined the trend of insane bonuses. It never achieved the extremes seen in America, but the direction is clear. We also have our special diseases such as a controlling shareholder's ability to line his pockets at the expense of the public, without taking real risks to justify his reward, and without any management skills to boot.

The common denominator is the narcissistic personality disorder that characterizes so many of the people sold to us as "leaders." But the main thing they're leading is a drive for their personal enrichment. They aren't running their enterprises for the long term. All they want is to look good at a given point in time.