Compensation of the Board of Management

Objectives

The compensation system for Covestro AG’s Board of Management for the year 2020 remains largely unchanged from the version approved by the Annual General Meeting on May 3, 2016. It is aligned with the corporate strategy and is designed to facilitate a long-term increase in the company’s value and responsible corporate governance. We aim to position Covestro as an attractive employer in the competition for highly qualified executives, and, at the same time, ensure statutory and regulatory compliance. Board of Management compensation is in line with the basic principles of the compensation structure and, as a principle, is structured uniformly for the Board of Management as well as for other executives, including managerial employees, in the Covestro Group.

In December 2020, the Supervisory Board resolved to revise the system approved by the Annual General Meeting in 2016 for compensating Board of Management members effective January 1, 2021. The total target compensation remains essentially the same. The changes primarily entail adding a sustainability target to long-term variable compensation, introducing rules for withholding or recovering variable compensation (penalty or clawback), and defining maximum compensation. These modifications were made pursuant to the provisions of the Act Implementing the Second Shareholders’ Rights Directive (ARUG II) of December 12, 2019, and the GCGC as amended on December 16, 2019. The company pension scheme will be adjusted as well. A detailed explanation of the revised compensation system will be published when the 2021 Annual General Meeting (AGM) is convened. It will be presented to the AGM for approval at that time.

The amount and appropriateness of the compensation of the Board of Management in view of both company and external standards are regularly reviewed by the Supervisory Board and the compensation adjusted, if necessary. The Supervisory Board used the services of an independent, third-party compensation consultant to determine appropriateness. As a rule, adjustments are in line with the increase in the consumer price index in Germany. If the need for a larger adjustment is ascertained, this is discussed in detail by the Human Resources Committee in view of the appropriate background information, and a resolution is proposed to the Supervisory Board as a whole. Covestro’s external peer group comprises the companies listed on the DAX and MDAX (not including banks and insurance companies due to limited comparability). Covestro is compared with these companies to determine, in particular, whether Covestro’s relative position within this group in terms of revenue, employees, and market capitalization is in line with the relative positioning of Board of Management compensation. An internal comparison also takes into account the compensation of senior leadership in Germany, i.e., the employees with management responsibilities at management levels 1 and 2 below the Board of Management, as well as the compensation of all employees in Germany. The Supervisory Board then votes on the proposed adjustment.

Compensation structure

The compensation comprises a non-performance-related component, an annual incentive, and a long-term stock-based component. The Covestro Group’s compensation structure, based on average total annual compensation for a Board of Management member at 100% target attainment, is as follows:

Board of Management compensation structure (German Commercial Code)¹

The non-performance-related compensation comprises the fixed annual compensation, which reflects the responsibilities and performance of the Board of Management members, along with fringe benefits. The performance-related compensation comprises a short-term variable component, which depends on the attainment of the corporate performance targets, and the long-term variable compensation, i.e., the stock-based compensation program Prisma. This is linked directly to changes in Covestro’s share price.

The members of the Board of Management also receive pension entitlements for themselves and their surviving dependents. Furthermore, Covestro AG has purchased liability insurance for the members of the Board of Management to cover their legally required personal liability arising from their service on the Board of Management. The deductible amounts to 10% of the loss up to a maximum of 1.5 times the fixed annual compensation of the respective Board of Management member, and is line with the current requirements of the German Stock Corporation Act (AktG).

Non-performance-related components

Fixed annual compensation

The level of the non-performance-related, fixed annual compensation for members of the Board of Management takes into account the functions and responsibilities assigned to them as well as market conditions. It is paid out in 12 monthly installments.

Fringe benefits

Fringe benefits mainly comprise a vehicle allowance (or company cars limited to the term of existing vehicle leases), use of the company carpool, payments toward the cost of security equipment, and reimbursement of the cost of annual health screening examinations. Due to her family’s place of residence in England and her British citizenship, Sucheta Govil also receives assistance from an external advisor in preparing her tax returns. Fringe benefits are reported at cost or the amount of the pecuniary advantage gained.

Performance-related components

Short-term variable compensation

The target value of the short-term variable compensation is 100% of the fixed annual compensation. This amount is adjusted in line with the company’s performance.

The members of the Board of Management participate in the Group-wide Covestro Profit Sharing Plan (Covestro PSP). It consists of a short-term variable compensation based solely on the company’s business performance. The system is based on the same performance indicators used to manage the company. The payout is based on performance in the areas of growth (core volume growth), liquidity (free operating cash flow, FOCF), and profitability (return on capital employed, ROCE), with each counting for one-third. In the year 2018, the Supervisory Board defined the global values for the threshold, 100% achievement, and the maximum amount for each performance indicator, which are applied for the three-year period from 2019 to 2021. These targets will not be adjusted after the fact. Between these values, linear interpolation is used to determine the payout.

For each individual performance indicator, the payout can be between zero (failure to meet minimum requirements) and three times the target value. However, the maximum payout for all three components combined is limited to 250% of the target value. The maximum payout is therefore 2.5 times the fixed annual compensation.

Components of short-term variable compensation

If a Board of Management member’s term begins or ends in the middle of a fiscal year, their PSP entitlement is prorated based on calendar days. The PSP entitlement for the fiscal year in which a Board of Management member leaves the company is forfeited in the event the member steps down (unless this occurs for good cause for which the member is not responsible) and in cases where the Board of Management member is terminated by the company for good cause.

The Supervisory Board is entitled to reduce the PSP payout to below the calculated amount or resolve to eliminate it entirely to the extent that target attainment falls far short of expectations (e.g., when the Covestro Group’s profitability, measured as ROCE, comes in below the weighted average cost of capital (WACC)), or if an incident occurs at one of Covestro’s plants resulting in death or a large-scale discharge of chemicals that affects the surrounding areas.

Long-term compensation

Prisma

The members of the Board of Management are eligible to participate in the Prisma compensation program as long as they are employed by the Covestro Group and fulfill the share ownership guidelines applicable to them. This program is based on a target opportunity set at 130% of the fixed annual compensation. When a member of the Board of Management retires, current tranches may be shortened, thus reducing their value.

The payout is determined by calculating two factors: The total shareholder return (TSR) factor is the return generated by a stock expressed as a percentage (total of the final price of the share and all dividends distributed per share during the four-year performance period, or tranche, divided by the initial price). The outperformance factor is based on the performance of Covestro stock during the performance period relative to the performance of the STOXX Europe 600 Chemicals index. If Covestro’s stock performance (in %) matches the performance of the index (in %), the outperformance factor is 100%. If the performance of Covestro stock (in %) underperforms the index by 100 percentage points or more, the outperformance factor is 0%. The outperformance factor increases in proportion with the deviation if Covestro’s stock performance falls within ± 100 percentage points of the performance of the index. The same is true if it outperforms the index by more than 100 percentage points.

Relationship between the outperformance factor and Covestro’s stock performance

The Prisma target opportunity of each participant is multiplied by the TSR factor and the outperformance factor to arrive at the total distribution figure. The total distribution is limited to no more than 200% of the target opportunity. The maximum payout is therefore 260% of the fixed annual compensation.

If a Board of Management member’s term begins or ends in the middle of the first year of a performance period, their Prisma claim is prorated based on calendar days in that year. Tranches awarded for previous years remain in effect if members leave the company. Prisma claims for the tranches still in effect when a Board of Management member leaves the company are forfeited in the event the member steps down (unless this occurs for good cause for which the member is not responsible) and in cases where the Board of Management member is terminated by the company for good cause.

Prisma performance periods

Share ownership guidelines

The members of the Board of Management are contractually obligated to acquire Covestro shares equivalent to half of the Prisma target value (65% of the fixed compensation) on their own account within three years of their initial appointment and to hold these shares for the duration of their service on the Board of Management. In the revised compensation system, this obligation was increased to 100% of the fixed annual compensation and is already written into the contracts of Sucheta Govil and Dr. Thomas Toepfer in this amount.

Pension entitlements (retirement and surviving dependents’ pensions)

The members of the Board of Management are entitled to receive a lifelong company pension after leaving the Covestro Group, though generally not before the age of 62. These pension payments will be made monthly. The arrangements for surviving dependents basically provide for a widow’s/widower’s pension amounting to 60% of the member’s pension entitlement, and an orphan’s pension amounting to 12% of the member’s pension entitlement for each child.

