advanced corporate governance · 3 % fringe benefits* 12 % long term incentives annual bonus 20 %...

Advanced Corporate Governance

Board Compensation

Univ.-Prof. Dr. Marc Eulerich ￭ Lehrstuhl Interne Revision ￭ WS 2019/20

Agenda

Univ.-Prof. Dr. Marc Eulerich Advanced Corporate Governance | WS 2019/20 2

Business Ethics

Board Diversity

Board Dynamics

Codetermination

Board Compensation

1

2

3

4

5

6 International Corporate Governance Systems

4 Board Compensation

Board compensation

Christine Hohmann-Dennhardt will receive 12 MEUR for 13 months as member of the

executive board of VW where she held responsibility for 'Integrity and Legal Affairs”.

Martin Winterkorn received up to 17 MEUR per year while serving as CEO of VW, after

vacating his position in the wake of the emission scandal he now receives a retirement

pension of 3100 EUR a day.


Source: Spiegel Online

Board compensation

Thomas Middelhoff was chairmen of the supervisory board of KarstadtQuelle AG, which later

operated under the name of Arcandor, from 2004 to 2005, and CEO from 2005 until 2009.

Four months after Middelhoff left the company in Feb 2009, Arcandor declared bankruptcy.

In a confidential agreement Middelhoff and supervisory board chair Friedrich Carl Janssen

agreed on the following terms for the end of his employment:

• A bonus of over 0.5 MEUR for the time between October 2008 and February 2009

• Severance pay in the amount of approx. 1.5 million EUR

• Continuation of monthly payments for the next twelve months totaling 2 MEUR

• Compensation for the waiting period caused by a no-competition clause in the amount of

1.13 MEUR

• Monthly benefit payments of 12 690 EUR beginning in 2011

• As well as rent payments for his apartment in Düsseldorf of approx. 3 500 EUR each

month.

Prof. Dr. Marc Eulerich Advanced Corporate Governance | WS 2019/20 5

Source: Wirtschaftswoche (2010, April)

Executive Board Compensation

Statutory provisions:

• Compensation is determined by the supervisory board according to§87 AktG.

• According to §120 (4) AktG shareholders have the right to vote on the executive board‘s

compensation during the general meeting („say on pay“).

• Compensation of listed companies‘ executive boards has to be disclosed according to §285 and §314 HGB.

Prof. Dr. Marc Eulerich Advanced Corporate Governance | WS 2019/20 6

German Corporate Governance Code (GCGC)


G. Remuneration of the Management Board

Principle 23:

The Supervisory Board decides on a clear and comprehensible system on the remuneration

for the Management Board members and, on this basis, determines the actual remuneration

for each Management Board member. The General Meeting adopts advisory resolutions on

the approval of the remuneration system for the Management Board members prepared by

the Supervisory Board, as well as proposing resolutions on the approval of the remuneration

report for the preceding financial year. The remuneration of Management Board members

must promote the corporate strategy and support the long-term development of the company.



1. Determining the remuneration system

G.1 The remuneration system shall define in particular:

− how the target and the maximum total remuneration is determined for each Management

Board member

− the relative share in the target total remuneration of fixed remuneration on the one hand,

and short-term variable and long-term variable remuneration components on the other

hand

− which financial and non-financial performance criteria are relevant for the granting of

variable remuneration components

− what kind of relationship exists between achieving previously-agreed performance criteria

and variable remuneration; and

− when and in what form Management Board members have access to granted variable

remuneration components



2. Determining total remuneration

G.2 The Supervisory Board shall establish the specific target and maximum total

remuneration for each Management Board member on the basis of the remuneration

system, which shall be appropriate to the corresponding Management Board

member’s tasks and performance as well as to the enterprise’s overall situation and

performance, and shall not exceed the usual level of remuneration without specific

reasons.

G.3 In order to assess whether the specific total remuneration of Management Board

members is in line with usual levels compared to other enterprises, the Supervisory

Board shall use an appropriate peer group of other third-party entities, and shall

disclose the composition of such group. The peer-group comparison shall be applied

with a sense of perspective, in order to prevent an automatic upward trend.

G.4 In order to determine whether remuneration is in line with usual levels within the

enterprise, the Supervisory Board shall take into account the relationship between

Management Board remuneration and the remuneration of senior managers and the

workforce as a whole, and how remuneration has developed over time.



