German Corporate Governance Code to Promote Long-Term Goals

In line with executive compensation principles endorsed by the G-20, the German Corporate Governance Code Commission proposed changes to the code to align executive compensation at German companies with long-term corporate performance. While noting that German corporate governance has proved its worth during the financial crisis, the Commission still believes that the code should be amended to strengthen incentives for sustainable corporate governance and facilitate further professionalization at the supervisory board level. In an effort to delink variable compensation from short-term focus, the Commission is also calling for an extension of the exercise period for equity options for up to three years.

There is broad agreement to create even stronger incentives for sustainable corporate development via appropriate compensation structures for management boards, so that senior managers receive remuneration commensurate with long-term corporate success, or lack thereof. Further senior management compensation should be measured in relation to a company's basic compensation structure in future.

At its recent meeting, the G-20, including Germany, endorsed major changes in executive compensation based on just announced Financial Stability Board principles. Regulation must ensure that compensation structures are consistent with firms’ long-term goals and prudent risk taking. Specifically, firms' boards of directors must play an active role in the design, operation, and evaluation of compensation schemes. Compensation, particularly bonuses, must properly reflect risk; and the timing and composition of payments must be sensitive to the time horizon of risks.

Payments should not be finalized over short periods where risks are realized over long periods, said the G-20 communiqué, and firms must disclose comprehensive and timely information about compensation. Stakeholders, including shareholders, should be adequately informed on a timely basis on compensation policies in order to exercise effective monitoring. The inclusion of stakeholders in the communiqué portends a role for shareholder advisory votes on executive compensation.