Executive incentive compensation in Germany

Incentive compensation

What are the prevalent types and structures of incentive compensation? Do they vary by level or type of organisation?

The remuneration of managers or directors usually consists of a fixed remuneration and a variable remuneration. Variable compensation typically includes both short-term incentives (STI) and long-term incentives (LTI).

For stock corporations that are listed in the German stock index (DAX) the breakdown is typically 25 per cent fixed income, 25 per cent short-term incentives, 40 per cent long-term incentives and 10 per cent additional benefits such as a company pension scheme. The higher the total remuneration, the lower is the fixed income in relation to variable remuneration. Executives in the Mid Cap Dax (M-DAX), for example, are typically granted a fixed income that makes up 30 to 35 per cent of the total remuneration.

Usually, the variable remuneration is contractually agreed as a royalty, based on the profits of the company. It is useful to point out the assessment basis (eg, accounting and finance, earnings before interest and taxes).

In case where a director or manager commences his or her position during the year, his or her variable remuneration is typically agreed to be calculated on a pro-rata basis.

Are there limits generally on the amount or structure of incentive compensation? Are there limits that adversely affect the tax treatment of the compensation relative to the employer or the executive?

There are no general legal obligations to limit the amount or structure of incentive compensation. However, paragraphs 1 and 2, section 87 of the AktG state that the supervisory board has to work towards a ‘reasonable’ compensation that also reflects changes in the company’s performance. A violation of the principle of appropriateness may lead to claims of damages against the supervisory board.

Special rules apply for certain financial institutions and insurance companies.

There are no limits that affect the tax treatment.

Is deferral and vesting of incentive awards permissible? Are there limits on the length or type of vesting and deferral provisions?

Deferral and vesting of incentive awards are mainly permissible. The agreement, however, has to contain clauses that differentiate between ‘good’ and ‘bad’ leavers according to the way the executive leaves the company. In case of termination of the employment contract owing to circumstances that contain no breach of obligation (good leaver), the executive is entitled to partial incentive awards. There is no fixed maximum vesting period. However, for pre-formulated employment contracts there has been a ruling on inappropriate discrimination according to paragraph 1, section 307 of the BGB for vesting periods over four years.

Different rules might apply for companies in the insurance and financial sectors.

Are there limitations on the individuals or groups eligible to receive the compensation? Are there aspects of the arrangement that can only be extended to certain groups of employees?

There are no limitations on the group of employees eligible to incentive compensation. Usually, however, directors and executive employees are granted incentive compensation elements in their employment contracts.

Concerns based on paragraph 2, section 87 of the AktG and the regulations of the DCGK are only applicable to members of the executive and supervisory board of stock corporations.

Can it be held that recurrent discretionary incentive compensation has become a mandatory contractual entitlement? Is this rebuttable?

The recurring concession of discretionary incentive compensation may lead to a contractual entitlement to incentive compensation by implied alteration of the employment contract when usually granted three years in a row. The employer can prevent the emergence of entitlement for the future by direct indication to the employee.

Does the type or amount of incentive compensation awarded to an executive potentially affect the compensation that must be awarded to other executives or employees?

Generally speaking, employees assigned to the same tasks have to be paid equally unless there is a particular reason for certain unequal treatments. The legal foundation is the principle of equal treatment. For executives, this principle applies only restrictively.

If the executive is a significant shareholder, this principle is not applicable to his or her advantage.

Even if the principle is applicable, it does not require executives to be awarded the same compensation. This is permissible as long as there are objective reasons for unequal compensation between two or more executives. In addition, agreements that are individually concluded do not fall under the aforementioned principle.

Is it permissible to require repayment of incentive compensation under certain circumstances? Are there circumstances under which such repayment is mandatory?

Repayment of compensation has to be individually agreed on in the contract (clawback-clauses) and is not prevalent in Germany.

These clawback-clauses give, for example, the supervisory board of a stock corporation the ability to cut variable remuneration. In addition, the supervisory board is obliged to reduce the total compensation including incentive awards of directors under the requirements of paragraph 2, section 87 of the AktG.

Furthermore, the current version of the DCGK states under section G11 that, the supervisory board is entitled to retain or reclaim variable compensation, if this element is agreed upon in the respective employment contract.

Can an arrangement provide that payment is conditioned on continuing employment until the payment date? Are there exceptions?

This depends on the kind of incentive. If the incentive is connected to the overall performance of the company (Tantieme), the payment cannot be conditional on continuing employment in the company.

The validity of incentives based on the achievement of certain objectives and pre-formulated in employment contracts is determined by No. 1, paragraph 1, section 307 of the BGB. Thus, the arrangement must not discriminate the employee inappropriately.

In a landmark decision by the Federal Labour Court in 2009, the judges ruled that an arrangement that stating that the payment of the incentive is conditioned on continuing employment until the payment date does not inappropriately discriminate against the affected employee and is therefore valid. However, the arrangement is only valid if the parties agree on objectives for the respective financial year and the arrangement does not include the obligation of the employee to continue working for the company beyond the payment date.

Individually negotiated contracts can state that the payment is conditioned on employment until the payment date.