2. Determining total remuneration (continued)

G.5 If the Supervisory Board calls upon an external remuneration expert to develop the

remuneration system and to evaluate the appropriateness of the remuneration, it should

ensure that the expert is independent from the Management Board and the enterprise.

3. Determining the total amount of variable remuneration components

G.6 The share of long-term variable remuneration shall exceed the share of short-term

variable remuneration.

G.7 Referring to the coming financial year, the Supervisory Board shall establish the

performance criteria for each Management Board member covering all variable

remuneration components; besides operating targets, the performance criteria shall

be geared mainly to strategic goals. The Supervisory Board shall determine to what

extent individual targets for each Management Board member – or targets for the

entire Management Board as a whole – are decisive for the variable remuneration

components.

G.8 Subsequent changes to the targets or comparison parameters shall be ruled out.



3. Determining the total amount of variable remuneration components (continued)

G.9 After the end of every financial year, the Supervisory Board shall establish the amount of

individual variable remuneration to be granted, depending on target achievement. The

target achievement shall be comprehensible in terms of both its rationale and

amount.

G.10 The long-term variable remuneration amounts of Management Board members shall

be largely invested in company shares by the respective Management Board

member, or shall be granted as share-based remuneration. Granted long-term

variable remuneration components shall be accessible to Management Board

members only after a period of four years. If the company disburses granted

benefits to Management Board members in a subsequent year, this shall be

disclosed in the remuneration report in a suitable form.

G.11 The Supervisory Board shall have the possibility to account for extraordinary

developments to an appropriate extent. It shall be permitted to retain or reclaim variable

remuneration if justified.



4. Benefits granted at contract termination

G.12 If the contract of a Management Board member is terminated, the dibursement of

any remaining variable remuneration components, which are attributable to the period

until contract termination, shall be based on the originally agreed targets and

comparison parameters, and on the due dates or holding periods stipulated in the

contract.

G.13 Payments made to a Management Board member due to early termination of their

Management Board activity shall not exceed twice the annual remuneration (severance

cap), and shall not constitute remuneration for more than the remaining term of the

employment contract. If post-contractual non-compete clauses apply, the severance

payments shall be taken into account in the calculation of any compensation

payments.

G.14 Benefit commitments made in connection with the early termination of a Management

Board member contract by the Management Board member due to a change of control

should not be agreed upon.



5. Other Provisions

G.15 If Management Board members have intra-group Supervisory Board mandates, the

remuneration shall be offset against.

G.16Supervisory Board mandates are assumed at non-group entities, the Supervisory Board

shall decide whether and to what extent the remuneration shall be taken into account.


Executive board compensation includes:

• The sum of all material benefits that board members receive from the company for their

work.

• Fixed and variable compensation.

• Retirement benefits

– Severance pay, pensions, provision for dependents.

• Benefits while serving on the board.

• Other monetary as well as non-cash benefits

– One-time payments, granting of shares, use of a company car, etc.



Compensation components (example):


Pension provision

Fringe benefits*3 %

12 %

Long term

incentives

Annual bonus

20 %

45 %

Fixed remunerations20 %

Variable

compensation

Fixed

compensation

= 100 %

*Fringe Benefits can include:

Deferred Compensation, Severance pay, Early retirement pension, Transitional payments, Payments in case of a change of

control / loss of mandate, etc.

Executive Board Compensation – Fixed Compensation

Fixed compensation:

As total compensation increases the amount of fixed compensation decreases:


Total compensation per

capita in TEUR

Amount of fixed compensation

until 250 70 %

250 – 500 60 %

500 – 1.000 40 %

1.000 – 2.000 30 %

more than 2.000 20 %

Executive Board Compensation – Variable Compensation

An annual bonus is a short-term, incentive-based compensation component which aims

for:

• an ex-ante alignment of board members‘ commitment and business activities with the

achievement of operational and strategic company objectives

• executive management's participation in the company‘s success or failure (similar to the

way in which shareholders participate)

• reduced room for manipulation and „window dressing“.

• Based on measures such as, e.g., EBT, EBIT, EBITDA, ROCE, ROE, EVA, DCF.

• Level and development of stock prices might not be an objective measure of company

value and board performance due to turbulences on the stock market, balance sheet

manipulations, etc.



Annual bonus:

Focus on „performance corridors“:

• E.g., bonus is paid only once 80% of the target value have been reached

– prevents rewarding unavoidable basic achievements

– stronger financial lever in the relevant performance range.

• Bonus cap for goals being exceeded by, e.g., 30% or 50%

– protection in case of extraordinary, unforeseeable developments.



