An Embarrassment of Riches?

Three-quarters of Israeli-listed companies are controlled by a few families or individuals, a concentration that some warn is a dangerous direction for the economy.

By ZIV HELLMAN
Biggest Borrowers (do not publish again) (photo credit: FLASH90)
Biggest Borrowers (do not publish again)
(photo credit: FLASH90)
WHAT WOULD YOU SAY about the economy of a country in which one quarter of all credit extended to businesses in the country is taken by only six business groups? In which 20 business groups control close to half of the total stock market capitalization, and approximately a fifth of all investment instruments are held in companies controlled by only eight people? A growing concern has been spreading in economic, legal and political circles that the Israeli economy is undergoing an accelerated trend of economic concentration, with an emerging small group of families and individuals holding control of so many diverse corporations in different but interacting industries that the trend itself may pose a threat to current and future economic growth. Moreover, the wealth being concentrated may also give a coterie of “tycoons” outsized political clout.
These concerns have reached the highest levels of government and business circles. A study by Bank of Israel economist Konstantin Kosenko revealed that half of the banks and insurance companies in the country are affiliated with only about 20 families, with the same set of families controlling companies that generate about half of the national Gross Domestic Product.
The OECD has several times warned of concerns it has regarding economic concentration in Israel, most recently in a report issued in March, in which it stated that the “Israeli corporate governance landscape is characterized by ownership concentration and family control of a significant number of listed companies,” the report said. “Three-quarters of Israeli-listed companies [of a total of 640] are controlled by family or individual interests.”
In October 2010, Prime Minister Benjamin Netanyahu appointed a task force led by the director general of his office, Eyal Gabai, to study the issue and provide him with a recommended course of action to reduce the concentration of economy-wide control in private hands.
“The economic concentration in this country is an existential threat,” says Daniel Doron, director of the Israel Center for Social and Economic Progress (ICSEP), a pro-market, public-policy think tank. “It warps the issuance of credit in an egregiously inefficient manner. It is holding back our growth,” he tells The Report, referring to the danger that conglomerates with significant shares in financial institutions may sway those institutions to favor their companies when issuing credit.
“Concentrated economic power is social and political power,” says Davida Lachman- Messer, a former deputy attorney general.
“This makes those holding it centers of power. They weren’t elected, but they decide who controls this country and how it looks.”
Identifying a problem, however, is not the same as solving it, and there is no clear consensus yet as to what should be done, if at all.
Amir Barnea, an economist at the Interdisciplinary Center in Herzliya who has served as a member of the board of directors of Bank Hapoalim, recommends – among other things – changes to corporate governance laws that will enable the appointment of strong and independent boards of directors of companies.
“There is currently no effective corporate governance in this country,” complains Barnea to The Report, “nor effective regulation of conglomerates by regulatory bodies.”
There have also been calls for using tax laws for reducing economic concentration.
But there are also observers who are convinced that only direct state action to break apart economy-wide conglomerates can have significant effect. “Believing this can be solved solely by amending corporate governance laws is like believing in a fairy tale,” Lachman-Messer asserts flatly. “The only way to deal with this is structural: break up the conglomerates.”
THE MAP OF ECONOMIC concentration in Israel is well known. The business daily “The Marker” regularly publishes lists of the economically most powerful individuals in the country, identifying in particular Nohi Dankner, Arnon Moses, Sheldon Adelson, Yitzhak Tshuva, Zadik Bino, Haim Saban, Moshe Wertheim, Eliezer Fischman, Yossi Maimon, Shari Arison, Lev Leviev, and Sammy Ofer.
The concentration of economic control represented by these families and individuals is in particular characterized by two phenomena that observers note make Israel an anomaly among Western-styled economies: The extent to which “pyramidal structures of ownership” of corporations have proliferated, and the broad dispersal across industries of the holdings of the most powerful families and individuals.
Economists describe pyramid ownership structures as being constructed step by leveraged step, potentially enabling a single individual vast control bought by a relatively small initial investment. It works like this: Suppose you gain control of Company A, holding half its shares. Company A, in turn, buys and holds half the shares of Company B.
Company B does the same for Company C, then Company D, and finally Company E, a major global corporation. This is a five-story pyramid. Whoever controls the base of the pyramid, Company A, controls all five.
