ESG: Environmental – Social – Governance

Sustainability Goals in Board and Remuneration Systems

Since 1 January 2020, listed companies have been obliged to gear their remuneration structure towards the company’s “sustainable and long-term” development. The legal basis for this is the restated section 87(1), sentence 2 German Stock Corporation Act based on the Act Implementing the Second Shareholders’ Rights Directive (“ARUG II”).

Whereas according to the prevailing view, section 87(1), sentence 2 German Stock Corporation Act, old version, was fulfilled if the remuneration structure was aligned with a longer-term economic interest, according to the legal committee’s reasoning, the terms "sustainable" and “long-term” are intended to clarify that the supervisory board must also “take into account” social and ecological aspects when determining the remuneration.

The German Corporate Governance Code (“GCGC”) also requires that the remuneration structure of listed companies be geared towards the sustainable and long-term development of the company. Accordingly, listed companies are required to take appropriate account of the concept of sustainability by selecting certain financial and non-financial criteria for assessing the remuneration. Company-specific solutions must be developed for this. We provide comprehensive advice to supervisory boards on the design of remuneration systems, including in particular on the implementation of the concept of sustainability.

An obvious solution that is widely used in practice is the integration of ESG targets into variable remuneration. According to the ESG concept, companies can choose from the areas of environmental (e.g. climate, resource consumption or biodiversity conservation), social (customer and employee satisfaction, diversity or health and safety at work) and governance (e.g. compliance). Depending on the industry and business model, it might make sense to focus on and incentivise just one target or to set several targets from different areas. We assist supervisory boards in selecting customary and measurable targets, the fulfilment of which has a material impact on the success of the company and thus provides a meaningful incentive for the members of the management board. In so doing, we take a look at which performance criteria and measurement systems from sustainability reporting – which has already been carried out – can be utilised.

As a next step, we advise on the specific configuration of the selected ESG targets. In particular, we always keep an eye on the current recommendations of institutional investors and proxy advisors. For example, in addition to selecting ESG targets, supervisory boards must decide:

  • what the ratio of sustainability criteria to financial criteria should be;
  • whether the sustainability targets should be integrated into the short-term (“STI”) or long-term variable remuneration (“LTI”);
  • whether ESG targets will be agreed as an additive performance indicator alongside the financial performance indicators or as part of a discretionary factor.

We then advise on how to present the targets in the management board remuneration system and the remuneration report in a way that is clear and understandable, and in compliance with the German Stock Corporation Act.