The German Federal Parliament, the Bundestag, has adopted legislation increasing the liability of a company’s supervisory board for management remuneration and mandating a shareholder advisory vote on management remuneration. The Act on Appropriateness of Management Board Remuneration (Gesetz zur Angemessenheit der Vorstandsvergütung) ensures that, when executive remuneration is determined by the supervisory board, there will be a greater focus on incentives concerning the company's long-term development. The hallmarks of the Act are transparency, accountability, and a focus on long-term sustainability. The Act must still pass through the Bundesrat. However, it does not require the consent of the Bundesrat, the federal council of states, and will enter into force on the day following its promulgation.
The legislation is based primarily on the belief by the Federal Republic that a factor contributing to the financial crisis is that the incentives in management remuneration promoted the wrong kind of conduct. Many companies were too focused on the attainment of short-term parameters, such as turnover figures or stock market prices on certain dates. As a result, management lost sight of the long-term state of well-being of the company. Moreover, providing the wrong incentives created the temptation to take irresponsible risks.
In order to achieve long-term incentives, variable components of the remuneration package will be based on assessment criteria covering a number of years, and longer periods will apply concerning the exercise of stock options. However, the legislation does not to establish a specific level of remuneration by law. This is not a matter for the State to decide, said Federal Justice Minister Brigitte Zypries, but should be up to the contracting parties.
If the supervisory board determines a level of remuneration that is inappropriate, it thereby makes itself liable to compensation vis-à-vis the company. This provision clarifies that determining an appropriate level of remuneration is one of the most important duties of the supervisory board; and that the board is personally liable for any violations of its obligations. Further, there must be an appropriate relationship between the remuneration of the company’s management board and the management board's performance. Management remuneration may not exceed the usual sector or country-specific level of remuneration in the absence of special reasons.
More broadly, the remuneration structure of listed companies must be oriented towards sustainable corporate development. Components of the remuneration package that are variable, such as bonuses, should be based on assessment criteria covering a number of years. The supervisory board should provide the possibility of introducing caps in the event of unusual developments.
Stock options may be exercised at the earliest four years after the option was granted. This provision is intended to give managers who benefit from such schemes a greater incentive to act with sustainable goals in mind and in the interests of the company.
Under the Act, the general meeting of shareholders of a listed company will be able to give a non-binding vote on management board remuneration. In this way, an instrument for controlling the existing executive remuneration system is put at shareholders' disposal, which enables them to express their approval or disapproval. Thus, pressure will be exerted on those responsible to act particularly conscientiously when determining management board remuneration.
The Act empowers the supervisory board to subsequently make cuts in the level of remuneration in the event that the company's situation worsens. Express statutory regulation was necessary in this respect since this constitutes an interference with existing contracts. An example of worsening in this sense would be where a company is forced to make redundancies and is unable to distribute profits. In such a case, continuing to pay the agreed remuneration to the management board members would be inequitable for the company in question. There is no requirement of insolvency to trigger this new power. The possibility of reducing pensions is restricted to the first three years following the board member's departure.
In order to enhance the transparency of compensation, a decision concerning remuneration of a board member may no longer be delegated to a committee of the supervisory board; but must be made by the supervisory board in a plenary meeting.
Also, companies are required to disclose more extensive information regarding remuneration and pension payments made to management board members when they discontinue their board activity, be it premature or under normal circumstances. This will enable shareholders to gain a better insight into the extent of agreements entered into with members of the management board.
If the company takes out directors and officers liability insurance, a mandatory deductible amount must be agreed upon. This amount must not be lower than one and a half times the amount of annual fixed remuneration. This is intended to promote business conduct that is focused on greater sustainability.
Finally, former management board members may not become a member of the supervisory board within a two-year period following their departure from the management board, in order to prevent any conflict of interest arising. However, in a bow to family-run companies, which are prevalent in Germany, this restriction does not apply if election to the supervisory board takes place at the instigation of shareholders who hold more than 25% of voting rights in the company.
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