Volkswagen Eyes CEO Pay Overhaul in Response to Activist Demands

Volkswagen Group (VLKAY) shares traded up Wednesday after the beleaguered automaker's CFO Frank Witter told activist fund manager Christopher Hohn in a letter that the German car company will be making changes to its executive compensation plans at the same time as it take steps to hike profits as part of a strategic review.

Witter's letter, which was obtained by The Street, is in response to a scathing five-page note sent May 6 by Hohn, founder of London-based Children's Investment Fund, or TCI, demanding it overhaul its "overpaid management" pay plans and improve share-price performance.

Hohn (pictured) also said in his letter, which was also obtained by The Street, that there is the potential for "massive profit and cashflow expansion" but that the company's value has been held back by "underperforming and overpaid management." The $10 billion fund, has a 2% stake in Volkswagen and has been a shareholder for four years.

Responding to Hohn's concerns, Witter said Volkswagen's current system of incentives for management requires change and that Volkswagen will take a look at setting up a new "remuneration system" as part of an on-going "Strategy 2025" review and that it will welcome Hohn's input as well as from other stakeholders. The "strategy 2025" review's aim, Witter said is to ensure Volkswagen has the ability to capitalize on its brands and "grasp the opportunities offered in the new era of digital connected cars powered increasingly by electricity, as well as cars driving autonomously where the driver wishes."

In addition, Witter said there is "no doubt that our financial performance needs to improve" and "on many points we are in agreement. Volkswagen can and should be the most profitable company in the automotive world."

In response, TCI partner Ben Walker said in a statement Wednesday that Witter's letter lays out a number of fine ambitions adding that it was "good to hear" that the current management's remuneration system required change.

 However, he added that corporate governance at the automaker had to change as well. Currently Porsche controls 52% of the voting rights for the automaker as of Dec. 31 while the German state of Lower Saxony controls another 20%. Qatar Holding controls an additional 17%.

In his note, Walker said that TCI's recommendations to hike Volkswagen's share price must be shared by Porsche, Qatar and Lower Saxony as well. "We now urge Lower Saxony and the unions to fully back the new management team and to give them the tools to improve productivity and control labour costs," Walker said. "It is a letter of fine ambitions but the unions and in particular Lower Saxony have to now fully back the new management team."

It is unclear whether Hohn and Walker would expand their campaign to include a proxy contest if Volkswagen's executive pay plan changes don't meet their expectations. The activist fund managers did not suggest they would launch one at Volkswagen but instead said they expected to see an improved management compensation system set up in time to be disclosed at an investor day expected to take place in the summer.

The Children's Investment Fund has launched director election battles in the past. However, Hohn Would have an impossibly high hurdle to jump over if he were to launch a proxy contest at Volkswagen seeking to elect directors since Porsche, and Lower Saxony having a controlling stake and would block his board nominee candidates. However, contests for director elections have been launched at controlled companies in the past.

Hohn's public pressure campaign could have an impact to drive changes to the executive compensation plans. The activist fund sought to connect his executive pay plan concerns to a major diesel emission scandal that hit the automaker last year. Volkswagen's share price dropped by roughly a third in the fall of last year after it admitting that more than 11 million vehicles had software installed that allowed them to cheat diesel engine emission tests. In the wake of the scandal, Volkswagen's board in April approved restrictions on executive bonuses, only allowing them to be fully paid out in 2019 if the company's share price had gained 25% in value.

At Volkswagen, TCI argued that management compensation hasn't been linked to transparent metrics and that executive pay plans have been paid in cash "with no vesting or deferral," all of which has encouraged "aggressive management behavior" contributing to the diesel emission scandal.

 Volkswagen last month reported a record net loss of E 1.6 billion for 2015 compared to a profit of E 10.8 billion in 2014.