Executive Compensation under German Corporate Law: Reasonableness, Managerial Incentives and Sustainability in Order to Enhance Optimal Contracting and to Limit Managerial Power

Abstract

In the aftermath of the Mannesmann case the German corporate law of executive compensation has been increasingly relying on incentive-based payments until the recent financial crisis. By including benchmarks for reasonable compensation in § 87 para. 1 of the Stock Corporation Act (AktG) as amended by the Law on the Appropriateness of Director Compensation in 2009, the German legislator further specified the crucial parameters for executive compensation, thus aligning the compensation agreement with market forces. In addition, a sustainable development of the company’s business is provided for as a guideline for the structure of the compensation system, which is supposed to eliminate adverse incentive effects. However, it is shown that its implementation raises quite a few questions that are far from being resolved yet. That leaves some room for a quite wide discretion of the supervisory board in its decision in compensation matters. Its ensuing responsibility is complemented by the advisory vote of the shareholder meeting on the compensation system under § 120 para. 4 AktG. Upon a closer analysis the pertinent provision shows distrust on the part of the German legislator towards managerial power. Therefore, overall the dilemma whether to rely on optimal contracting as a governance mechanism or to primarily restrain managerial power has not been resolved yet in the German Law on the Appropriateness of Director Compensation of 2009.