Transparency of directors’ pay– a DSW survey

The starting position

In the year 2002 DSW started to analyse the pay of the Dax 30 directors. Before, a serious analysis was impossible due to a lack of information. The majority of the Dax companies only disclosed what was explicitly demanded by German law: the total amount paid to the management board as a whole.

In this respect, improvements have been achieved over the past years. Here, both the public discussion and the German Corporate Governance Code played a major role in improving the German situation. In this code in 2003 the recommendation to individually disclose the managers’ pay was implemented. All stock-listed companies wanting to abstain from transparency were obliged to publish this in the so-called declaration of conformity. In 2004, twelve of the Dax companies did not comply with this recommendation. The remaining 18 companies individually disclosed their managers’ remuneration. For more details see

http://www.dsw-info.de/DSW_s_Remuneration_Survey_2005.576.0.html.

The DSW surveys on directors’ pay showed that an increased transparency not necessarily leads to an increased understandability of the directors’ pay (structure). Against this background we now looked at the remuneration reports with a view to understandability and transparency.

The result gives a warning that the new “Law on disclosure of Management Board Remuneration (VorstOG)” will not necessarily lead to the openness expected from the legislator and the capital market. The law, a reaction of politics to the hesitant implementation of the code recommendation by the companies, is in force since August 2005. From the financial year 2006 on, companies are obliged to individually disclose their directors’ remuneration. However, the new regulation leaves a wide scope for the companies.

With the creation of an opt-out rule the legislator gave companies the possibility to get away from transparency by a resolution of the general meeting: If 75 % of the voting rights present at the general meeting agree upon the opt-out the company can abstain from an individual disclosure. 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 in 2005, 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 share capital.

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. Not to forget that the capital risk for both groups remains the same.

But even shareholders of companies that will not make use of this opt-out possibility do not receive a guarantee for clear and understandable pay reports. Although the law demands for a set of information it does not include a regulation about the way of disclosure. 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 individually inform their shareholders on directors’ pension benefits if those benefits considerably differ from the company’s overall pension schemes.

The issue “transparency of directors’ pay” will therefore remain on the agenda – even beyond 2007.

The survey

DSW looked at the remuneration reports 2004 of the Dax 30 companies with a view to the following questions:

· Where to find the information on directors’ pay?

· How understandable is the pay structure?

· Which pay components are disclosed individually?

· How understandable is the individualised disclosure of the particular pay component?

Additionally we looked at the stock option plans and how they were explained to the shareholders. The results, however, did not find an entry in our overall assessment as not all companies have issued stock option plans.

The results

Where to find the information on directors’ pay?

Almost one third of the Dax companies does not not disclose the information on pay bundled in one report. Instead, shareholders have to search the necessary information at different places in the annual report. This is especially true for the pay structure and the remuneration actually paid. The pay structure often is described in the remuneration report as part of the management report; the effective remuneration, however, can be found in the notes of the annual financial statement. Noticeable is that six of the nine companies acting that way are disclosing in line with the code recommendation, i.e. individually. Those companies are namley Commerzbank, Continental, Deutsche Boerse, Deutsche Lufthansa, E.ON, and Schering.

Ten companies disclose all information on their directors’ pay in the remuneration report as part of the management report. Nine companies followed the code recommendation to include all pay information in the notes to the annual financial statements. BMW and BASF disclose the information both in the management report and in the notes.

How understandable is the pay structure?

The understandability of the pay structure is the weak point of the companies surveyed. None of the reports were convincing in this respect.

A positive example here is Deutsche Lufthansa: The airline informs its shareholders very concrete on the directors’ pay structure: “In addition to a fixed annual salary, emoluments for the Executive Board include variable remuneration that depends on the Group's absolute operating results published in accordance with IFRS in the Annual Report as well as on their year-on-year improvement. The basis for calculation is the result disclosed in the Annual Report. For every Euro 100m of operating profit and result improvement compared with previous year, Executive Board members receive a bonus averaging twelve per cent of their fixed annual salary.“

Unfortunately, the company does not say a word about the structure of the pension payments which lead to a deduction in the assessment.

All in all, only six companies give information on the pension scheme structure, namely Allianz, DaimlerChrysler, Henkel, HypoVereinsbank, MunichRe and ThyssenKrupp. And although RWE is the only Dax company that informs individually on the prospective pension payments the structure of the pension schemes is not described. This might be explained by the company’s history although we think that at least the structure of the pension payments for the current directors should be made available to the shareholders.

Absolutely no information on the pay structure are disclosed by Fresenius Medical Care (FMC). Shareholders are only informed that the whole board received USD 9.2 million. The company at least stoops to explain that USD 4.1 million of this amount has been paid as a fix payment and USD 5.1 million account for variable payment. How this variable payment is assessed? Ask the company. For the shareholders this remains a secret.

Which pay components are disclosed individually?

In 2004, at least 18 of the 30 Dax companies disclosed information on the fix and the variable pay component for each director. Three more companies gave these information for their CEOs (HypoVereinsbank, MAN and VW).

When it comes to individual disclosure of pension payments or the so-called ‘other paments’ the situation is completely different: Only four companies (Deutsche Lufthansa, SAP, Siemens and Schering) inform their shareholders about the other payments of each director. And RWE is the only company that individualises the pension payments.

How understandable is the individualised disclosure of the particular pay component?

An understandable remuneration report requires a clear structure. From DSW’s perspective, this implies at least a tabular form and a comparison to the preceding year. Furthermore, an understandable explanation of the benchmark for the variable pay component is indispensable.

Here, the report of SAP can be highlighted. The company tabulates the fix, the variable as well as the other payments including a comparison to the preceding year (only the overall figures). The benchmark is clearly explained (“The directors’ profit-sharing element depends on the SAP Group’s success in achieving its target for operating income before stock-based compensation expenses and acquisition-related charges and on software revenue growth.”).

Especially intransparent were the reports of FMC, Infineon, DaimlerChrysler, VW, MAN, Continental and Altana. FMC could not reach a single point in this category. Particularly annoying is that the remuneration in 2004 is expressed in USD whereas the 2003 remuneration has been indicated in Euro. This means that even with a look into the preceding annual report a pay comparison is impossible.

Total results

All in all none of the analysed companies could reach the maximum of 20 points in the DSW survey. The best ratings received SAP and RWE. Both companies received a good grading shortly followed by Lufthansa and Siemens which were graded as sufficient. Insufficient were the remuneration reports of FMC and Infineon Technologies. Here, shareholders virtually get no information on structure and amount of their directors’ pay. The few information have to be collected at different places and are hardly understandable. An assessment, if the payments are justified by the operating result of the company therefore is almost impossible.

The results of the DSW survey can be found here: