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Inflated Salaries Merkel Joins Battle against Executive Pay

Both the European Union and Switzerland have drawn a line in the sand recently when it comes to excessive compensation packages. Now, Berlin too wants to cap salaries. For Chancellor Merkel, the move marks a U-turn, but with growing public discontent, she had little choice. By SPIEGEL Staff

There are many faces of injustice. A member of Volkswagen's executive board recently said that he thought it was unfair that he earned €6 million ($7.8 million) last year. Only €6 million.

In 2011, he and his colleagues had earned between €7.2 and 8.1 million. Yet in 2012, Europe's largest carmaker did even better, with record-high revenues, sales and profits. According to their contracts, the board members should also have seen their earnings increase. Instead, their pay was cut by about 20 percent.

The supervisory board of the Wolfsburg-based company wanted to set an example. The salary of VW Chief Executive Martin Winterkorn was reduced  to €14.5 million, and the salaries of the remaining top executives fell as well. Several of them were unable to understand why. After all, they argued, it was only the salary of their boss, which would have increased to €20 million without the cuts, that had trigged the current debate over executive pay.

It's not that he needs or desperately wants the money, says the executive whose salary was reduced to €6 million, but that he initially perceived the cut as an affront. In the mean time, he says, he has come to understand that there is more at stake when it comes to executive pay, namely the social acceptance of managers and the company. He now feels that the salary cut is "completely okay."

VW CEO Winterkorn and his fellow executives believed the matter to have been settled. At the Geneva Motor Show early last week, they expected to be talking about a new one-liter car (a car that gets 235 miles to the gallon). Instead, they were constantly asked about their salaries.

It is a hot topic throughout Europe these days. Earlier this month, the European Union moved to cap banker bonuses  at twice their base salary  as of 2014. In Switzerland, a referendum "against rip-off salaries" received a two-thirds majority, making company shareholders, as opposed to the supervisory board, responsible for determining executive pay. And in Berlin even Rainer Brüderle, the parliamentary floor leader for the pro-business Free Democratic Party (FDP), portrayed himself as an opponent of excessive executive compensation. The Swiss solution, said Brüderle, was "pure FDP."

Merkel Speaks Out

The issue promises to be an important one this election year. All of Germany's major parties have recently felt compelled to comment on the issue, with the center-left Social Democrats (SPD) planning to include the demand for an "established maximum relationship between base salary and bonuses" in its campaign platform.

On Tuesday, Chancellor Angela Merkel's Christian Democrats (CDU) followed suit. Completing yet another policy U-turn, senior CDU parliamentarian Michael Grosse-Brömer announced that the conservatives would introduce a law before the summer recess to regulate manager salaries.

In an interview with the newspaper Freie Presse, published on Wednesday, Merkel likewise entered the fray. "Exorbitance cannot be allowed in a free and socially minded society," she said, adding that she understands "when people shake their heads over salaries that tip the scale and want them to stop."

The amounts at issue in the current salary debate are indeed exorbitant. Deutsche Bank, for example, granted its star trader Christian Bittar a bonus of €80 million for 2008 alone. Bittar was not even a member of the executive board, and he is now under suspicion of having played a role in the manipulation of the benchmark LIBOR interest rate. Swiss pharmaceutical company Novartis planned to pay its departing chairman Daniel Vasella €59 million to prevent him from working for rivals in the next six years. And the deferred compensation Daimler is guaranteeing its not particularly successful CEO, Dieter Zetsche, is worth about €40 million. In return, Zetsche doesn't have to work until he's 67; in fact, he can retire at 60 instead.

The market economy thrives on a certain amount of societal inequality. The chance to earn more money and accumulate more wealth animates people to improve their performance. But there is also an invisible limit, and when it is exceeded, the gap between those at the top and those at the bottom becomes big enough to jeopardize social harmony.

Unions Complicit

The poverty and wealth report released by the German government last week suggests that this gap has reached disconcerting proportions in Germany. Many can no longer support themselves with the money they earn in a full-time job. Almost one in four workers earn less than €9.15 an hour, which translates to about €19,000 a year. This is less than one-seven hundredth of what the CEO of VW makes.

