Corporate Governance

L8 – Executive Remuneration

Dr. Dr. Petra Inwinkl

Steuerberaterin und Wirtschaftstreuhänderin

Department of Accounting, Innovation and Strategy,  

Oskar-Morgenstern-Platz 1, 1090 Wien,
Room 04.338
Mobile: +43-664-60277-38125

DR. DR. PETRA INWINKL STB 1

Compulsory reading

Shleifer, A. and Vishny R.(1997), A Survey of Corporate Governance, Journal of

Finance, Vol. LII, No.2, C. Incentive Contracts
Obermann, & Velte. (2018). Determinants and consequences of executive
compensation-related shareholder activism and say-on-pay votes: A literature review
and research agenda. Journal of Accounting Literature, 40, 116-151.
EU Guidance on Executive Remuneration in the financial services sector
http://ec.europa.eu/internal_market/company/directors-remun/index_en.htm
Directive (EU) 2017/828 of the European Parliament and of the Council of 17 May 2017
amending Directive 2007/36/EC as regards the encouragement of long-term
shareholder engagement (Text with EEA relevance)
http://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32017L0828&from=EN

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Executive compensation (remuneration)
Executive remuneration is one of the most important drivers of shareholder activism.

 Executive compensation is usually structured in

 fixed-cash salary,
 incentive-based payments (variable compensation) and
 other compensation, such as severance agreements.
1. Salary is able to reduce dissent because it is associated with lower overall payments.
2. Severance agreements, short-term bonuses, or other incentive-based payments are frequently opposed
by shareholders.
3. Other incentive-based payments class, disagreement is currently focused on equity compensation.
 Equity compensation raises further concerns due to the level of dilution (loss of voting power), which is
linked to the value of the issued stocks or stock options (loss of money).
 Dilution is usually measured as the sum of shares and options requested plus the sum of shares and
options already available in current plans, divided by the total number of outstanding.
Source: Obermann, & Velte. (2018). Determinants and consequences of executive compensation-related shareholder activism and say-on-pay votes: A literature review and research agenda. Journal of Accounting
Literature, 40, 116-151.

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Pay-performance-sensitivity (PPS) ratios
Measurement of executive remuneration
 there are specific pay-performance-sensitivity (PPS) ratios
Overall compensation structure
 PPS is an important issue for investors

PPS proposals are used by shareholders when CEOs are excessively paid or managers use
their power in order to manage discretionary accruals in their favor.
 Low PPS values increase SOP voting dissent, and intense shareholder oversight
 However specific investors (e.g. labor unions), seem to have little ability or ambition to
challenge firms with inefficient compensation contracts.
 They ignore those with higher abnormal CEO compensation.

Source: Obermann, & Velte. (2018). Determinants and consequences of executive compensation-related shareholder activism and say-on-pay votes: A literature review and research agenda. Journal of Accounting
Literature, 40, 116-151.

DR. DR. PETRA INWINKL STB 4

Total compensation
 Total compensation is the most important reason for proxy vote dissent.
 There is ample evidence that high total or excessive compensation attracts negative
voting reactions
 In the USA and the UK , especially when the compensation is abnormally high.
 In Australia, increased dissent is reported in times of higher payments.
 When assessing the annual compensation, shareholders use the granted amount
rather than the payouts.
 Reason: Equity payments have vesting periods, and contingency payments can
be subject to deferrals.

Source: Obermann, & Velte. (2018). Determinants and consequences of executive compensation-related shareholder activism and say-on-pay votes: A literature review and research agenda. Journal of Accounting Literature, 40, 116-
151.

DR. DR. PETRA INWINKL STB 5

CEO compensation
CEO compensation rose 940% from 1978 to 2018,
compared with a 12% rise in pay for the average
American worker during the same period,
according to the Economic Policy Institute.

In 2018, average CEO pay at the 350 biggest U.S.

companies was $17.2 million.
Chief executives at large companies make roughly
$278 for every $1 a typical worker earns´.

DR. DR. PETRA INWINKL STB 6

DR. DR. PETRA INWINKL STB 7
Waxman: I have a basic question for you. Is this fair?

Case of Lehman Brothers in USA

Richard Fuld (Lehman Brothers CEO) remuneration ($)
1993-2008
Compensation 500 000 000

Average annual salary in the USA 2008 ($)

41 335

How many years you would have to work to accumulate wealth earned by Richard Fuld in years 1993 - 2008?
Years
12 096

https://www.youtube.com/watch?v=0GGV3GGHD2Qhttps://www.theguardian.com/business/2008/oct/07/lehmanbrothers.banking

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 Development of reward systems
The idea:

◦ Shleifer, A. and Vishny R.(1997) discuss the agency problem when complete,
contingent contracts are infeasible. Do you remember the agency
theory we were discussing?

◦ Managers possess more information and expertise than shareholders.

◦ Managers typically end up with the residual rights of control, giving them
enormous latitude for self-interested behavior.

◦ In some cases, this results in managers taking highly inefficient actions, which cost
investors far more than the personal benefits to the managers.

