Compensation Report 2010

Compensation Report 2010

Principles of the Management Compensation Report

The management compensation report explains the principles applied when establishing the compensation to be awarded to members of the Board of Management and Supervisory Board of MTU Aero Engines Holding AG, and states the amount and composition of that compensation. The management compensation report follows the provisions of Article 314(1), no. 6 of the German Commercial Code (HGB), German Accounting Standard DRS 17 of December 13, 2010, the draft German Accounting Standard E-DRS 22 ‘Reporting on the compensation paid to board members’, and the recommendations of the German Corporate Governance Code. In so doing, the report also takes account of the requirements of the International Financial Reporting Standards (IFRSs) regarding key management personnel compensation (as formulated in IAS 24 ‘Related Party Transactions’).

At the proposal of its chair, the Supervisory Board decides on a system of compensation for the members of the Board of Management, including the main components of their contracts, and reviews this system at regular intervals. The Act on the Appropriateness of Management Board Compensation (VorstAG) of August 5, 2009, introduced various new legal and regulatory requirements. These were cause in 2009 and 2010 for the Supervisory Board to review and adapt the company’s compensation structure again, with a view to aligning it more closely with what the legislators of the VorstAG intended. In the process, the Supervisory Board took the aspects below into account. An independent external compensation specialist was consulted when designing the new compensation system.

The revised system focuses on linking Board of Management compensation to a style of corporate management and development that has a sustainable and long-term orientation. This entails an appropriate mix of fixed and variable compensation components. In addition, and to a greater extent than before, the payment of variable compensation is now based on multi-year assessment periods and is, in large part, deferred for one or more years. It is even possible to subsequently cancel deferred variable compensation components altogether. The intention of these changes is to align the interests of the members of the Board of Management more closely with those of the company by increasing their participation in the company in the long-term.

In 2010, the members of the Board of Management were awarded total compensation of € 8,671,911 (2009: € 7,781,882) for their service during the financial year.

This total amount comprises the following components: see table Annual Report 2010 on page 26.

The members of the Board of Management received no compensation for their activities on the boards of group companies, nor were they granted any loans by the company.

Principles of the compensation system for members of the Board of Management

At the proposal of its chair, the Supervisory Board determines both the overall level of compensation (so-called target direct compensation) and its composition for the members of the Board of Management. 40 % of the target direct compensation is non-performance-related, while 60 % is Performance related. Around half of the performance-related components are linked to development of the share price of MTU Aero Engines Holding AG.

The target direct compensation comprises the following components:

NON-PERFORMANCE-RELATED COMPONENTS
The non-performance-related components consist of the basic salary and other benefits that are regularly reviewed and paid on a monthly basis. ‘Other benefits’ comprise taxable reimbursements of expenses and the non-cash benefit deriving from payments in kind such as the use of a company car for business and private purposes, and insurance premiums, including any taxes on such benefits paid by the company.

PERFORMANCE-RELATED COMPONENTS
Performance-related components comprise an Annual Performance Bonus (APB), a Long-Term Incentive Performance Share Plan (PSP) and a Matching Stock Program (MSP), any or all of which may be deferred in full or in part. After the PSP assessment period, the members of the Board of Management may, under the Share Matching Plan (SMP), opt to have their payment from the Performance Share Plan (PSP) converted into shares in the company.

PERFORMANCE-RELATED COMPONENTS WITHOUT LONG-TERM INCENTIVE EFFECT
Rules valid until December 31, 2009
Until December 31, 2009, the Board of Management’s performance-related compensation consisted of a variable bonus that depended on the achievement of certain business goals and was contractually limited to an amount corresponding to between 83 % and 100 % of the fixed compensation.

Rules valid from January 1, 2010

Part of the APB is granted as a short-term compensation component. The legal requirement that this compensation component be assessed over several years is met by withholding half of the bonus amount achieved. Of the amount withheld, one half is intended for payment in each of the following two years; the actual amount paid, however, is based on the goal achievement level in each of these years. Thus, the value of the portions withheld depends on the company’s performance in the following years, the risk/opportunity being that these amounts may not be paid out at all or may increase in value.

