Executive pay is, in the first instance, a function of company performance. It can, of course, also be a motivator as it is for other employees. But for whatever purpose, executive pay has to be structured so that it is simple and easy-to-understand. Considering the way Germany’s top managers are paid these days, we are some way away from that.
While the transparency of executive pay in Germany has improved in the past few years and is even above the international norm, the complexity of the system has also increased. The result is that no one is really the wiser as to how top German executives are paid or indeed what their pension benefits are.
Until the 1990s, things were plain and simple. German executives received a salary and an annual bonus that depended either on corporate earnings or dividends. In 1998, however, the Federal Law for Corporate Control and Transparency (KonTraG) allowed, for the first time, remuneration via the granting of shares in the company. The result was an explosion of executive share options among big listed firms and then later, to ensure a level-playing field, in virtually all of corporate Germany.
In 2009, the government changed the rules on executive compensation by obliging listed companies to stretch that pay over several years and relate it to more sustainable factors. These include corporate social responsibility (CSR) as well as customer and employee satisfaction. Yet, unfortunately, these changes have also led to more complexity. Today, about one-third of the 30 companies traded on Germany’s blue-chip Dax stock index have at least four different executive compensation schemes. Within those schemes, they also use, on average, four different metrics to determine pay. Indeed, the public debates about executive pay are, in part, a reflection of such complexity. We feel that there are too many metrics in a system that is complicated enough and some of them are not sensible either. Neither shareholders nor the managers themselves understand the system, and that is in nobody’s interest.Even well intentioned metrics like customer and employee satisfaction are often nothing more than “window dressing” and actually lead to less variable compensation.
One can’t say it enough: Not all the company’s goals can be reached by trying work out what the executive should earn. Even “old school” corporate managers know that the human being is not inherently evil or can only be motivated by money to do the right thing!
There is also a firmly held belief that the system for executive compensation is fair and sensible when it is based on mathematics. Yet successful leadership and business sense cannot be ascertained by maths alone. Despite this, board directors continue to agree specific goals at the beginning of each year with company managers. What the manager gets at the end of the year depends on the fulfilment of such goals. But even when such goals are met, this may not be in the company’s interest. Why? Because in today’s turbulent and globalised economy, previously agreed goals can become irrelevant within six months. Of course this makes things difficult for board directors, but German law requires them to re-consider executive compensation if the relevant circumstances have changed.
Therefore: We feel that truly “sustainable” executive compensation can be achieved if board directors are willing enough, to again simplify the system. Board directors also must have the courage to adapt to changing circumstances, drop the insistence on a mathematical formula and restrict undeserved pay for executives.
Christian Strenger is a member of the German government’s special Corporate Governance Committee. He is also a former Chief Executive of DWS, the mutual fund arm of Deutsche Bank.
Michael Kramarsch is Managing Partner of HKP Group, a Frankfurt executive compensation firm.