The fraction of the total company shares you hold is therefore one-half raised to the fifth power, about 3 percent. Yet you control all five businesses. Moreover, by strategically clever leveraging, this can be achieved at relatively small initial expense, with most of the “heavy lifting” conducted by instructing companies at various pyramidal levels to seek corporate credit for profitable acquisitions.
Several studies indicate that the biggest borrowers in the country are also the wealthiest individuals. According to a study conducted by the Knesset’s Research and Information Center, as of 2009, six of Israel’s biggest business groups, owned by Dankner, Arison, Ofer, Bino, Tshuva and the Bronfman family, had taken 100 billion shekels in credit, which comes to one quarter of all credit extended to businesses in the country. They use this borrowed money to buy controlling interests in companies, enabling them to appoint both the ranks of corporate management and a majority of board members.
The other significant characteristic of the economic concentration in Israel is the sprawling extent over several industries of each economic empire. To name a few, Tshuva, the principal owner of the Delek Group, an energy company, is also significantly invested in real estate and construction companies, the HOT cable company, and the insurance companies, Phoenix and Menorah.
Arison, principal owner of Bank Hapoalim, also owns a water technology company and construction company; she also owns Shikun Uvinui, through which she also has significant ownership of Derekh Eretz, the franchise holder of Israel’s only toll road, Route 6. Lev Leviev, the diamond tycoon who divides his time between London and Tel Aviv, owns real estate company Africa Israel, and has significant holdings in energy company Dor Allon and television franchise Channel 9.
Some of the big-name holdings in the hands of one owner are particularly staggering.
Dankner, the principal owner of IDB, has used the company as a vehicle for diversifying his economic interests to Clal Life Insurance, Clal Industries and Biotechnology, the Internet provider Netvision, the Supersol supermarket chain, the mobile telephone company Cellcom, the Israir airline company, and the Golf clothing chain – in addition to holdings in construction and cement companies.
THE TECHNICAL ECONOMIC term for two or more corporations in different industries under single ownership is a conglomerate. The proliferation of sprawling conglomerates in Israel seems at first glance puzzling to economists, who have for decades regarded conglomerates to be “dinosaurs” destined to die out under normal conditions in Western-styled economies.
Afad for conglomerates in the United States in the 1960s ended with a major sell-off of shares in conglomerates in the 1970s, when they proved to be less profitable than expected.
Business schools since then have emphasized the importance of focusing on core competency within corporations, in place of over-diversification.
“Running a conglomerate seems inefficient,” explains Barnea, “since spreading thin over too many industries can lead to lack of focus and lack of specialization. There are also significant overhead costs that need to be taken into account in operating a widespread conglomerate. In most stock exchanges, shares of conglomerates trade at lower values than corporations focused on single industries.”
Balancing this, however, are some advantages that conglomerates bring. The economies of Japan and South Korea are conglomerate-heavy, characterized by structures that bear some resemblance to the emerging Israeli conglomerates, with interlocking shareholdings tying together companies in disparate industries, and significant interests in financial institutions.
“With presence in several industries, a conglomerate can obtain synergistic data on consumer preferences that can be used profitably,” notes Barnea. “Profits from a company in one industry can be used to enable a company in another industry to sell at a loss while it drives out competitors by undercutting their prices. Interests that are normally conflicting – such as that between suppliers and buyers – can be harmonized, and sheer size can give a conglomerate clout in both the labor market and in the political sphere.”
THE ISRAELI CONGLOMERATE holdings may be profitable for their owners, but many economic analysts regard them as ultimately harmful to the overall economy. “A conglomerate merger may facilitate, in particular cases, tacit collusion in certain markets,” David Gilo, an expert in antitrust law and economics at Tel Aviv University, tells The Report. “Suppose that following the conglomerate merger in question, two conglomerates establish presence in the same markets, such as the cellular industry, the construction industry and the supermarket industry. Then a conglomerate that deviates from tacit collusion in the cellular market, if such collusion exists, may be “punished” by the other conglomerate in the construction and supermarket industries.
Nevertheless, as the economics literature shows, this conclusion depends on the particular facts of the case, since such multimarket contact may also encourage a conglomerate to deviate from tacit collusion in all of the markets at once. Also, in certain cases, when conglomerates operate in several markets that are close enough to each other, a ‘balance of fear’ may discourage them from entering each other’s markets.”
“If Supersol belongs to the same conglomerate as Cellcom, and Cellcom seeks a way to reach new customers by offering special deals in supermarkets, it will naturally partner with Supersol,” Barnea notes. “What chance have competitors got in this case? There is also a danger that conglomerates will become ‘too big to fail,’ therefore trusting that a government bailout may await them if they get into economic difficulties, and this could lead them to undertake risky projects.”