The amount of the short-term compensation component depends on the results achieved in respect of two company performance targets and on the board member’s individual performance. The company performance targets are based on the key performance indicators at group level ‘EBIT adjusted’ and ‘free cash flow’, which are given equal weighting. The results to be achieved to ensure payment of 100 % of the APB are set annually in advance by the Supervisory Board, taking the annual planning figures into account. In addition, an entry threshold is set for each performance target at a figure 30 % below the planned value; this corresponds to a goal achievement level of 50 %. Members of the Board of Management who do not reach this entry threshold are not entitled to a short-term compensation component. Similarly, the maximum goal achievement level of 180 % is fixed at a figure 15 % above the planned value for each of the two performance targets. Between the entry threshold, the 100 % level and the maximum value, the degree of goal achievement is interpolated using a straight-line method. The Supervisory Board takes the individual performance of each Board of Management member into account by decreasing or increasing the goal achievement figures for each performance target by up to 20 % (so-called discretionary factor), depending on its assessment of the individual performance of that member.

The method used to adapt and disburse compensation components that have been withheld remains unchanged until final payment, even in cases where a member of the Board of Management leaves the company prior to the payment date.

PERFORMANCE-RELATED COMPONENTS WITH LONG-TERM INCENTIVE EFFECT
Performance-related compensation with long-term incentive effect comprises the following components, introduced for the first time in the financial year 2010:

Annual Performance Bonus (APB)
Half of the APB is disbursed in the calendar year following the financial year in which it was earned. The remaining 50 % of the APB is deferred and paid out in equal portions in the second and third consecutive financial years.

The deferred components of the annual performance bonus 2010 (APB, Deferral 1 and Deferral 2) were agreed for the first time with effect from January 1, 2010 (for Egon Behle with effect from July 1, 2010). The ultimate amount to be paid depends on the goal achievement level attained in respect of the two key performance indicators at group level and on the discretionary factor applied in the financial years 2011 and 2012.

Performance Share Plan (PSP)
Additionally, as from the financial year 2010, the long-term compensation awarded to members of the MTU Board of Management will include ‘annual tranches’ granted within the framework of a Long-Term Incentive Performance Share Plan (LTI-PSP).

The first tranche was granted on January 1, 2010, or, in the case of Egon Behle, on July 1, 2010. On this date, a provisional number of performance shares was calculated on the basis of the average price of the MTU Aero Engines Holding AG share over the last 30 trading days prior to commencement of the assessment period and allocated by the Supervisory Board to the individual members of the Board of Management in accordance with each member’s long-term target compensation. At the end of the assessment period, these performance shares will entitle the recipients to a payment either in cash or in shares, as the Supervisory Board sees fit. The assessment period for the first tranche of performance shares begins on January 1, 2010 (for Egon Behle on July 1, 2010) and ends on December 31, 2013 (for Egon Behle on June 30, 2014).

The actual number of virtual shares allocated is determined after expiry of a four-year assessment period. This number reflects the performance of the MTU share compared with the other stocks listed on the MDAX index, based on the total shareholder return (TSR). The TSR is calculated as the total return on the stock including all increases in the share price and all dividends paid during the assessment period. The TSR ranking of the MTU share relative to that of all other MDAX-listed shares at the end of the assessment period is the main factor determining the number of shares allocated.

Depending on this ranking, the level of goal achievement may be between 0 % and 150 %, with 100 % being the value for an average ranking. The amount disbursed equals the actual number of performance shares multiplied by the average MTU Aero Engines Holding AG share price over the last 30 trading days prior to the end of the assessment period. The maximum payment is limited to 300 % of the individual long-term target compensation. The Supervisory Board has the right to impose further limits if any extraordinary events should occur.

Share Matching Plan (SMP)
The members of the Board of Management are entitled to use the amount disbursed under the Performance Share Plan (PSP) to purchase MTU Aero Engines Holding AG shares, which must then be held for a further three years. At the end of the vesting period, these shares are matched on the basis of a Share Matching Plan (SMP), with each Board of Management member being awarded one additional free share for every three MTU shares acquired in this way. The entitlement to additional free shares is deemed to have expired once the corresponding number of such shares has been transferred to the member of the Board of Management. The total value of the matching shares available for allocation at the end of the vesting period is limited to three times the initial purchase price.

Matching Stock Program (MSP)
The Matching Stock Program (MSP) is a share-based form of compensation covering the financial years 2005–2009 that has been in place since the financial year 2005. Depending on the attainment of an exercise price, this program grants phantom stock over a period of five years until the financial year 2009. After expiry of a further vesting period of two years for each tranche, and on condition that the minimum exercise thresholds have been exceeded, the net profit from the MSP is used to purchase MTU shares. A further two years after allocation of the MTU shares, the members of the Board of Management are free to dispose of the shares as they wish

Individual compensation of the members of the Board of Management

The members of the Board of Management were awarded the following compensation for their activities on the board in 2010 and – where applicable and comparable – in 2009: see table Annual Report 2010 on page 29.

PERFORMANCE-RELATED COMPONENTS
In the financial year 2010, the performance-related components were calculated as follows:

APB
In the financial year 2010, the actual EBIT adjusted of € 311.3 million (2009: € 292.3 million) and the actual free cash flow of € 144.8 million (2009: € 120.2 million) were much higher than the respective targets set at the beginning of the year (€ 285.0 million for EBIT adjusted and € 125.0 million for free cash flow).

The goal achievement level for EBIT adjusted was 149.2 %, and 180.0 % for free cash flow. The aggregate level of goal achievement was thus 164.6 %. As the new compensation arrangements did not take effect for Egon Behle until July 1, 2010, his annual performance bonus was calculated pro rata from a baseline representing the company’s first half-year results up to that date, resulting in an aggregate level of goal achievement of 100 %.

Performance Share Plan
The number of performance shares provisionally allocated under the PSP to members of the Board of Management in the financial year 2010 was calculated by dividing the target amounts granted in each case by the average MTU share price (XETRA) over the last 30 trading days prior to commencement of the plan. On March 10, 2010, the Supervisory Board resolved to change the compensation system with effect from January 1, 2010 (or with effect from July 1, 2010 in the case of Egon Behle).

The table in the Annual Report 2010 on page 30-31 shows the number of performance shares granted to the members of the Board of Management in the first year of the PSP. These form the basis for calculating the performance-related benefit payable at the end of the assessment period for the first tranche of the PSP.

The fair value per performance share of the first PSP tranche for the financial year 2010, which was calculated by an independent expert in accordance with the recommendations of IFRS 2, amounted to € 22.96 at January 1, 2010, and € 27.13 at July 1, 2010, taking into account a fluctuation rate of 4 %. At December 31, 2010, the fair value per performance share in this tranche was € 30.67 and € 32.35 respectively. The accounting methods used to calculate these figures are documented in the fairness opinion established at the grant date. The fair values at December 31, 2010, as shown in the table are based on the assumption of an unchanged fluctuation rate of 4 %.

Share Matching Plan
The number of future matching shares depends on the amount paid out under the PSP. In order to determine the fair value, a combined Monte Carlo simulation and Black-Scholes pricing model was used. The expected payout was determined on the basis of exactly the same assumptions used to value the LTI. The payout calculated serves as a basis for valuing the Share Matching Plan (SMP) in accordance with the Black-Scholes pricing model. The fair value of this forward option estimated at the grant date is recognized in the balance sheet taking into account the vesting conditions. The vesting period of the forward option is 52 months.

The fair value per performance share of the SMP, which was calculated by an independent expert in accordance with the recommendations of IFRS 2, amounted to € 3.72 at January 1, 2010, and € 4.23 at July 1, 2010, taking into account a fluctuation rate of 4 %. The accounting methods used to calculate these figures are documented in the fairness opinion established at the grant date. Rounded to the nearest thousand, the total expense of the 40,727 performance shares granted under the share matching program in the financial year 2010 was € 158,000, of which € 31,000 was recognized in the financial year 2010.

Matching Stock Program
The table in the Annual Report 2010 on page 32-33 shows the number of shares and fair value of phantom stock granted to members of the Board of Management under the Matching Stock Program (MSP). The fair value of this program was obtained using the Black-Scholes pricing model. Changes in the contractual conditions under which the equity instruments were issued were taken into account. For a more detailed explanation of the exercise conditions, please refer to Note 29.4.

The fourth tranche, which was allocated in the financial year 2008, was exercised in the financial year 2010 as the exercise thresholds had been exceeded. Thus, after a further holding period of two years from the time the phantom stock is exercised, the allocated shares from this tranche will be free for disposal as from June 30, 2012.

The fifth tranche of the MSP was allocated in the financial year 2009. Exercise of this, the final tranche of the Matching Stock Program (MSP), will depend on how the MTU share price develops between now and the end of the vesting period in 2011.

