Member Article

1.       Introduction

As a reaction to the financial market crisis and the too-high incentives politicians have identified in the area of manager's compensation, the German government has enacted the Law on Equitableness in Executive Compensation (German: Gesetz zur Angemessenheit der Vorstandsvergütung,  abbr: VorstAG). The VorstAG modifies the German Stock Corporation Act (AktG) and the German Commercial Code (HGB). It became effective as of August 5, 2009. At the same time the German Corporate Governance Code was modified. The new law regulates compensation for members of stock corporation’s management boards with the aim of orienting their compensation toward sustainable development of the company. The main changes involve the following:

 

2.       Amount of Compensation

The VorstG defines more specifically the amount of executive compensation which may be deemed equitable. In addition to the company's economic situation and the executive board's tasks, in determining a particular manager's compensation one must now take into consideration the executive's individual performance and the customary compensation. Furthermore intra-company salary structures must be adhered to. Executive compensation may only exceed customary compensation if there is good reason to do so. All of these criteria must be applied not only to prospective regular payments but also analogously to retirement and other related payments, for instance those which may be made to surviving dependents.

The supervisory board of a company is responsible and liable for determining what compensation is equitable. Although this liability of the supervisory board is not new, it has now been explicitly set out in the German Stock Corporation Act.

3.       Compensation Reductions, Pensions and Related Benefits

Under the new laws, the supervisory board "is supposed to" reduce executive compensation if the company's business has worsened to such an extent that the originally agreed compensation is inequitable. Under the old regulations the supervisory board was "allowed" to reduce compensation in the event business had worsened "substantially" and there was "grave" inequity. The new law deems a company's situation to have worsened if it has had to let employees go, reduce wages or if it is no longer in a financial position to pay dividends to its shareholders. 

The obligation to reduce executive compensation extends to pensions and related benefits. Reductions to such items after the executive has left the board, however, can only be made within the first three years after retirement.

 

4.       Structure of Compensation

The structure of the compensation must be aimed at sustainable development of the company's business. In particular in determining variable compensation components, both positive and negative developments must be taken into account. Variable compensation for executives of listed companies must be determined on a multi-annual basis; for this reason, executives may no longer exercise share options after only two years subsequent to issue, as was the case before, but must now wait four years.

5.       Responsibility for Determining Compensation

By law it is the responsibility of the supervisory board to determine the amount of executive compensation. This matter can no longer be delegated to a committee, as had previously been customary and acceptable. The entire supervisory board must take part in the decision, and no single item of the compensation decision, such as fixed salary, bonus, stock options or pension, may be delegated to committee.

6.       Shareholder Assembly Participation

The shareholder assembly may pass resolutions concerning the structure of executive compensation. However, such resolutions are not deemed to establish rights or duties of the supervisory board. The supervisory board remains free to negotiate compensation with each executive individually.

 

7.       D&O Insurance

If a company takes out Directors' and Officers' Liability Insurance, the policy must include a deductible for the executive member. The mandatory minimum for such a deduction is 10% of the damage incurred and a minimum of one and a half times the executive's fixed annual compensation at the time the breach of duty occurs. In contrast, D&O insurance for supervisory board members need not include a minimum percentage deductible.

 

8.       Waiting Period for Executives Before Joining Supervisory Board

A former executive board member must wait two years after leaving the executive board before he or she may join the company's supervisory board. An exception to this is in the event election of that member to the supervisory board has been put forward by 25% of the voting shareholders. Additionally, the German Corporate Governance Codex recommends that an executive board member of a listed corporation shall not be a member of more than three supervisory boards of other listed corporations.

9.       Conclusion

The VorstAG and the modifications made to the German Corporate Governance Code are intended to enforce new, more long-term orientation in determining executive compensation. The new provisions will have a great deal of influence on the structure of compensation and as a consequence will play a large role in the drafting or amendment of board-members' contracts in future. Existing compensation agreements need not be amended, however, as the VorstAG does not apply to agreements which are already in place.