“Mergers or transactions between supplier and customer can sometimes harm competition in a relevant market,” agrees Gilo. “For example, a merger between a food producer and a supermarket, a construction company and a bank providing credit, or a telecommunications infrastructure supplier and a mobile telephone company,” he says, pointing out several potential conflicts of interest, “may create at times the foreclosure of rival firms.
This, however, does not necessarily hinge on the conglomerate structure of companies, but simply on the vertical supplier-customer relationship between co-owned companies.”
Doron is even more emphatic in warning of the harm caused by the economic concentration in Israel. “It is holding back our growth,” says Doron.
“There is also a systemic risk: if the big conglomerates fall, they could take with them our pensions, because institutional investors have bought much of the shares in companies owned by the tycoons. And the resulting lack of competition enables tycoons to raise the prices of consumer items by 20 percent to 30 percent, which directly affects the income of every family, especially those in the economically weaker segments of society, who spend most of their budgets on consumer items.”
Not everyone agrees that there is a problem of overconcentration of power in the economy. Dankner, in a letter sent to senior IDB officials in October of last year, stated that “there is no problem of over-concentration in the economy. To the contrary, the economy is competitive and strong, characterized by good and effective regulation.”
Dankner quoted from a study conducted by Dr Yaakov Sheinin, the CEO of Economic Models Ltd., a private economic analysis company, and Professor Ephraim Sadka of the Tel Aviv University economics department.
The study concludes that the extent of economic concentration in Israel is not unusual for the country’s size, and may even be less than the norm. The authors claim that the ten largest economic concerns produce only 8 percent of business production. They also describe the formation of economic control in Israel as a dynamic and fast-changing phenomenon, characterized by greater mobility than in Europe.
Doron strongly disagrees with this assessment.
“Relative to the world, in measured central control of the economy, Israel is 118th out of 140 countries,” he says. “That is a very bad position to be in.”
ONE MIGHT EXPECT A PHENOMenon of overconcentration of economic power to be a proper subject for antitrust enforcement. But, as Barnea explains, antitrust legislation concentrates on market share within particular industries.
Antitrust regulators look for companies that have attained such commanding market share that they can single-handedly determine prices. In each particular industry, however, conglomerates manage to operate ‘underneath the radar’ of antitrust laws, building their power precisely by not taking over one particular industry, but by spreading out over several key industries at once.
“There are also laws that limit mergers and acquisitions,” continues Barnea, “and limiting financial companies from operating simultaneously in several different fields, such as banking and insurance, and restrictions on the formation of cartels. But there is no antitrust legislation that specifically handles economic concentration.”
Significantly amending antitrust laws to enable regulators to break up conglomerates with a presence in several industries might not lead to immediate results, according to Gilo, because it will take time for a staff of regulators focused on that sort of economic activity to be assembled and to gain experience. “The prevailing antitrust law as it currently is formed is not built to handle economy-wide concentration,” he says, but rather focuses on concentration within specific markets.”
What else can be done? Barnea advocates amending corporate governance laws, to enable the appointment of strong and independent boards of directors. The Knesset passed an amendment to the corporate code March 3, bolstering the independence of boards of directors and instituting new rules intended to prevent situations in which a minority of shareholders can approve deals favored by controlling interests in companies.
The tax code has also been suggested as a means of curbing the concentration of power in conglomerates, mainly by a proposed tax on dividends paid between subsidiaries of a single conglomerate, to make interlocking shareholding less profitable. Sheinin and Sadka advocate against such a move, noting that apart from the United States, no country in the world has adopted such a tax, which they characterize as a form of “double taxation.”
Lachman-Messer is skeptical that any efforts apart from a direct approach to breaking up conglomerates by law will have a significant effect. “Corporate governance laws will not make a difference,” says Lachman- Messer, nor can shareholders be counted on to stop this phenomenon, because many of the shareholders in the conglomerates are institutional – such as pension funds and insurance companies – making use of money invested by the public but controlled by the conglomerates themselves. What is needed is a law restricting the amount of economic control any one individual can concentrate.”
“The problem not something off in the future,” she adds. “It is a major problem, damaging the economy and civil society. Ultimately, it is bad for democracy, because a small number of people are making decisions for the rest of us.”