It isn't just the scope of inequity that is so disconcerting, but also the fact that this development is only becoming more exacerbated. Average employee wages have increased by 6.1 percent since 2000, while the salaries of senior executives at companies traded on Germany's DAX stock exchange index have risen by almost 55 percent during that time period.

FDP politician Brüderle is utilizing the debate to question the system of German participative management. In publicly traded corporations, the supervisory board decides on the salaries of executive board members. Supervisory boards are divided equally between representatives of labor and capital. "Union leaders have been complicit," Brüderle says, "and now they are complaining about excesses."

Jörg Hofmann is one of the people Brüderle is referring to. He is a district manager for the metalworkers' union IG Metall in the southwestern state of Baden-Württemberg and a member of the Daimler supervisory board. Hofmann says that a few things have been changed, especially in response to pressure from employees at Daimler and other DAX-listed companies.

The changes were urgently needed, particularly in the case of Daimler. The Stuttgart-based company is well known for executive excess, a situation which only worsened as globalization fundamentally changed the German economy.

As recently as 1987, the average executive board member at a DAX-listed company earned the equivalent of €446,000 a year. But after the fall of the Berlin Wall and the Iron Curtain, German managers increasingly emulated their role models in the United States. American-style capitalism, driven by financial performance and shareholder value, increasingly took hold in Germany.

Unsustainable System

In 1998, Daimler acquired US automaker Chrysler -- and the American pay structure along with it. Critics said derisively that it was the primary motivation for the merger. Daimler's then chairman, Jürgen Schrempp, became Germany's top-paid manager, earning more than €7 million in 2002.

The Daimler-Chrysler merger proved to be one of the biggest flops in German economic history, and Schrempp was forced out in 2005. At the time of his involuntary departure, he owned stock options worth an estimated €50 million.

The unions went along with everything. There was an unwritten rule that shareholder representatives determined executive salaries and employee representatives rubber-stamped their decisions. In return, the unions could expect the capital side to accommodate their plans.

Union official Hofmann, not surprisingly, disagrees with this interpretation. He blames salary excesses on the "limits of co-determination." In other words, if there is a draw in a vote between representatives of capital and labor, the chairman of the supervisory board can exercise his right to a double vote.

In 2004, unions realized that this system was unsustainable. As co-defendant in the Mannesmann trial, former IG Metall Chairman Klaus Zwickel was accused of not having opposed €30 million in bonuses and financial settlements for Klaus Esser, who, at the time, was CEO of the former industrial conglomerate. It was a bitter defeat for the unions. How could they credibly represent the interests of ordinary employees if they didn't rebel against so many millions in executive compensation?

After the Mannesmann trial, union leaders became more critical of excessive executive pay. In addition, a law enacted in 2009 had a moderating effect. In many DAX-listed companies, the rules were changed so that a higher share of senior executives' salaries, often 70 percent, was based on company performance. When companies did poorly, as Daimler did in 2008, executive pay dropped. Schrempp's successor Zetsche saw his salary drop from €10 million to €5 million at the time.

Today, bonuses are usually dependent on several years' worth of performance. In addition, a cap was imposed on so-called golden handshakes, the severance packages top executives collect when they are released prematurely from their contracts.

The Trend toward Control

By now, representatives of capital also accept that executive compensation is no longer strictly an internal company issue. Business needs social and political acceptance, as former Deutsche Bank CEO Josef Ackermann once said. This acceptance is lost, he added, "when there is a feeling within the public that a few people are filling their pockets to the detriment of the community."

A number of changes have taken place, but it still isn't enough. Otherwise Deutsche Bank wouldn't be paying €3.2 billion in bonuses to its executives for last year, when its net profit was a relatively low €665 million. And otherwise corporations wouldn't pay signing bonuses for executives headhunted away from competitors, along with a "joining bonus" for showing up on the agreed date -- to be followed by a "retention payment" for managers who actually stay for the duration of their contracts instead of switching back to a competitor. "It simply isn't acceptable, having to pay managers so that they'll step out of the shower in the morning," says business professor Margit Osterloh of Britain's Warwick Business School.