The annual pension entitlement is based on defined contributions. From September 1, 2015, onward, Covestro has provided a hypothetical benefit amounting to 33% of the respective fixed compensation beyond the relevant income threshold in the statutory pension plan. This percentage comprises a 6% basic contribution and a matching contribution of up to 27% – three times the member’s maximum personal contribution of 9%. The total annual contribution is converted into a pension module according to the annuity table for the applicable tariff of the Rheinische Pensionskasse VVaG pension fund. The annual pension entitlement upon retirement is the total amount of the accumulated pension modules, including an investment bonus.

For their fixed compensation up to the statutory contribution ceiling, the members of the Board of Management, like all entitled employees, remain subject to the rules governing the basic company pension and are regular members in the respective pension plan.

Dr. Klaus Schäfer has additionally been granted a vested entitlement to a fixed annual pension of €126,750.

The actual pension entitlement cannot be precisely determined in advance. It depends on the development of the member’s compensation, the number of years of service on the Board of Management, and the return on the assets contributed to the Rheinische Pensionskasse VVaG. Certain assets are administered under a contractual trust agreement (CTA), providing additional insolvency protection for pension entitlements resulting from direct commitments for the members of the Board of Management in Germany. As a rule, future pension payments are adjusted by at least 1% per year. Depending on the pension obligation, an additional adjustment may be made if the investment bonus of the Rheinische Pensionskasse VVaG or the consumer price index exceeds 1% per year.

Cap on compensation

The individual performance-related components are capped at the grant date. To comply with the recommendation of the GCGC, a cap has also been agreed for the compensation as a whole. In 2018, the Supervisory Board resolved to include company pension expenditures above and beyond the components already taken into account (fixed annual compensation and variable components) in calculating total target compensation, i.e., the total of the individual components in the case of 100% target attainment of the variable components.

The cap was set at 1.9 times the respective target compensation. This value was chosen to ensure that compensation will not have to be reduced even if both short-term and long-term compensation reach the maximum possible cap. In the event of such a scenario, it can therefore be expected that the total compensation accrued will not exceed the permitted cap, even when fringe benefits are added, the amount of which cannot be precisely determined in advance. A sample calculation is presented below using the compensation of the Chair of the Board of Management serving as of December 31, 2020.

Benefits upon termination of service on the Board of Management

Post-contractual noncompete agreements

Post-contractual noncompete agreements exist with the members of the Board of Management, providing for compensatory payments to be made by the company for the duration of these agreements (maximum of two years). The compensatory payment amounts to 100% of the average fixed compensation in the 12 months preceding termination of service.

Change of control

Agreements exist with the members of the Board of Management providing for severance payments to be made in certain circumstances in the event of a change in control. The amount of the severance payments, including any ancillary benefits in the case of early termination of service on the Board of Management as a result of a change in control amounts to 2.5 times the contractual fixed annual compensation and is limited to the compensation payable for the remaining term of the service contract.

Early termination of service on the Board of Management

The amount of the payments, including any ancillary benefits, made upon early termination of service on the Board of Management is limited to the value of two years’ compensation in line with the recommendation in the GCGC.

Unfitness for work

In the event of temporary unfitness for work, members of the Board of Management continue to receive the contractually agreed compensation. Covestro AG may terminate the service contract early if the member has been continuously unfit for work for at least 18 months and is likely to be permanently incapable of fully performing his or her duties (permanent incapacity to work). A disability pension is paid in the event of contract termination before the age of 60 due to permanent incapacity to work. The amount of this disability pension corresponds to the entitlement accrued on the date of contract termination, plus, where applicable, a fictitious period of service from that date to the member’s 55th birthday where applicable.

Compensation of the Board of Management for the fiscal year

The following section reports the compensation of the Board of Management of Covestro AG for fiscal 2020. The members of the Board of Management of Covestro AG are the same as the members of the Board of Management of Covestro Deutschland AG, which became a subsidiary of Covestro AG on September 1, 2015. Compensation is not paid for the members’ work on the Board of Management of Covestro Deutschland AG.

