Jerusalem Post Editorial: Salary caps

The belief was that cronyism and corruption were the cause of inflated executive pay. And if stockholders were empowered to stop it that’s what they would do.

March 21, 2016 20:57
3 minute read.

A WOMAN uses an automated teller machine outside a Bank Hapoalim branch in Tel Aviv three years ago.. (photo credit: REUTERS)

In a rare demonstration of cooperation between the coalition and the opposition, MKs in the Knesset Finance Committee last week passed a bill seeking to place a cap on the salaries of executives employed in publicly traded financial institutions.

If the bill is passed by the Knesset, the salaries of executives employed in banks, insurance companies and investment firms will be capped at NIS 2.5 million.

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Every shekel paid beyond that amount will not be eligible for a tax deduction.

Further, the bill passed by the committee said that top salaries could not exceed 35 times the cost (or 44 time the take-home salary) of the lowest-paid worker in the company. Given the minimum wage, however, that amount would also amount to roughly NIS 2.5m.

Legislators on both sides threw their support behind the bill. Finance Minister Moshe Kahlon and chairman of the Knesset Finance Committee Moshe Gafni (United Torah Judaism) support it. So do MKs Shelly Yacimovich (Zionist Camp) and Meretz leader Zehava Galon.

The goal of the bill is appealing and honorable. Who isn’t opposed to the ridiculously high salaries earned by executives in the large financial firms? Israel suffers from one of the highest income inequality levels in the world. Capping the salaries of the highest paid would close the gap between the richest and the poorest.

But fighting the high salaries of executives through legislation or regulations simply does not work. The US example is instructive. In the aftermath of the financial crisis of 2008, which amplified anger about exorbitant CEO salaries, reformers looked for ways to rein in the practice. They seized on say-on-pay, which empowered stockholders to have more of a say about the salaries paid to the executives of their companies. It became law in the US in 2010, as part of the Dodd-Frank bill.

The belief was that cronyism and corruption were the cause of inflated executive pay. And if stockholders were empowered to stop it that’s what they would do.

But since the passage of Dodd-Frank, executive salaries in the US have continued to rise. In fact, they are as high as they have ever been. That’s because cronyism and corruption are not the main reasons that executive pay has soared. The reason executives get paid well is because the shareholders want them to. In the US, shareholders, it turns out, rather than balking at big pay packages, approve most of them by very large margins.

Generous compensation packages consistently get majority approval.

In Israel the situation is no different. Attempts to cap the salaries of executives in financial firms (Gafni and others want to expand it to all publicly traded companies) will fail, because board members and shareholders will find ways to get around them.

If salary levels are restricted, shareholders will compensate their executives in other ways – through stock options, performance perks or other benefits not directly related to salary. They might also forgo the tax deduction and pay their executives more than the NIS 2.5 million anyway.

Stopping exorbitant executive pay through legislation won’t work. It can only be achieved through an ideological shift. Just about everyone at board meetings that decide on executive pay assumes that talent is rarer than ever, and that only outsize rewards can lure suitable candidates and insure stellar performance. But there is little evidence for this.

A major study by economists Xavier Gabaix and Augustin Landier quoted last year by The New Yorker’s James Surowiecki found that found that if the company with the 250th-most-talented CEO suddenly managed to hire the most talented CEO, its value would increase by a mere 0.016 per cent.

The correlation between high pay and success as an executive is sketchy at best. Paying someone more than NIS 2.5 million a year is not going to make that person any more creative or smarter. Unfortunately, there is little economic incentive to change. Banks, insurance companies and investment firms have such huge market capitalization and profits that shareholders are willing to continue to pay exorbitant salaries to get the person they want, whether it helps the company’s bottom line or not. And there is very little legislators can do about it.

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