DSW's Remuneration Survey 2005

The regulatory framework – past and future

Germany’s public companies were given three years to comply with the voluntary Corporate Governance Code. But with only 70 percent of DAX-30 planning to comply by the end of this year the government has decided it is time to compel the companies to disclose such information.

In July 2005, the German Government approved a Law on Disclosure of Management Board Remuneration, the so-called VorStOG. The annual reports for the financial year 2006 for the first time have to individually disclose information on board members’ pay. This means that investors in 2007 will be informed about the individual remuneration of all management board members. This is what we thought. But unfortunately, the politicians got cold feet when adopting the law. With the so-called opt-out rule the shareholders' meeting may pass a resolution, with a three-quarters majority of the shares present, allowing the company to refrain from publishing board members' remuneration. Erich Sixt, CEO, founder and major shareholder of the Munich car rental company Sixt AG was the first to use this barn door. At the general meeting of Sixt, 98 percent of the present shares voted against an individualised disclosure of board members’ pay. And there was no doubt that Mr Sixt would receive the necessary majority. He himself already holds 57 percent of the company’s shares.

This case clearly shows the danger of the opt-out rule. Especially at companies with major shareholders it will lead to a two-class society: On the one side the big ones knowing the individual board members’ pay anyway – due to their position. On the other side the private shareholders who are not allowed to see behind the curtain.

And Sixt will not remain the only objector. Other transparency opponents already announced to follow the Bavarian example. One of the most inveterate opponents is Porsche-CEO Wendelin Wiedeking. He, too, can be sure that the 75-percent-hurdle will not pose a problem: All of Porsche's common shares are held by the Porsche and Piech families so Porsche will not need to disclose individual figures in future. The remaining preference shareholders will still be in the dark.

But even shareholders of some companies which already disclose their directors’ pay individually will also be left in the dark. Even when complying, companies have enough possibilities to enhance intransparency when it comes to individual director’s pay. For example, the new law refrains from demanding a standardised disclosure. Experience shows, though,that we can only approach the aim of understandable and comparable information if this is specified by regulations. Furthermore, the VorstOG in some passages does not go far enough: With regard to share options, for instance, it only demands to disclose the market value at the time of granting. And for pension payments, companies are only obliged to inform their shareholders on directors’ pension benefits if those benefits considerably differ from the company’s overall pension schemes.

The recommendations of DSW

According to DSW, a remuneration report shall individually disclose the following information in a standardised format:

1. Fixed fee

2. variable remuneration/cash bonus

3. payments of third parties and affiliated group companies

4. “golden hellos”/termination payments

5. other remuneration/non-cash benefits (e.g. company car)

6. share-based compensation with information on

a. number and market value of options at the beginning of the fiscal year

b. options granted/expired during the fiscal year

c.  (hypothetical) market value of options (granting and exercise date) exercised during the fiscal year including the number of shares acquired

d. number and (hypothetical) market value of outstanding options at the end of the fiscal year

e. maximum number of exercisable options together with the (hypothetical) market value

f. end of the blocking period

g. expiry date

7. pension benefits with information on

a. years of service which allow for pension benefits

b. existing pension entitlements at the beginning of the fiscal year divided into

i. cash benefits

ii. other benefits (e.g. company car) including equivalent cash value

c. pension entitlements acquired during the fiscal year

d. existing pension entitlements at the beginning of the fiscal year divided into

i. cash benefits

ii. other benefits (e.g. company car) including equivalent cash value

e. amount deferred or spent for this purpose

f. existing pension entitlements at the beginning of the fiscal year divided into

i. cash benefits

ii. other benefits (e.g. company car) including equivalent cash value

The neighbours

With such a standardised disclosure Germany would not lead the way. Other countries have a long tradition when it comes to disclosure on director’s pay:

In France, listed companies have to disclose their individual board members pay since 2001. Though the pressure in France rather came from the AMF (Autorité des Marchés Financieres) than from the legislator: The AMF supervisory demands detailed information on the composition of fixed and variable remuneration.

In Great Britain, listed companies have to file a remuneration report which must include details on all parts of the individual managers remuneration (fix and variable remuneration, share options, pension benefits and other benefits). Since 2002 companies even have to disclose their future remuneration policy as well as payments for the following year. The shareholders approve the remuneration report at the general meeting.

In the USA the disclosure of board members pay traces back to the Securities Exchange Act 1934. All listed companies are obliged to disclose their directors’ pay individually, even pensions, bonus payments or health insurances paid by the company.

The systematics

We analysed the average cash salary of the executives in the financial years 2003 and 2004 and compared the development to that of the Earnings per Share (EpS) of the respective company. As in the years before we had to deal with different levels of transparency. On the one hand the companies already individualising the pay of their top management. In 2004 nine more companies for the first time decided to disclose board members pay individually and with that followed the nine transparency pioneers. Three companies at least disclosed the remuneration of the CEO. Nine DAX companies still stick to disclosing the overall pay figure.

The results

The results of the DSW survey show that directors of the Dax-30 companies earned an average of 1.6 millions of Euro in fiscal 2004. In 2003 they received 1.5 millions of Euro. This is an increase of about 8 percent.

The strongest pay rise was up to Adidas with an increase of almost 90 percent. The EpS at the same time increase by 20 percent. The disproportionate increase in pay, though, is especially due to accrued expenses for a long term incentive plan in an amount of 4.55 millions of Euro.

The second place in pay rise goes to ThyssenKrupp with an increase of 66 percent. The EpS in the same period of time increased by 60 percent.

E.ON managers had to face the biggest loss in pay: Almost 25 percent less the company transferred to its managers. The EpS decreased by 7 percent. Deutsche Bank’s top management had to accept a decrease of 18 percent but with an average pay of 3.035 millions of Euro the bank still is the top payer among the DAX 30 companies.

The pay range again is very wide although not as wide as in 2003. This years' top payer Deutsche Bank hands roughly 2.2 millions of Euro more to each of its top executives than number thirty (Deutsche Lufthansa) on our list.

The absolute amount top executives receive is just one thing. It is also important that the remuneration reflects the respective management performance. Pay should not rise when profit falls! And here, companies seem to have learned from the past. While in 2003 five companies increased the pay for the top managers while the EpS decreased, this development could no longer be viewed in 2004. We hope that this positive development has its grounds in a change of mind and is not due to the fact that only E.ON and Volkswagen decreased their EpS. At Volkswagen we would have wished for a more distinct salary cut than only 2.28 percent as the EpS decreased by more than 30 percent.

Lack of transparency

Although the number of companies individually disclosing their directors’ pay has increased since our last survey, shareholders still lack information. This is especially due to the variable parameters which are used by the companies to measure the success of their directors’. Here, the range is wide and a standardisation is not in sight. EpS and EVA or dividend are used as well as Gross Cash Flow or ROCE. Some companies even use five different variable parameters to measure the success of their directors without disclosing the proportion of the respective parameter to the whole variable part of the managers remuneration. Another probem is that these parameters are usually not underlaid with figures so that shareholders are not able to check whether the variable remuneration has been adequately adjusted to the development of the respective parameter. Especially nebulous are those parameters that are not based on facts but rather on soft factors. Directors of Deutsche Börse, for example, can increase their income with a high ‘social and analytic competence’, at Adidas ‘personal performance’ plays a role and TUI managers have a ‘personal assessment factor’ determining their remuneration.

Unfortunately, the VorstOG will not have an impact on these nuisances because it gives too much leeway to the companies in creating their remuneration reports. So, even in 2007 there will be a large number of German companies with intransparent remuneration models.