The global debate surrounding CEO compensation remains important and contentious. While many countries have implemented advisory frameworks for say-on-pay votes, Israel has taken a pioneering approach with its binding dual-majority voting system. Introduced in 2012 through Amendment 20 to the Companies Law, this mechanism seeks to align executive pay with shareholder interests. By granting minority and institutional investors substantial authority over decisions on CEO pay, Israel is reshaping corporate governance dynamics in ways that stand out globally.

In a recent article, we investigate the implications of this framework. Using a survey of 106 directors from companies traded on the Tel Aviv Stock Exchange (TASE), the article explores how this distinctive system influences decision-making, accountability, and governance effectiveness. The article also highlights our findings, the challenges revealed, and the lessons Israel’s system offers to global corporate governance.

The Israeli Mechanism

Israel’s approach to CEO pay governance differs fundamentally from advisory mechanisms, such as those used in the United States. Amendment 20 mandates that CEO compensation must receive approval from both a majority of shareholders and a majority of minority shareholders. This dual-majority vote elevates institutional investors as key decision-makers, ensuring that their perspectives hold substantial weight in executive pay policies.

An essential feature of this framework is the unique role of external directors, who are legally required in publicly traded companies to protect minority shareholders and ensure good governance. Unlike other directors, their appointment requires approval not just from the majority of shareholders, but also from the majority of minority shareholders, including institutional investors. Reliance on institutional support reinforces the independence and accountability of external directors, distinguishing them from directors elected by a simple majority.

Unlike advisory systems, where boards retain the discretion to override shareholder opinions, Israel’s mechanism makes shareholder approval binding. Boards can only overrule a vote in exceptional cases, and these decisions must be rigorously justified as being in the company’s best interest. This unique framework amplifies minority shareholder voices, enhances accountability, and fosters a governance environment where stakeholder alignment is central.

Insights from the Survey

The survey conducted for our study provides valuable insights into how Israeli directors perceive and navigate the binding vote system. Participants included external, independent, and regular directors and chairpersons, representing diverse industries such as banking, insurance, real estate, and retail. Below are the key findings:

1. The Role of External Directors
   External directors, who constitute the majority on compensation committees, emerged as key advocates for institutional-shareholder perspectives. They were significantly less likely than other directors to support decisions that overrule shareholder votes, reflecting their role as impartial gatekeepers. This underscores the importance of their independence in aligning boardroom decisions with shareholder interests.
2. Gender Dynamics in Governance
   Gender diversity played a notable role in governance attitudes. Female directors demonstrated a stronger tendency to oppose overruling institutional votes, emphasizing collaborative and inclusive decision-making. This finding highlights the value of diversity in fostering balanced and thoughtful governance.
3. Institutional Investors as Catalysts for Change
   Institutional investors have become influential players in shaping CEO compensation governance. Their assertive voting behavior reflects growing expectations for fairness, transparency, and alignment with long-term corporate goals. Directors acknowledged the growing power of these investors and the critical need to engage them proactively.
4. Challenges in Overruling Votes
   Despite the strengths of the binding-vote mechanism, challenges persist. In 2023, six cases of boards overriding shareholder votes on CEO pay attracted significant media attention and public criticism. These cases highlight the fine line boards must walk between exercising their discretion and respecting shareholder authority.

The Cost of Conflict

Two high-profile cases in 2023 illustrate the complexities of Israel’s binding-vote system. In both instances, boards overruled shareholder votes on CEO pay, citing exceptional circumstances such as the strategic indispensability of the CEO. However, these decisions provoked significant backlash from institutional investors.

In both cases, institutional holders responded by voting against the reappointment of external directors who supported the board’s decision, using their power as a form of accountability. These incidents highlight the personal and systemic consequences of governance misalignment, emphasizing the critical need for transparency, trust, and active engagement between boards and shareholders.

Implications for Corporate Governance

The findings from our study suggest several insights for improving corporate governance under binding vote systems:

1. Fostering Transparency and Communication
   Open dialogue between boards and shareholders is essential. Engaging institutional investors early in the decision-making process can prevent conflicts and build trust.
2. Balancing Expertise and Accountability
   Binding votes empower shareholders but also heighten the responsibility of boards to justify their decisions. Directors must navigate this dual accountability by blending expertise with a commitment to stakeholder interests.
3. Strengthening the Role of External Directors
   External directors play a crucial role in bridging shareholder interests and boardroom dynamics. Their impartiality and focus on governance principles are vital for maintaining trust and credibility.
4. Embracing the Power of Diversity
   The collaborative approaches of female directors illustrate the tangible benefits of boardroom diversity. Broader representation enhances governance quality by fostering balanced and thoughtful decision-making.

Lessons for Global Governance

Israel’s binding vote mechanism offers a unique lens through which to explore governance innovation. It demonstrates the potential of shareholder empowerment to address agency problems, align executive pay with stakeholder interests, and foster greater accountability. However, its challenges also highlight the need for balance. Other markets considering similar frameworks must carefully weigh the interplay of shareholder power and board discretion, ensuring systems are both effective and adaptable.

A Mechanism for Collaborative Accountability

Israel’s distinctive approach to CEO pay represents a bold step toward greater corporate accountability. By empowering shareholders with binding authority, it redefines traditional power dynamics and sets a new standard for fairness and transparency. Yet, as our study illustrates, the system is not without its challenges. Boards must carefully balance authority with accountability, fostering trust and alignment to avoid conflicts.

As governance mechanisms continue to evolve globally, Israel’s experience provides valuable lessons for companies, regulators, and investors. Prioritizing communication, embracing diversity, and enhancing transparency are essential not only for CEO-pay decisions but also for building stronger, more resilient organizations.

This post comes to us from Professor Keren Bar-Hava at Hebrew University of Jerusalem – Jerusalem School of Business Administration and Erez Barak, an institutional shareholder proxy adviser. It is based on their recent article, “Does Institutional Holders’ Approval Really Matter? An Examination of Israel’s Binding Vote on CEO Compensation, from Directors’ Point of View,” available here.