The Problem With Executive Pay

The biggest problem with the Neeman committee is that nobody on it has asked what it is talking about.

Her disappointment was no surprise, at least. A week beforehand, Shelly Yachimovich had said the Justice Ministry’s recommendations to the committee discussing whether to somehow cap executive pay at publicly traded companies were “anemic and meaningless.”
Yachimovich possibly overstated the case. The recommendations were not utterly meaningless, but they certainly were anemic.

Shelly Yacimovich
Ofer Vaknin

Surely, however, Yachimovich should have expected the stew cooked by the committee that Justice Minister Yaakov Neeman headed to be tasteless, and not only because the head cook, Neeman, is one of the closest associates the rich have in government. There is a far more prosaic reason.

It’s a question of ingredients. When you put the wrong ones into the pot, and mix wildly while bellowing about “corruption,” “inequality,” “poverty” and “piggishness,” the result isn’t going to taste good.

A technical cap on pay, set at a certain sum or a certain multiple of the lowest pay at a given company, can’t work. Not because the government shouldn’t intervene in the free market: it should, it must, when the market does not come to the right equilibrium.

It can’t work because it’s a generalization, an all-encompassing technical blanket decree that fails to make distinctions. It is senseless to force an identical rule on managers of companies contending in international markets and managers of local monopolies. You can’t limit executive pay at publicly traded companies while allowing pay to run free at private companies that draw their profits from the taxpayer or a captive market.

The purpose is: _____ (Fill in the blank‏)

Yachimovich’s arguments were good enough to arouse debate on executive pay, but not good enough to govern the debate. Ultimately, she may have served the people who want to kill the idea. The committee’s discussions were confined to technical ideas and solutions. There was no effort to delve into the nature of the problem.

What is the purpose of limiting executive pay? What is the purpose of debating the issue? Is it to hurt the rich? To punish executives? To reduce inequality? To protect the poor from being gouged? To try to institute new norms and values?

Or was the intention perchance to stimulate economic growth, productivity and prosperity?
Does high executive pay motivate managers to think only in the short-term, to consider how to raise product prices while reducing quality?

If we bothered to define the problem, the chances of finding solutions would be better.
If we were to decide, for instance, that the issue is inequality, we’d have to check if ‏(and to what degree‏) the billions paid to about 1,000 top executives increase the Gini coefficient, which measures inequality. We could also check how the non-participation of Haredi and Israeli Arabs in the workforce affects the Gini coefficient and possibly, how the sky-high pay given to the people heading the great government monopolies and other bodies affects that index.

If we were to decide that the real issue is that minority shareholders at public companies are being milked, then we should find clear-cut cases of this, see to what degree the minority shareholders are being squeezed and if that’s the main way they are being trampled − or if the main way is ‏(perhaps‏) insider transactions.

The list is endless, because the issue of executive pay touches directly and indirectly on just about every economic issue there is.

Questions not asked

I think the main question not being asked is this. Is executive pay a macroeconomic problem? Or is it merely a symptom of other macroeconomic problems?

If we conclude that executive pay has become, or will become, a macroeconomic or social problem in and of itself, we still can’t tackle it before studying its roots and the environment in which it grew. You can’t tackle the issue of executive pay until you address the following:
• Most of the highest salaries in Israel are at monopolies, cartels and oligopolies, or companies whose profits depend on government regulation ‏(or the lack of it‏).

• Institutional investors that are supposed to vote for ‏(or against‏) high executive pay can’t or don’t want to deal with it. They too, just like the managers of the public companies, are riding on the public’s money. They belong to the club of the executives, not the clients.

• The directors at the public companies who approve the profligate pay packages don’t want, and sometimes can’t, confront the executives and the controlling shareholders, because of the horrifyingly concentrated nature of the Israeli economy. A director who does his job properly knows he may well be blacklisted.

• Company owners pay the talent huge amounts mainly when their own stake is small. They risk other people’s money, not their own, and inflating the pay of their hirees is often the best way to ensure they serve the person who hired them, not the general good.

• No clear correlation has been found, in Israel or anywhere else, between an increase in executive pay and corporate performance. Sometimes the opposite is true. Executive pay is more a function of the company’s size, the state of the market and competition than a given executive’s performance.

Instead of a thorough, exhaustive debate based on actual facts and figures taken from management, finance, antitrust law and macroeconomic analysis, what we got was a socialist rant against capitalism. We got a diatribe on intervention versus nonintervention, rich versus poor, and volumes of legal gibberish. What we got was empty, meaningless sloganeering.

If the committee had looked into topics such as executive performance, the competitiveness of the companies they lead, conflicts of interest among institutional investors, and the concentration of power in the business sector, not to mention sweetheart relations between directors, controlling shareholders, managers, lawyers and auditors, the debate would have had value.

If the committee had addressed the real issues, then everybody from executives to company owners, directors, regulators and institutional investors would have broken out in sweat. Their secrets would have started to come to light and the public would have started to understand the system − and maybe would have grasped that the problems underlying the sky-high executive pay packages are far worse than the wages themselves.

The Justice Ministry’s suggestion of raising taxes on the highest salaries has its upsides and its downsides. The upside is that higher taxes on especially lucrative salaries are progressive: They reduce inequality and send the right message. The disadvantage is, of course, that they will simply result in tax dodging and won’t address the problem of company owners milking the public.

But the main problem with the Justice Ministry’s proposal is that it tackles the symptom, not the disease. It deflects the debate from the structural problems that our Knesset members and politicians have been avoiding like the plague.
If the Neeman committee ends with a tax hike, or merely tightens some screws in the engine of corporate governance, then the harm the public debate did will outstrip the good. Executive pay won’t drop and the problems will just get worse.

Shelly’s vocabulary

Despite her populist bent, don’t dismiss Shelly Yachimovich’s contribution to the public debate. Yachimovich is one of Israel’s most creative, courageous parliamentarians. She boldly goes where others fear to tread, attacking issues that concern the most powerful people in the land.

But Yachimovich often fails to use certain key terms − growth, standard of living, quality of life, meritocracy, talent, economic freedom, creativity, productivity, innovation and equality of opportunity.

A debate confined to terms such as rich, poor, capitalism, inequality, redistribution, unions and organization is inadequate. Without growth and the rest, the terms that Yachimovich actually likes can’t exist.

If Yachimovich wants to evolve from a provocative parliamentarian into an economic leader with substance, she cannot ignore these issues. She will have to confront productivity, efficiency, freedom and equality of opportunity throughout the economy, including at the powerful unions that she applauds.

No politician in Israel has ever done that − consolidate an agenda and economic concept that tackles the powerful interest groups and all the issues that matter. The magnitude of the challenge is great and the political feasibility is low, because of the unions’ clout among the parties. But the potential is there: a million or more voters who do not feed from the trough, who aren’t members in the tycoons’ club remain unrepresented.