Long-term incentives aim to:

• motivate board members to pursue sustainable growth of internal and external company

value.

• effectively link board members‘ interests to those of shareholders and other stakeholders.


Executive Board Compensation – compensation

systems


Source: Ackermann et al. (2005)

Value oriented compensation systems

Share price

oriented

Genuine equity

instruments

Virtual equity

instruments

Genuine equity

instruments

Traditional key

figures

Value Oriented key

figures

• Stock options

• Employee shares

• Stock appreciation

Rights

• Phantom Stocks

• Profit / annual surplus

• ROI

• Revenue

• Value added

• Growth

• Dividend payout

• Economic value

• CFROI

• DCF

• Balanced Scorecard


Determinants of board compensation:

• Company‘s earning performance

• Company size

• Position within the board

• Executive responsibilities

• Personal performance

• Seniority

• etc.


Company size as a compensation determinant

Number of company

employees

Per capital compensation in TEUR*

Lower quartile Median Upper quartile

until 250 217 273 387

250 – 500 181 334 442

500 – 1.000 404 557 715

1.000 – 5.000 460 661 1.303

5.000 – 10.000 640 1.064 1.496

10.000 – 50.000 1.157 1.460 2.082

more than 50.000 2.340 2.790 3.268

* For the year 2007


Normal Market Remuneration

Vertical and horizontal comparison is used to determine the appropriateness of board

member compensation.

Vertical comparison looks at the board member‘s job profile and requirements in

comparison to the in-house compensation structure.

Horizontal comparison looks at whether the compensation is:

- customary in a specific industry (dt. „branchenüblich“)

- customary for a company‘s size (dt. „größenüblich“)

- customary for the country (dt. „landesüblich“).


Vertical comparison of DAX30 companies

Company 2009 2010 2011 2012

Adidas AG 77:1 80:1 105:1 38:1

Allianz SE 43:1 54:1 36:1 48:1

BASF SE 32:1 43:1 55:1 46:1

Bayer AG 34:1 48:1 36:1 39:1

Beiersdorf AG 18:1 19:1 18:1 24:1

BMW AG 22:1 33:1 49:1 50:1

Commerzbank AG 7:1 8:1 8:1 18:1

Continental AG 26:1 48:1 52:1 45:1

Daimler AG 40:1 67:1 64:1 62:1

Deutsche Bank AG 38:1 46:1 42:1 27:1

Deutsche Börse AG 15:1 18:1 23:1 21:1

Deutsche Lufthansa AG 25:1 45:1 39:1 29:1

Deutsche Post AG 82:1 68:1 69:1 70:1

Deutsche Telekom AG 29:1 63:1 30:1 34:1

E.ON AG 53:1 50:1 39:1 51:1

Fresenius Medical Care AG & Co. KGaA 52:1 54:1 57:1 59:1

Fresenius SE 44:1 52:1 61:1 62:1

Heidelberg Cement AG 68:1 53:1 48:1 52:1

Henkel AG & Co. KGaA 44:1 54:1 63:1 85:1

Infineon Technologies 20:1 35:1 53:1 37:1

K+S AG 35:1 17:1 30:1 30:1

Lanxess AG 17:1 31:1 31:1 33:1

Linde AG 69:1 71:1 61:1 73:1

Merck KGaA 29:1 38:1 51:1 48:1

Münchener Rück AG 32:1 35:1 33:1 35:1

RWE AG 55:1 51:1 40:1 40:1

SAP 43:1 35:1 46:1 47:1

Siemens AG 50:1 68:1 64:1 58:1

ThyssenKrupp AG 18:1 47:1 46:1 41:1

Volkswagen AG 86:1 103:1 168:1 123:1

Average DAX 40:1 48:1 51:1 47:1

Salaries and wages per employee in relation to executive board compensation per board

member:


Horziontal comparison

Index differences in the average executive board member total compensation for the year

2016 (in TEUR):


938

631

427

373

743

547

354

347

1.334

623

243

346

481

237

170

85

170

85

85

45

- 500 1.000 1.500 2.000 2.500 3.000 3.500 4.000

Dax

MDax

SDax

TecDax

Base compensation

STI

LTI

Pensions pay

Fringe benefits


Industry differences in the average executive board member total compensation for the year

2016 (in TEUR):