In the 2020 reporting period, the aggregate compensation for the members of the Board of Management of Covestro AG amounted to €6,947 thousand (previous year: €6,274 thousand). This amount comprised €3,285 thousand (previous year: €3,001 thousand) in non-performance-related components and €3,662 thousand (previous year: €3,273 thousand) in performance-related components.

The following table shows the total compensation of the individual members of the Board of Management who served in the years 2020 and/or 2019 according to the HGB.

Fixed annual compensation

The fixed compensation of Board of Management members was increased as of January 1, 2020, based on the change in the previous year’s consumer price index (1.53% from November 2018 to October 2019). The Board of Management members took a pay cut totaling 15% of their fixed compensation from June to November 2020 as part of a Group-wide show of solidarity during the coronavirus pandemic. However, because the economic situation in the second half of fiscal 2020 proved to be more positive than could be expected during the year, employees worldwide received a one-time gross payment to compensate for their participation in the solidarity initiative. Based on a clause in the waiver signed by the Board of Management, members were reimbursed in December 2020 for the compensation withheld.

The fixed compensation of all members of the Board of Management in the 2020 reporting period totaled €3,168 thousand (previous year: €2,771 thousand).

Short-term variable compensation

In the year 2020, the short-term variable compensation for all Board of Management members totaled €313 thousand (previous year: €549 thousand) after deduction of the solidarity contribution which is explained below. This was based on a payout of 10.8% of the respective target value whose calculation is presented in the table below. The solidarity contribution is made by all employees of the companies covered by the respective agreements with the employee representatives to help safeguard jobs at the German sites. For the 2020 reporting period, the contribution amounted to 8.44% of each employee’s Covestro PSP award. By resolution of the Supervisory Board, this contribution is also withheld from the Board of Management.

Long-term compensation (Prisma)

The total compensation according to the HGB includes long-term stock-based compensation (Prisma) with a fair value when granted of €3,349 thousand (previous year: €2,724 thousand).

As of December 31, 2020, provisions of €4,585 thousand (previous year: €10,570 thousand) had been accrued for long-term compensation payable to members of the Board of Management; former members of the Board of Management accounted for €1,015 thousand (previous year: €6,027 thousand) of this figure.

Shareholdings

The following table lists the number of Covestro shares held by currently serving Board of Management members as of the reporting date.

Pension obligations

The pension service cost recognized for the members of the Board of Management in the reporting year was €1,208 thousand (previous year: €956 thousand) according to the HGB, while the current service cost for pension entitlements recognized according to IFRSs was €1,443 thousand (previous year: €1,351 thousand). Pension obligations are shown in the following table.

The pension service cost differs on account of the different principles applied in measuring the settlement value of pension obligations in accordance with the HGB and the present value of defined benefit pension obligations in accordance with IFRSs.

Disclosures pursuant to the recommendations of the German Corporate Governance Code

The amended GCGC no longer provides recommendations on reporting Board of Management compensation using the sample tables included in the version dated February 7, 2017. However, for purposes of improved comparability, the following tables continue to show the compensation and fringe benefits paid for the reporting period (2020) or the prior-year period, including the minimum and maximum achievable variable compensation, and the allocation of compensation for the reporting period or the prior-year period.

The first tranche of the Prisma long-term compensation program ended at the close of the year 2019. The awards are based on the opening and closing prices of Covestro stock and the STOXX Europe 600 Chemicals index, calculated in each case as the average of the relevant closing prices during the months of November and December in the years 2015 and 2019. For the 2016–2019 tranche, the overall payout factor was 179.1%. The target opportunity for each Board of Management member is determined individually. These figures and the calculation of the distribution amounts and of the factors relevant for the payout (TSR factor and outperformance factor) are presented below as a sample calculation based on the long-term compensation for the current Chair of the Board of Management. The dividend payments for individual years are provided on Covestro’s website.

Sample calculation of the 2016–2019 Prisma tranche based on the compensation of the Chair of the Board of Management¹

In the 2020 reporting period, former Board of Management members Frank H. Lutz and Patrick W. Thomas received €2,111 thousand and €3,260 thousand respectively for the 2016–2019 tranche of the Prisma long-term compensation program. Neither former Board of Management member received any payments from the 2015–2018 Aspire tranche in 2019.