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 Incentive contracts - Jensen and Meckling (1976),
Fama (1980)

Proposal:
Incentive component of pay should be substantial.
 In this way, incentive contracts can induce managers to act
 in investors' interests without encouraging blackmail.

Company failures of the past

show that this seems not to
be the appropriate solution

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Development of reward systems
Performance-related pay is a generic term
for reward
Since the 80ies
In recent decades there has been a move
toward performance-related pay schemes
in many organizations.
This has lead to a situation where a
higher portion of the employees pay is
dependent on performance.

This should lead to efficiency savings.

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Key elements of directors’
(executives’) remuneration

1) Base salary and benefits

(car with driver, housing,
healthcare, etc.)
2) Bonus payments
3) Stock options/long-term
options
4) Restricted share plans
(stock grants)
5) Termination payment
6) Pension payments

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Management Board
Bayer Annual Report 2016
Board of Management Compensation (German Commercial Code)

Long-term stock-
Long-term variable cash based cash
Fixed annual Short-term variable compensation based on virtual compensation Aggregate
    compensation   Fringe benefits   cash compensation1   Bayer shares (50% STI)2   (Aspire)3   compensation   Pension service cost4
  2015 2016   2015 2016   2015 2016   2015 2015 2016   2015 2016   2015 2016   2015 2016
No. of
  € thousand € thousand   € thousand € thousand   € thousand € thousand   shares € thousand € thousand   € thousand € thousand   € thousand € thousand   € thousand € thousand
Serving members of the
Board of Management as
of December 31, 2016                                      
Werner Baumann
(Chairman)5   906 1 285   47 47   1 237 2 329   10 377 1 237 –  262 1 983   3 689 5 644   227 764
Liam Condon   – 800   – 44   – 1 106   – – –  – 1 624   – 3 574   – 330
Johannes Dietsch   725 750   44 83   917 978   7 698 917 –  210 1 522   2 813 3 333   220 318
Dr. Hartmut Klusik   – 750   – 140   – 1 053   – – –  – 1 522   – 3 465   – 316
Kemal Malik   725 775   40 35   917 1 050   7 698 917 –  210 1 573   2 809 3 433   222 318
Erica Mann   – 750   – 182   – 798   – – –  – 1 522   – 3 252   – 219
Dieter Weinand   – 800   – 34   – 1 274   – – –  – 1 623   – 3 731   – 240
Former members                                      
Dr. Marijn Dekkers6   1 374 475   40 99   1 995 475   16 739 1 995 –  398 964   5 802 2 013   967 382
Michael König   725 –  36 –  917 –  7 698 917 –  210 –  2 805 –  211 –
Total   4 455 6 385   207 664   5 983 9 063   50 210 5 983 –  1 290 12 333   17 918 28 445   1 847 2 887
1 In line with the change in the compensation system for the members of the Board of Management, the entire amount of the STI is paid out in cash, starting with the STI for 2016. The 50:50 split of the STI into a cash payment and a grant of virtual Bayer shares blocked for three years was last
made for 2015.
2 The long-term variable cash compensation based on virtual Bayer shares was discontinued as of 2016.
3 Fair value at grant date; the figure for 2016 includes the new Aspire 2.0 tranche. For Dr. Marijn Dekkers, 4/12 of the grant amount for Aspire 2.0 is shown.
4 Including company contribution to Bayer-Pensionskasse VVaG, Rheinische Pensionskasse VVaG and to a pension fund outside Germany
5 The increased variable compensation for Werner Baumann in 2015 resulted mainly from his temporary duties as head of Bayer HealthCare in addition to his primary responsibilities as a member of the Board of Management.
6 Dr. Marijn Dekkers additionally received a severance payment of €4,341 thousand. This puts him in the same position as if he had held office until December 31, 2016, and had then retired.

DR. DR. PETRA INWINKL STB 13

 Example of a problematic distribution structure

1) Base pay (salary)

2) Annual incentives
(short term incentives)

3) Long term incentives

"The only thing that's not possible is self-

regulation or the status quo.“ Michel Barnier on
Sep 24, 2012
DR. DR. PETRA INWINKL STB 14
 What is
on EU
level on EU Guidance on executive remuneration
this topic?

2004: COMMISSION RECOMMENDATION 2004/913/EC

fostering an appropriate regime for the remuneration of directors of listed companies

2005: COMMISSION RECOMMENDATION 2005/162/EC

on the role of non-executive or supervisory directors of listed companies and on the
committees of the (supervisory) board

2009: COMMISSION RECOMMENDATION

complementing Recommendations 2004/913/EC and 2005/162/EC with regards to the regime for
the remuneration of directors of listed companies

EU Commission new guidelines for directors’ remunerations issued in 2009. However the
guidelines are non-binding

2009: COMMISSION RECOMMENDATION on remuneration Official discussion

policies in the financial services sector started already close
to 20 years ago

DR. DR. PETRA INWINKL STB 15

EU Guidance on executive remuneration

Recommendations contains four main provisions

Disclosure of company remuneration Prior shareholder approval

policies: of share-based
Clear and comprehensive remuneration schemes:
overview of company should be By way of a separate
provided to shareholders resolution at the annual
general meeting prior to the
adoption
Disclosure of individual directors’
The majority of member states follow
remuneration: the Commission’s Recommendation
Total remuneration & other benefits of regarding the approval of share-based
directors should be disclosed in detail in remuneration schemes by
shareholders at the general meeting.
the annual accounts or in the notes to This requirement is quite often
annual accounts implemented through law.