808

838

430

701

482

581

550

901

661

777

583

665

304

830

541

444

660

367

785

597

1.078

829

375

687

914

611

748

674

1.196

1.115

239

385

75

351

75

256

225

446

150

344

50

50

20

75

75

75

50

50

75

75

- 500 1.000 1.500 2.000 2.500 3.000

Utilities

Telecommunication

Real estate

Raw, auxiliary and operating materials

IT

Manufacturing

Health

Finance

Consumer Staples

Discretionary consumer goods

Base compensation

STI

LTI

Pensions pay

Fringe benefits


DAX – Average total compensation according to position (MEUR):


1,5

0,8

1,2

0,7

2,4

1,2

0,7

0,4

0,2

0,1

0

1

2

3

4

5

6

7

CEO Other Members' Exec. Board

25%

26%

25%

21%

22%

20%

41%

37%

40%

10%

13%

12%

3%

2%

3%

0% 20% 40% 60% 80% 100%

2014

2015

2016

25%

25%

26%

21%

22%

21%

40%

38%

36%

11%

12%

14%

3%

3%

3%

0% 20% 40% 60% 80% 100%

2014

2015

2016

2016

2016

Base compensation STI LTI Pensions pay Fringe benefits

CEO

Other Members‘ Executive Board

2014

2016

2014

Supervisory Board Compensation


Increasing juridification of supervisory board work:

Work is becoming more and more demanding and time-consuming.


Source: Kienbaum (2016)

Year 1998 2002 2004 2005 2009 2010 2012 2013 2014 2015 2016

EU

initiatives

Recommen-

dation on

the role of

supervisory

board

members

Green book

FI and APr

Action plan

CG

Balance

directive

Share-

holder

directive

„say on pay“

Laws Kon-TraG Trans-PuG BiReG BilKoG

UMAG

BilMoG

VorstAG

AReG

APAReG

Company

law

amendment

Soft Laws,

Standards

GCGC COSO ERM COBIT 4.1 COBIT 5.0 DIN Spec

33456




Determinants of

supervisory

board

compensation

Company

characteristics

Board members’

individual

characteristics

Functions and

tasks within the

board

Market environment

(availability of suitable

candidates, etc.)

Regulations &

liability

(AktG, GCGC, etc.)

Functions and tasks within the board:

• Role of supervisory board with regards to

corporate governance

• Role and function within the board

• Chairmanship or membership in committees

• Competence and temporal requirements

related to the specific function

Board members‘ individual characteristics:

• Specific competences, skills, experience

• Number of board mandates

• Supervisory board membership as main

occupation

Company characteristics:

• Company and board size

• Business model and current situation of the

company as well as resulting competence

requirements

• Degree of internationalization



GCGC

I. Remuneration of the Supervisory Board

Principle 24:

The members of the Supervisory Board receive remuneration that is appropriate to their tasks

and the situation of the company. Remuneration is specified by resolution of the General

Meeting, or in the Articles of Association, if applicable.

G.17 The remuneration of Supervisory Board members shall take into account, in an

appropriate manner, the higher time commitment of the Chair and the Deputy Chair of

the Supervisory Board, as well as of the Chair and the members of committees.

G.18 Supervisory Board remuneration should be fixed remuneration. If members of the

Supervisory Board are granted performance-related remuneration, it shall be geared to

the long-term development of the company.

Principle 25:

The Management Board and the Supervisory Board prepare an annual remuneration report,

in accordance with legal provisions.


Compensation structure is often simpler than for the executive board compensation:

• Fixed compensation

• Annual bonus

• Long-term incentives

• Attendance fees

• Others.



Fixed compensation component should not be too small:

• e.g. ratio between 50% and 75%

• Ensure attractiveness of board membership for qualified personnel even in times of crisis

• Compensate board members for their time and effort in a reasonable manner.

German Trade Union Association demands exclusively fixed compensation:

• Monitoring increases with decreasing corporate success

• Variable compensation can impede independence since the supervisory board profits

from the executive board‘s decision.



