Taking Stock / It's a Volatile World

Ever heard of Dudu Tuboul? Probably not. At least not until he made ninth place on the list of the highest earners among the companies traded on Tel Aviv Stock Exchange.

Don't feel upset if you haven't heard of him. It doesn't mean you're out of the loop. Tuboul took charge of the Gmul investment bank two years ago as CEO, after having served as offerings manager at Leumi & Co, as CEO of Tamir Fishman Underwriting, and as CEO of Gmul Sahar Stock Exchange Services.

Not many good things happened at Gmul under Tuboul's stewardship. The company lost NIS 70 million, its disappointed shareholders - the Trump brothers, no relation to Donald - sold it at a loss, and Bank Hapoalim, which had financed their takeover and has been involved with the company at all sorts of levels, is working to minimize the damage the company has wreaked upon it.

So it goes. But there is one thing Tuboul knew how to do, and that was to waltz off with NIS 5.5 million pay in 2003. That's more than Osem Food Industries CEO Dan Propper made, that's more than Agis Industries leader Mori Arkin took home, that's more than Cellcom CEO Yitzhak Peterburg could boast.

How did he do it? One trivial explanation might be that Tuboul was fired last year and that his NIS 5.5 million wage cost includes his severance compensation. But that isn't the story. The story is that Tuboul's employment agreement gave him a bonus, 3 percent of the company's pretax profit. In 2003, Gmul presented a pretax profit of NIS 62 million. That alone made him NIS 1.9 million.

Sign here, please

So what are we caviling about? The man has an employment agreement, the company made money, he got a bonus. That's how capitalism works.

Yes, but first let's understand just how Gmul made that profit in 2003. Gmul is an investment company that acts directly and indirectly through the capital market. Its 2003 profit was due to the boom on the capital market that year, and mainly, to the massive NIS 130 million loss it posted in 2002.

And that is the key point in Tuboul's employment agreement, and that of most managers worldwide. They get rewarded when the company makes money and get off scot-free when the company loses money. They just hunker down and wait for the storm to pass.

During 2003, Israel's economy just began to exit three years of deep recession, yet the wages and employment terms of CEOs were shockingly high. Behind many of the fat paychecks stood a common factor - the extraordinary volatility of recent years, namely the yawning losses in 2002 followed by the steep profits in 2003. The gains in 2003 were largely the mirror image of the 2002 debacle, but again, CEOs get rewarded for profits and go unpunished for losses.

In the last decade, companies around the world and in Israel began giving their executives stock options. Unlike direct pay, argued the executives, the options created a direct link with the investors' gains, mainly because they had nothing to do with profit in this or that calendar year.

Destroying value

But the truth is that using options to reward executives is an even bigger bluff than bonuses based on booked profits. Just ask the directors at Koor Industries. In the last seven years, the Koor management has been responsible for the greatest destruction of value the Tel Aviv Stock Exchange has ever seen. It took a concern worth $1.7 billion and shaved a billion dollars off its price tag. So how is it that a handful of Koor managers and directors earned NIS 100 million during 2003 from stock options? How is it that each of the seven directors who received allocations hold options worth NIS 4.5 million? How is it that Jonathan Kolber possesses NIS 15 million worth of options?

The answer lies in volatility and timing. A few months after Koor hit rock-bottom, its board approved a stock options plan at an exercise price of NIS 89.7 per share. Since then, Koor stock doubled. Nobody at the management board meeting had the bad taste to mention than the management received Koor when it was worth NIS 300 per share and more. No, volatility is a dirty word in boardrooms.

Or take Avigdor Kelner, the CEO of Polar Investments, who starred on the salaries list with pay of NIS 13.3 million in 1999 and 2000, as the company made NIS 250 million from the stock market boom.

And then the stock market crashed. During the last three years, Polar has accrued losses of NIS 440 million. All the profits that Kelner shared have evaporated, but Kelner did not have to return a red cent to the company. That's how it works. Naturally, we can expect Kelner to do well for himself in 2004; the market has reversed and, at some point, Polar can be expected to hit the black.

Up and down, round and round

The issue here isn't Tuboul, or Kelner or Koor. Those are mere anecdotes. In fact, the entire business world depends on volatility. Most of the sky-high executive salaries here, too, were structured around fluctuations. Most of the great success stories owe everything to volatility - in the market, the economy and in financial statements.

The entire industry of managing other people's money is based on volatility. Why are Israelis stampeding to invest in mutuals and investment portfolios? Because they believe that over ten years, stocks will yield a real 7 to 10 percent? Of course not, it's because the stock market rose 80 percent in a year and a whole bunch of bitty smallcaps they track rose 100 to 1,000 percent. Why did they rise 100 to 1,000 percent? Because they'd dropped 80 or 90 percent in the preceding three years, of course. Volatility, don't you know?

The same goes for the banks. During the 1990s, they extended credit in the billions to business and in the following three-year recession they wrote off NIS 15 billion for those very loans. Next year, when the markets will have recovered, they'll be able to scale down their provision for doubtful debt and even get some of their bad loans back. They will achieve tremendous profits, scoop up huge bonuses and strut their success in the papers again.

You don't need a doctorate in economics to see that volatility is the great enemy of the stock market, and the best friend of executives and people who manage other people's money. The former's losses are the latter's gains.

Add the rapid turnover of executives and the short memory of the people to the volatility, mix well, and you get the greatest wealth-transfer mechanism in the world: from investors and taxpayers to the managers.