Under the Matching Stock Program, a total of 411,456 units of phantom stock (2009: 411,456) had been granted and allocated to members of the Board of Management as of December 31, 2010. Of these, 144,936 units (2009: 289,872) were not yet exercisable at the end of the financial year 2010 for the remaining duration of the Matching Stock Program. At December 31, 2010, the average weighted exercise price for not-yet-exercisable phantom stock amounted to € 22.69 per share (2009: € 25.52).

The total expense of the phantom stock granted under the Matching Stock Program in the financial year 2010 was approximately € 0.2 million. This expense was recognized in the income statement.

Rules for terminating the contracts of members of the Board of Management

Above and beyond the general amendments made to Board of Management members’ contracts to meet the requirements of the Act on the Appropriateness of Management Board Compensation (VorstAG), the rules for terminating such contracts were also revised in the financial year 2010. This included not only the benefits promised to members of the Board of Management in the event that their contracts expire in a normal manner, but also those payable if their contracts are terminated prematurely.

RULES VALID UNTIL DECEMBER 31, 2009
Rules for normal termination of contract
Until December 31, 2009, the pension obligations to members of the Board of Management principally comprised an entitlement to retirement, survivors’ and disability pensions.

Retirement and survivor's pension
Under the previous arrangement, members of the Board of Management were entitled to claim retirement benefits on reaching the age of 60. The annual retirement benefit amounted to 25 % of the last basic salary drawn by the beneficiary prior to the insured event. Retirement and survivors’ benefits were automatically increased by 1 % each year subsequent to the year in which they became payable.

Family members entitled to survivors’ benefits received 75 % of the retirement pension in the case of a surviving spouse and 15 % for each dependent child (30 % if both parents were deceased), subject to the condition that the sum of the benefits did not exceed 100 % of the retirement pension.

Disability pensions
Members of the Board of Management whose contracts were terminated prematurely owing to disability were entitled to a pension for reduced earning capacity equivalent to 25 % of their last basic salary.

Rules for premature termination of contract
The contractual agreements with members of the Board of Management made no provision for further payments once their contracts had been terminated. Only in the event of premature termination of contract without serious cause were members of the Board of Management entitled to receive a payment equivalent to the fixed basic compensation that would otherwise have been awarded for the remaining term of their contract. In line with the recommendations of the German Corporate Governance Code, such severance payments were limited to no more than the value of two years’ compensation (severance payment cap).

RULES VALID FROM JANUARY 1, 2010
Rules for normal termination of contract
Company pension plan
The members of the Board of Management are insured under a defined benefit plan in which the benefits promised are based on the contributions made. The benefits payable to members of the Board of Management under this plan correspond to those of their peers in comparable companies.

Retirement and survivor's pensions
The previous system was replaced on January 1, 2010. Since that date Egon Behle, Dr. Rainer Martens, Dr. Stefan Weingartner and Reiner Winkler have been earning company pension entitlements in accordance with the new plan: ‘MTU PENSION CAPITAL – Pension Regulations for Members of the Board of Management of MTU Aero Engines Holding AG’. The goal of the plan is to provide a pension amounting to 60 % of each member’s newly determined basic salary after 15 years of service (on the Board of Management). At the time of the changeover, the vested benefits that each member of the Board of Management had earned up until December 31, 2009, were transferred to the new plan in the form of initial units. This entitlement represents the benefit payable at age 60 under the old plan, adapted to reflect the ratio between the actual number of years of service with the company and the number of years from start of service with the company until age 60. The initial units transferred to the new plan correspond to the current cash value of the pension converted into a lump sum.

Once this amount has been determined, a pension account is opened for each member of the Board of Management to which further capital units are credited annually, for the first time on December 31, 2010. The amount of the annual capital units is calculated on the basis of an individually defined contribution and an age-dependent factor, with the latter taking into account an interest rate of around 6 % p.a. until age 60. The contribution period is capped at 15 years of service on the Board of Management, ending at the latest when the insured person reaches age 60. As of the age of 61, the pension account earns interest at an annual rate of 4 % until such time as the pension is drawn (= bonus amount). The sum of the accrued annual capital units plus the units initially transferred to the account plus any bonus amounts credited to the account make up the pension capital available to finance retirement benefits. If a member of the Board of Management dies before reaching age 60, 50 % of the benefits that he/she could still have earned until that age are added to the accrued balance on the pension account – taking into account the remaining duration up to the end of the contribution period. The pension capital may be drawn either in a single lump sum, in installments, or as a lifelong pension increased at an annual rate of 1 %.