DR. DR. PETRA INWINKL STB 16

EU Guidance on executive remuneration

shareholders’ vote

vote on the ex post

remuneration policy remuneration reports
Cyprus, the Netherlands, Sweden,
Bulgaria, Hungary, Lithuania, Malta,
Lithuania, Spain, and the United
Romania, and Slovakia
Kingdom

result result
binding vote = approval needed by advisory vote
shareholders Directive (EU) 2017/828 of the European Parliament and of the Council of 17
May 2017 amending Directive 2007/36/EC as regards the encouragement of
long-term shareholder engagement (Text with EEA relevance)

DR. DR. PETRA INWINKL STB 17

EU Guidance on executive remuneration

2009: RECOMMENDATION on remuneration policies in the financial services sector

Based on the following issues:

DR. DR. PETRA INWINKL STB 18

 Executive remuneration

Should a board member receive severance pay also in the case of serious fault?
Set a maximum 2 year limit of fixed component of director remuneration on severance pay
and ban severance pay in case of failure
Should there be a compensation limit in the amount of variable pay?
Require a balance between fixed & variable remuneration to strengthen the link between
performance and pay
Promote a long-term sustainability of companies through a balance between long and short term
performance for directors’ remuneration
How should non-executive board members be renumerated?
Non-executives should not receive share options as a remuneration to avoid conflict of interests

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Executive remuneration

Further aspects of the recommendation

Allow companies to reclaim variable remuneration awarded which proved to be
manifestly misstated (clawback)
Extend certain disclosure requirement to improve shareholder oversight of
remuneration policies
Strengthen the role and operation of the remuneration committee
Ensure that shareholders attend general meetings

DR. DR. PETRA INWINKL STB 20

Banking Directive including remuneration issues

2010: Amendment of the Capital Requirement Directive review of remuneration

policies

Since 2014:
EU's bonus cap is one of the most high-profile rules approved by the 28-
country bloc following public anger over high pay at banks, many of which were
propped up by taxpayers in the wake of the 2008 financial crisis.
The rules limit bankers' bonuses to 100% of annual salary, or twice the annual
salary if shareholders explicitly approve.

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Problem with directors pay disclosure 
It is often difficult to identify the important information in the current directors' remuneration
reports.

The complexity of directors' pay makes it hard to disentangle what executives are actually
earning and to judge whether this is appropriate.

The quality of disclosure is insufficient.

This makes it
• time consuming
• costly to assess remuneration
• costly to assess remuneration to compare between companies
• costly to assess remuneration to compare between companies across borders.

DR. DR. PETRA INWINKL STB 22

Coming back to
SOP proposal effects – shareholder pressure
1. As SOP votes are not always binding
◦ executives could ignore low dissent votes
◦ A overall high level of support for SOP votes encourages
managers to increase their pay packages

Source: Obermann, & Velte. (2018). Determinants and consequences of executive compensation-related shareholder activism and say-on-pay votes: A literature review and
research agenda. Journal of Accounting Literature, 40, 116-151.

DR. DR. PETRA INWINKL STB 23

Conclusion executive compensation
Executive compensation is mostly affected by SOP voting dissent
 

◦ When facing shareholder disagreement

◦ firms reduce the growth of CEO compensation, total remuneration, decrease in
fixed salaries and make cuts in short-term bonus payments.

The reduction of compensation is more pronounced in companies with

 overall poor market
 operational
 or abnormal compensation

Source: Obermann, & Velte. (2018). Determinants and consequences of executive compensation-related shareholder activism and say-on-pay votes: A literature review and
research agenda. Journal of Accounting Literature, 40, 116-151.

DR. DR. PETRA INWINKL STB 24

Your next step after this session
 Repeat the information for this session

 Watch and reflect on Additinal Video Seminar V9 & V10 – Legitimacy & Stewardship Theory

 Solve Mini-Quiz 5

 Prepare for the upcoming Midterm Quiz (16:00 – 17:00, 18.Nov.2021)

 Prepare PPT slides & Discussion questions for Group Assignment – Part B and submit your

work by the deadline (23:59, 27.Nov.2021 & 28.Nov.2021)

DR. DR. PETRA INWINKL STB 25

 Thank you for
your
participation!

Have a good
rest of the day
and all the
very best for
you!

Petra Inwinkl
Bildquelle: https://pixabay.com/service/terms/ (Stand 20.05.2020)

DR. DR. PETRA INWINKL STB 26