Ahead of today’s Volkswagen AGM, Dr Hans-Christoph Hirt, Co-Head of Hermes EOS, comments on concerns over corporate governance and its voting recommendations on key agenda items:
Voting at the AGM
In light of longstanding concerns about Volkswagen’s corporate governance and the company’s emissions scandal, Hermes EOS recommended its clients and – through a counterproposal initiated by Hermes EOS – formally requested other investors to vote against the discharge of the management and the supervisory board at today’s AGM. In addition, Hermes EOS has initiated a request for a special audit to investigate the acts and potential breaches of duty by the two boards and supported the extension of the agenda proposed on behalf of a group of shareholders by Deminor with a similar request. Hermes EOS also recommended its clients to vote against the election of the candidates proposed for election or re-election to the supervisory board, but support the only independent non-executive director among its members.
Background and principal concerns
Our initiative around the AGM follows a decade of engagement with Volkswagen by Hermes EOS, including interventions at its AGMs in 2006 and 2007 and the EGM in 2009, and a public letter to the chairman of the supervisory board ahead of the AGM in 2012. In our engagement we have focused on the underlying corporate governance issues at Volkswagen, not least the influence of its principal shareholders and the composition and effectiveness of the supervisory board.
The company’s continuous disregard of fundamental corporate governance principles may have contributed to the emissions scandal. It has undoubtedly tarnished the reputation of the German two-tier board system and employee representation among foreign institutional investors, resulting in collateral damage to the German economy.
At the AGM, Hermes EOS on behalf of its clients will formally make its proposals to other investors and outline the following corporate governance concerns.
1. Serious concerns about supervisory board composition and effectiveness
We have raised concerns about the composition of Volkswagen’s supervisory board and its effectiveness for more than a decade. In our view, its composition has become more problematic since we started our dialogue with the company. The supervisory board oversees and, is ultimately responsible for, Volkswagen’s corporate governance and culture in which the emissions scandal was able to unfold and remain undetected for many years. The board is, in our view, short of people with the relevant experience and skills and – significantly – independence from the key shareholders, which would enable it to function as an effective control and advisory body. Given the size and global presence of Volkswagen, we do not believe its current supervisory board can adequately protect the interests of all stakeholders, including those of investors. We believe the questionable composition of the supervisory board may have contributed to the apparent deficiencies in its monitoring of the management board in relation to the emissions scandal, its fundamental duty pursuant to section 111 I of the German Stock Corporation Act.
In this context, the proposal to elect Mr Pötsch, who, as CFO from 2003 until 2015, has played a key role among the most senior Volkswagen executives for over a decade, to the supervisory board is highly concerning. The suggested move of Mr Pötsch not only goes against best corporate governance practice in Germany but gives rise to serious conflicts of interest. We are struggling to understand how Mr Pötsch will be able to discharge his duties as a member of the supervisory board, which will for the foreseeable future include dealing with the causes and aftermath of the emissions scandal, in particular determining whether Volkswagen has a claim for damages against its (former) executives and deciding whether to pursue this claim.
Volkswagen needs an overhaul of its corporate governance, including the composition and effectiveness of its supervisory board. As a first step, we urge the company to undertake an externally-facilitated supervisory board evaluation as soon as possible after the AGM. This should include a systematic analysis of the experience, skills, as well as the independence of the supervisory board members relative to the company’s requirements. The high level results of the board evaluation should be published and a plan to refresh and strengthen the supervisory board be presented. We believe that in addition to having the relevant experience and skills, at least half of the members of the shareholder-elected representatives should be genuinely independent.
2. Inappropriate management board remuneration
We have long had concerns about Volkswagen’s remuneration system and voted against it at the company’s AGM in 2010. The plan lacks transparent, meaningful and challenging performance criteria and a sufficient long-term orientation aligned with the time it takes to devise and implement a strategy in the automotive sector. As such, it fails to adequately align the interests of the management board with those of long-term shareholders interested in sustainable value creation. Following the CEO’s annual remuneration of almost €20 million under the system for 2011, in a public letter to the chair we again pointed out its shortcomings ahead of the AGM in 2012. Volkswagen’s remuneration policy and practice needs a radical overhaul.
The manipulation of diesel-fuelled vehicles led to a loss in excess of €4 billion in the fiscal year 2015. The management board was paid more than €63 million during that period, of which around €35 million was performance-related. In our opinion, the payment of the majority of the performance-related component of the management board’s remuneration for the fiscal year 2015 violates section 87 of the German Stock Corporation Act. The agreed retention of 30% of the performance-related component for active management board members does not reflect the loss in value incurred by investors during the fiscal year 2015 and the long-term damage to Volkswagen. In our view merely retaining 30% of the performance-related pay – with the option to get paid out the full and even double the amount in case of a favourable share price development – constitutes an inappropriate reward for failure.
Furthermore, there are considerable doubts about the appropriateness and lawfulness of the remuneration of the former chair of the management board, Professor Dr Winterkorn, in the fiscal year 2015. He received more than €7 million, of which €5.9 million was performance-related. The supervisory board agreed with Mr Winterkorn to merely defer 30% of his variable remuneration.
We will continue our engagement with Volkswagen at, and after, the AGM, as we believe a radical overhaul of corporate governance and culture is required before the company can sustainably create value for investors and other key stakeholders.
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