Compensation Report 2011

Compensation Report 2011

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 ‘Reporting on the remuneration of members of governing bodies’, 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. In 2010, in the context of this review process, the Supervisory Board revised the new compensation structure for the Board of Management in consultation with an external compensation specialist.

The revisions made in 2010 focus 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 basis for payment of variable compensation was shifted to multi-year assessment periods; large parts of the variable compensation can now be deferred for one or more years, or not paid out at all. 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 2011, the members of the Board of Management were awarded total compensation of € 6,452,608 (2010: € 8,075,962) for their services during the financial year. This amount includes post-employment benefits. Members of the Board of Management did not receive any compensation for their activities on the boards of MTU group companies, nor were they granted any loan facilities by the company.

Table "Total Compensation", please see Annual Report 2011, page 44

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. Of the target direct compensation (excluding post-employment benefits), 40 % is non-performance-related, while 60 % is performance-related. Around half of the performance-related compensation is linked to the 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 insurance premiums or the use of a company car for business and private purposes, including any taxes on such benefits paid by the company.

PERFORMANCE-RELATED COMPONENTS
Performance-related components comprise an Annual Performance Bonus (APB) and a Long Term Incentive Performance Share Plan (LTI). 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
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 is based on the goal achievement level in these two 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 level; 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 Board of Management members 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:

Annual Performance Bonus (APB)
Half of the APB is disbursed in the calendar year following the financial year in which it was earned. The withheld portion of the annual performance bonus (the remaining 50 %) is paid out in two equal portions (Deferral 1 and Deferral 2) in the second and third consecutive financial years.
The deferred components of APB 2010 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. The deferred components of APB 2011 were agreed for all members of the Board of Management with effect from January 1, 2011. 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 2012 and 2013.

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.

The first tranche was granted on January 1, 2010 or, in the case of Egon Behle, on July 1, 2010. On these respective dates, 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 began 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 second tranche was granted to all members of the Board of Management with effect from January 1, 2011. The assessment period for this second tranche begins on January 1, 2011 and ends on December 31, 2014.

The actual number of virtual shares allocated is determined after expiry of the four-year assessment period for each tranche of granted shares. This number reflects the performance of the MTU share compared with the other shares in the MDAX index, based on 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 performances hares 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 for each tranche of granted shares is limited to 300 % of the individual board member’s 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 benefits payable under each tranche of the Performance Share Plan (PSP) to purchase MTU Aero Engines Holding AG shares,which must then be held for a further three years after the grant date. At the end of each 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 3 MTU shares acquired in this way. The entitlement to additional free shares is deemed to have been fulfilled once the corresponding number of such shares has been transferred to the member of the Board of Management. The total value of the free shares allocated at the end of the vesting period is limited to three times the purchase price of the shares originally acquired through the PSP.

Individual compensation of the members of the Board of Management

The members of the Board of Management were awarded the following total compensation – as defined in Section 314(1) no. 6a of the German Commercial Code (HGB) – for their activities on the board in 2011 and 2010:

Table “ Individual compensation of the members of the Board of Management”, please see Annual Report 2011, page 47

PERFORMANCE-RELATED COMPONENTS
The performance-related components were calculated as follows:

Annual Performance Bonus (APB)
At the end of the financial year 2011, the actual EBIT adjusted of € 328.0 million (2010: € 310.7 million) and the actual free cash flow of € 129.0 million (2010: € 144.8 million) were much higher than the respective targets set at the beginning of the year, which were € 300.0 million for EBIT adjusted (2010: € 285.0 million) and € 113.0 million for free cash flow (2010: € 125.0 million).

The goal achievement level in 2011 was 149.8 % (2010: 149.2 %) for EBIT adjusted and 175.5 % (2010: 180 %) for free cash flow. The aggregate level of goal achievement was thus 162.7 % (2010: 164.6 %). As the new compensation arrangements for Egon Behle did not take effect until July 1, 2010, his annual performance bonus for 2010 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 (PSP)
The number of performance shares provisionally allocated under the PSP to members of the Board of Management in the financial years 2010 and 2011 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.

The following table on shows the number of performance shares granted to the members of the Board of Management in the first and second years of the PSP. These form the basis for calculating the performance-related benefit payable at the end of the vesting period for the respective tranches of the PSP.

Table “ Performance Share Plan 2011” , please see Annual Report 2011, page 48

The fair value per performance share of the second PSP tranche for the financial year 2011, which was calculated by an independent expert in accordance with the recommendations of IFRS 2, amounted to € 31.26 at January 1, 2011, taking into account a fluctuation rate of 4 %.
The fair value per performance share of the first PSP tranche for the financial year 2010, which was also calculated by an independent expert, amounted to € 22.96 at January 1, 2010, and € 27.13 at July 1, 2010, taking into account a fluctuation rate of 4 %.

Table ”Performance Share Plan 2010”, please see Annual Report 2011, page 49

The methods used to calculate these figures are documented in the fairness opinions established at the respective grant dates. The fair values at December 31, 2011, as shown in the table are based on the assumption of an unchanged fluctuation rate of 4 %, as in the previous year.
The total carrying amount of the cash-settled share-based payment liabilities under the PSP developed as follows:

Table “Development of total carrying amount”, please see Annual Report 2011, page 49

Share Matching Plan (SMP)
The number of future matching shares depends on the cash 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 cash settlement was determined on the basis of the exact same assumptions used to measure the value of the PSP. The cash settlement serves as a basis for measuring the value of the Share Matching Plan (SMP) in accordance with the Black-Scholes pricing model. The fair value of the forward options at the grant date was calculated on the basis on the following assumptions:

Table “Share Matching Plan”, please see Annual Report 2011, page 50

The expected volatility was determined on the basis of the weekly closing stock prices over the 3-year period preceding the respective measurement date.

The following share-based SMP compensation agreements were in place during the current reporting period and earlier reporting periods:

Table “ Share Matching Plan (SMP)”, please see Annual Report 2011, page 51

Total expense incurred for share-based compensation
The total expense incurred for share-based compensation in the financial years 2011 and 2010 respectively can be broken down as follows for the individual members of the Board of Management:

Table ”Total expense incurred for share-based compensation”, please see Annual Report 2011, page 51

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

The rules for terminating the contracts of members of the Board of Management cover 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 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 survivors’ 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 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 accrued annual capital units plus the units initially transferred to the account plus any bonus amounts credited to the account together 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 permissible 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 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 following table:

Table “ Existing benefit entitlements”, please see Annual Report 2011, page 53

The differences in the annual contributions to the MTU pension accounts result from the remaining periods of service on the Board of Management until the end of the respective contribution period, from the respective age-dependent factors and from the different salary amounts eligible for pension contributions.

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 following table shows the service cost for the financial years 2011 and 2010, 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, 2011, and December 31, 2010, respectively:

Table “Changes to service costs, provisions and DBO”, please see Annual Report 2011, page 53

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:

Table “ Provisions established to cover current and future pension obligations”, please see Annual Report 2011, page 54

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 APB and 50 % of the long-term incentive Performance Share Plan 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 these 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

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 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 of 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.

In addition, the Supervisory Board is entitled to commute the agreed 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 LTI plan is automatically terminated in the event of a change of control. By way of compensation for termination of the LTI plan, the member of the Board of Management in question receives a pro rata payment that is calculated as if the LTI plan had been continued. 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 2011 (page 43-54).