Germany to Curb Executive Compensation

In March of this year, Switzerland took the lead in an attempt to give shareholders of listed stock corporations more direct influence on the compensation the company is paying to its executives. In a referendum, the Swiss voters decided that there has to be a binding annual resolution by the general shareholder assembly on the overall amount of compensation paid to the executives. With the upcoming election this fall in mind, the German government intends to follow.

1. The current legal situation in Germany

A German stock corporation comprises three corporate bodies, all of which are mandatory. These are the shareholders’ meeting, the supervisory board and the executive board. The shareholders’ meeting has the competence to determine the compensation of the members of the supervisory board (either by resolving on a respective provision in the company’s articles of association or by resolving upon the compensation within the shareholders’ meeting).

In contrast, and with regard to the remuneration of the members of the executive board, the shareholders’ meeting historically had no say at all, but it has always been within the power of the supervisory board to determine and resolve upon this topic. This changed with the Act on the Appropriateness of Management Board Compensation, which in 2009 introduced the concept of a shareholders’ “say on pay” into German Corporate Law and established an optional advisory shareholder vote on executive compensation for the first time.

It was then that the German legislator introduced Sec. 120 (4) German Stock Corporation Act providing that the shareholders’ meeting of a listed company may resolve on the approval of the compensation scheme relating to the members of the executive board.

This German version of the say-on-pay vote is limited to listed companies and constitutes a new feature in German corporate law. Since then, shareholders may decide on the „system” of executive remuneration, including fixed and variable pay components, the balancing of those components and temporal assessment bases, but also pension and retirement benefits, as well as bonuses with regard to M&A transactions, namely „golden parachutes” in form of caps for extraordinary developments. The vote is purely optional and the stock corporations that have “say-on-pay”-resolutions on the agenda of their annual shareholders’ meeting typically do not resolve on an annual basis, but rather irregularly.

According to the official reasons of the Act], the main function of the optional shareholder vote on executive pay is not to protect minority shareholders, but to encourage consultation between, on the one side, the management board and the supervisory board and, on the other side, key (institutional) investors. Although optional, the majority of the larger listed stock corporations in Germany decided to let the shareholders have their say and introduced the “say on pay”-resolution to the agenda of their annual shareholders’ meeting. However, the German lawmakers nevertheless considered the provision as not far reaching enough and lately resolved upon to substantially expand the provision.

2. “Say on Pay” 2.0

In late June 2013, the German Bundestag resolved upon an amendment of Sec. 120 (4) German Stock Corporation Act. The amendment still needs to pass the German Bundesrat to become effective. The Bundesrat will meet for the last time prior to the upcoming election on September 20, 2013, where the amendment may be finally approved.

Sec. 120 (4) German Stock Corporation Act will then provide that it is mandatory for the supervisory board of a listed stock corporation to provide the annual shareholders’ meeting with the compensation scheme relating to the members of the executive board on which the shareholders’ meeting shall in turn resolve upon. Pursuant to the German government the amendment aims to provide an effective answer to excessive remuneration in individual German stock corporations.

The major differences to the current version of Sec. 120 (4) German Stock Corporation Act are as follows:

  • The „Say on Pay“-resolution is no longer optional, but mandatory;
  • the „Say on Pay“-resolution must be taken on an annual basis;
  • the supervisory board must draw up a specific compensation scheme which it introduces to the shareholders’ meeting;
  • the „Say on Pay“-resolution has a binding effect for future decisions of the supervisory board relating to executive compensation.

3. What happens next?

As already indicated above, the German Bundesrat still needs to approve the revision to become effective. Although the majority of the legal commentators assumes that this will be the case (and that the revised version of Sec. 120 (4) German Stock Corporation Act will then become effective some time later this fall), there is of course no certainty in this regard.

Further, although the above described amendments may seem pretty straightforward in the first place, a variety of questions associated with the correct implementation as well as the legal consequences of it are already being discussed. We will update you on the further developments in this regard.