In any insured event, the pension account is topped up where necessary to the level of benefits the insured party would have reached under the previous plan (guaranteed capital).

Pension benefits do not become not payable until such time as an insured event occurs (i.e. on reaching pensionable age, or in the event of disability or death), even if the insured party leaves the Board of Management. The pension entitlement is non-forfeitable after the initial contribution has been paid.

Dr. Rainer Martens, Dr. Stefan Weingartner and Reiner Winkler had already been promised under the previous pension plan that their years of service with former group companies would count towards their pensions.

Details of the above-mentioned obligations and benefits are shown in the table in the Annual Report 2010 on page 36.

The differences in the annual contributions to the pension accounts result from the varying remaining periods of service on the Board of Management until the end of the contribution period, from the respective age-dependent factors and from the different salary amounts eligible for pension contributions. The guaranteed capital under the new pension plan is identical in value to the retirement pension at age 60 under the old pension plan.

Disability pensions
Under the new pension rules of January 1, 2010, if a member of the Board of Management is disabled before reaching the age of 60, 50 % of the benefits that he/she could still have earned before reaching the maximum age limit are added to the balance on the pension account at the time of disablement. This arrangement is based on the contributions payable when the person leaves the Board of Management, and also applies in cases where that person dies before reaching the age of 60.

The table in the Annual Report 2010 on page 37 shows the service cost for the financial years 2010 and 2009, the corresponding pension provisions, and the amount of the defined benefit obligation (DBO) for the members of the Board of Management as of December 31, 2010, and December 31, 2009, respectively.

The new company pension plan for members of the Board of Management came into effect on January 1, 2010. The resulting changes in plan arrangements led to an increase in the vested benefits and to an increase in provisions and the defined benefit obligation.

Provisions established to cover current and future pension obligations to former members of the board of management
The pension obligations to former members of the Board of Management have changed as follows: see table in the Annual Report 2010 on page 37.

Rules for premature termination of contract 
Severance payments on premature termination of contract for members of the Board of Management
Depending on the terms of their individual contracts, the members of the Board of Management are entitled to receive severance payments if MTU prematurely terminates their appointment. In the case of ordinary termination, a severance package is payable that corresponds to the board member’s basic salary, 50 % of the Annual Performance Bonus (APB) and 50 % of the Long-Term Incentive (LTI) for the time from the end of the notice period until the date on which the contract would normally have expired. The amount of the severance package may not exceed two full years of payments of the aforementioned compensation components. If the employment contract is terminated for good cause, no severance package is payable.

Severance payments on premature termination of contract for members of the Board of Management in the event of a change of control or substantial changes in the ownership of MTU Aero Engines Holding AG


RULES VALID UNTIL DECEMBER 31, 2009

Board of Management contracts made no provision for any compensatory payments in the event that a board member’s term of office should be prematurely terminated as the result of a change of control.

RULES VALID FROM JANUARY 1, 2010
If another company acquires a controlling interest in MTU as defined by the German Securities Acquisition and Takeover Act (WpÜG) or if the ownership structure of MTU changes substantially as a result of a merger or comparable transaction or proposed amalgamation, the members of the Board of Management are entitled to receive a severance payment on condition that the Supervisory Board relieves them of their duties within one year of such a change of control or if their employment contracts are not renewed as a result of the change in control. In these cases, the amount payable corresponds to the Board member’s basic salary for the period between leaving the Board of Management and the date on which their contract would otherwise have expired. The amount of the severance payment may not exceed three years’ basic salary.

In addition, the Supervisory Board is entitled to commute the agreed Annual Performance Bonus (APB) for the year in which the change of control occurs, together with any deferred components of the APB from the two previous years, and to pay out a capital sum equivalent to at least 100 % of the target amount.

Further, the Long-Term Incentive Plan (LTI) is automatically terminated in the event of a change of control. By way of compensation for termination of the LTI, the member of the Board of Management in question receives a pro rata payment that is calculated as if the LTI had been continued according to plan. The only difference is that the goal achievement level as expressed in the TSR is determined on the date of change of control, and that the final number of virtual shares is multiplied by the average MTU share price (XETRA) over the last 30 trading days prior to the change of control.

The sum total of all severance payments made in connection with a change of control may not exceed three years’ total compensation in each case.


Further information about the Board of Management compensation can be found in the Annual Report 2010 (page 25-38).