Per capita compensation for the year 2015:



Stock exchange

segment

Surveyed

companies

Compensation in TEUR Per capita in TEUR

Supervisory

board total

Per capita Lower

quartile

Median Upper

quartile

DAX 30 2.561,3 156,5 99,7 137,6 193,1

MDAX 45 1.072,3 90,3 63,9 82,6 102,2

SDAX 44 318,7 47,1 28,0 38,8 63,3

TECDAX 27 359,3 56,2 40,7 50,3 70,3

GEX 23 131,0 36,3 23,3 33,7 50,0

Other listed

companies452 119,4 21,9 8,9 15,7 28,4

Not listed 979 135,8 13,7 3,4 7,5 15,0


Development of DAX and MDAX supervisory board and executive board compensation:



Total compensation

executive board

Fixed compensation

executive board

Total compensation

supervisory boardFixed compensation

supervisory board

Board Compensation in the US


“High pay for outside directors of corporations guts the whole idea of these representatives of

the shareholders making independent judgments. How does a board member challenge a

CEO when the director is being paid oversize amounts likely to be important to his or her

lifestyle?”

- Loomis, C. J., 2010, “Board pay: Unchecked and out of hand”


Source: Fortune Magazine (2010)

Questionable compensation components

• Guaranteed bonuses

• Re-setting of stock options

• Golden hellos

• Golden parachutes

– Common in the US: e.g. James Kilt, CEO of Gillette, who received $165 m. after the

company was acquired by Procter & Gamble in 2005

– Supposed to ensure that CEOs negotiate advantageous takeover deals even, if they

might lose their position as a consequence of the change in ownership

– Can be part of a ‘poison pill’ strategy to dissuade takeover attempts through the

increase of takeover costs

– Supposed to be of limited applicability in Germany, since the Stock Cooperation Act

(AktG), as well as the GCGC, state that executive board compensation has to be

reasonable in relation to a board member‘s tasks and performance, GCGC

additionally includes a severance cap.



Possible determinants of director compensation:


Source: Brick et al. (2006); Farrell et al. (2008); Bryan et al. (2000), Dah/Frye (2017)

Investment opportunities

Tobin's Q equal to the sum of the market value of equity, liquidating value of preferred stock, and debt

divided by the book value of total assets.

R&D/At ratio of research and development expenses to total assets.

Adv/At ratio of advertisement expenses to total assets.

Liquidity ratio of current assets minus current liabilities to total assets.

Firm complexity

Sales company‘s sales

Employees number of employees

Board meetings total number of board meeting during a given year.

Business segments total number of business segments.

Need for monitoring

Leverage ratio of long term debt to total assets.

PPE/At ratio of property, plant, and equipment to total assets.

Capx/At capital expenditures to total assets.

CEO ownership ppercentage of the firm's equity that is held by the CEO.

Performance and risk

ROA return on assets

CF/At ratio of operating cash flow to total assets.

Volatility standard deviation of the firm's daily returns during a given year.


Possible determinants of director compensation:


Source: Brick et al. (2006); Dah/Frye (2017)

Governance and rent extraction

Percentage Insiders The percentage of board members who are insiders.

Board Size The total number of board members.

Director Tenure Average tenure of all directors in a given firm.

Director Age Average age of all directors in a given firm.

Director Interlock Average number of other boards served on by the firm's directors.

Percentage Female The percentage of board members who are female.

Gender The CEO’s gender.

E-index Entrenchment index presented by Bebchuk et al. (2009).

Duality CEO is simultaneously chair of the board of directors.

CEO age The CEO's age.

Industry Industry the company operates in.


How does excess director compensation affect the firm's internal monitoring?

• Overcompensation may act as an incentive for board members to exert more effort and,

thus, improve the soundness of the firm's governance structure.

• It is possible that excess compensation leads to more monitoring as directors may feel

beholden to shareholders to work hard and retain their high pay.

• Alternatively, the surplus in director compensation might indicate that directors are

entrenched and not effective monitors.

• Brick et al. (2006) suggest that excess director compensation is associated with a culture

that does not allow for constructive criticism.

• Directors may be hesitant to destabilize the status quo and jeopardize their positions and

compensation.


Source: Dah/Frye (2017)


For the firms that overcompensate their directors:

• CEO turnover-performance sensitivity is lower

• thus, the overpayment of board members provides the CEO with additional immunity and

job security.

For undercompensated directors:

• no significant effect of excess compensation on turnover-performance sensitivity

• however, some evidence that undercompensated directors may be more likely to replace

underperforming CEOs

• evidence consistent with cronyism between directors and CEOs: excess director

compensation is positively related to CEO total compensation

• excess compensation for overcompensated directors reduces CEO pay-for-performance

sensitivity, which supports the notion that overcompensation leads to less monitoring.

Overall, findings suggest that director excess compensation may be a sign of board

entrenchment, where overcompensated directors are not necessarily focused on

protecting shareholder interests.


Source: Dah/Frye (2017)

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