Executive Compensation Reform – Amendment No. 20 to the Companies Law
Background, possible effects and suggested solutions
Background
The amendment, which was enacted on December 12, 2012, reforms executive compensation in Israel. The new legislation aligns Israel with other Western economies in the use of effective shareholder participation and the alignment of executive and board compensation policy with the long-term interest of the company and its shareholders – an Israeli “say on pay” model. Compensation policy requires shareholders’ vote prior to final approval and CEO compensation agreements are presented to the shareholders meeting for approval prior to finalization by the board.
The amendment sets out corporate governance rules which include the following:
Compensation committee:
All public companies are required to establish a compensation committee comprised of at least three directors with a majority of outside directors (and all have to be independent). The committee recommends the company compensation policy (goals, size and activities, incentives and termination payments) to the board of directors and approves CEO, directors and corporate officers compensation. The establishment of this committee is designed to permit an objective and independent evaluation of the sensitive subject of incentives and bonuses as measured against targets and performance. Compensation policy must be approved at least every three years.
Caps on variable components:
A company is required to contemplate whether to authorize the board to have full discretion to lower variable compensation components and whether to set a cap on stock based actual variable components. All other variable components must have a clear cap. The award of variable components must be based on long term and measurable performance criteria; the company must also set a balance between fixed and variable pay. This is a board of directors empowering measure, which will also indicate the level of professionalism and objectivity of the board members.
“Say before Pay” rules:
Following board approval of the compensation policy recommended by the compensation committee it then goes for approval to the general meeting in a non-binding vote. If the policy is not approved by the majority of the minority shareholders then the board will have to hold further deliberations. Following such deliberations the policy can either be approved in its original form despite the minority’s disapproval, or adjustments made and again sent for approval.
Summary
The amendment to the law is significant and is designed to enhance the power of independent board directors as well as consideration being given to professional and transparent appointments to serve as board directors. Such power enhancement should lead to a more rational relationship between targets and results, and the various components of executive compensation.
Possible effects and suggested solutions
WCGW (what can go wrong)
One of the main problems with legislation of this type is that everyone sees what everybody else is doing. Compensation plans become generic and a lowest common denominator (which quickly becomes the norm – and at a high level) is fixed.
This has the opposite effect to the purpose of the legislation and drives up total compensation packages instead of reducing them. A case in point was the State’s rejection of Bank Leumi’s executive compensation plan (the State has shares in Bank Leumi and thus has significant influence). However, this only proves the premise, in most cases executive compensation packages will go through on the nod, directors who serve on compensation committees will cover themselves by inquiring of company lawyers what questions they should ask (in order to be included in the minutes of the meeting) and the same lawyers will also assist the company in drafting satisfactory responses. All this just underlines the flimsiness of Israel’s regulatory framework when it comes to protecting the rights of shareholders in public corporations.
However, high pay for top executives isn’t a problem in itself. Appropriate, generous compensation can help companies attract the most talented managers and spur them to maximize company profits. The problem is the composition of the compensation plans where contribution to the company is not measured and, often, large salaries are received by executives just for turning up to work.
Genuine measurable objectives
So the challenge is to give teeth to Amendment 20 in order for its objectives to be achieved. How is this to be done? Here are a few thoughts which may contribute:
- Truly independent directors – support should be given to the proposal to establish a “pool” of Securities authority approved independent directors from which public companies can choose, instead of even independent directors being appointed by control holders, as is the situation today. This will mean that such directors are not “beholden” to the control holders and can express a truly “independent” opinion.
- Israel Securities Authority oversight – I am no fan of increased regulation but comments by the Authority quoting specific cases may spur companies to improve corporate government norms.
- Comparative compensation packages – this is the task of the economic journalists. Just as tables of the highest paid directors are published when companies’ annual financial statements are produced, so should there be a running table of approved compensation packages. Hopefully this will indeed encourage companies to be fiscally responsible in respect of executives’ compensation packages.