Switzerland plans to introduce an alternative to the German system, in which the supervisory board sets executive compensation. It would seem to be a tempting model, in which those who own a company, its shareholders, will have the final say on management pay.

This could lead to lower salaries, as initial experiences in Great Britain have shown. Last year, for example, investors refused to pay the unsuccessful CEO of pharmaceutical company Astra-Zeneca his lavish salary plus bonus. He was forced out of the company, as was the CEO of the insurance company Aviva, whose salary was set to increase despite a 47 percent decline in profits.

But the model has its pitfalls. "Shareholders have no sense of loyalty," says Professor Osterloh. Shareholders want to maximize their dividends. Some are merely interested in short-term gains in the stock price, so that they can sell their shares at a profit. Many hedge funds, which often own significant stakes in publicly traded companies, couldn't care less whether an executive earns one, 10 or 20 million euros. And if a manager promises shareholders a quick profit of several hundred million, they'll approve virtually any salary.

What Is Suitable?

"The Swiss referendum has symbolic value, but the model is nonsense," says Osterloh. She advocates a fixed salary plus profit sharing for all employees.

The EU is bringing another alternative to the German model into play: an attempt to limit bonuses without specifying a fixed value. The EU wants to see bonuses for top bankers capped at twice their base salaries. Deutsche Bank employees already know how their bank is likely to react to the measure. "Then they'll simply raise base salaries," says a bank executive in Frankfurt.

Neither the Swiss model (shareholders decide) nor the Brussels plans (bonuses are capped) can solve the problem. It's time for the government to step in. Current laws only broadly stipulate the "suitability of executive compensation." Instead, lawmakers should define what exactly is suitable.

The Confederation of German Trade Unions (DGB) wants the maximum total compensation of executive board members to be pegged to average employee income within the company. Using company- and industry-specific developments as a benchmark, individual supervisory board members would determine what this factor should be. If necessary, laws would have to be enacted requiring companies to establish such executive compensation systems.

The fact that the DGB itself doesn't want to set a maximum factor stems from the lack of unity among its representatives. Last year, for example, IG Metall Chairman Berthold Huber defended the €17.5 million salary of VW CEO Winterkorn, saying that he believed Winterkorn's compensation agreement was "okay." Other union officials felt that the CEO's pay was exorbitant. "No one can tell me that the work performed by the company's CEO is worth 300 times as much as that of other employees," says DGB Chairman Michael Sommer. But even despite the differences of opinion among union leaders, they do now agree that an annual salary of €10 million should be the upper limit.

'Socially Intolerable'

Shareholder representatives are also opposed to fixed limits, although they too see the pain threshold at roughly where the unions have identified it. The Deutsche Schutzvereinigung für Wertpapierbesitz, an association of private investors, says: "Pay in excess of €10 million becomes socially intolerable."

A cap on salaries would not weaken German industry. There would be no exodus of capable managers to other countries. Unlike the failed former Siemens CEO Klaus Kleinfeld, few executives have gone to the United States, even though they stand to earn several times more there, especially in the automotive industry.

"Money isn't everything," says BMW CEO Norbert Reithofer. The carmaker has no trouble attracting high-quality executives, even though it pays them less than other DAX-listed companies. Reithofer is against a statutory cap on executive pay. We don't need even more government intervention in the economy, he says. "When it wants control, the supervisory board has it."

In the case of BMW, the Quandt family, which holds just under 50 percent of common stock, and Works Council Chairman Manfred Schoch have ensured that salaries and pension commitments remain within reason. No matter how high profits go, Reithofer's income cannot increase to €10 million.

BMW has imposed its own salary limits, which shows that government intervention is unnecessary for some companies. But it also proves that setting such limits would not have harmful effects. After Volkswagen, BMW is the world's most successful automaker. "There are some companies I wouldn't switch to even if they offered me €20 million," says Reithofer.

BY DIETMAR HAWRANEK, HORAND KNAUP, MICHAELA SCHIESSL, CORNELIA SCHMERGAL and JANKO TIETZ

Translated from the German by Christopher Sultan
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