Compensation Report

Compensation of the Board of Management

The following section reports the compensation of the Board of Management of Covestro AG for fiscal 2022. 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 is a wholly owned subsidiary of Covestro AG. Compensation is not paid for the members’ work on the Board of Management of Covestro Deutschland AG.

Guiding Principles for Compensation

The compensation system for the Board of Management of Covestro AG is based on the corporate strategy and 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 Covestro Group’s compensation structure, which is standardized for all Covestro employees in line with our “We are 1” corporate culture:

• The variable compensation of the Board of Management and all participating employees is based on a uniform system and identical criteria.
• Differences exist only in the target percentages related to fixed compensation.

The variable compensation is based on Covestro’s corporate performance, which is measured based on financial and environmental targets and share performance:

• The system and criteria for short-term variable compensation are closely aligned to Covestro’s annual performance.
• The system and the criteria are agreed upon and binding for a three-year period. The Covestro Profit Sharing Plan (Covestro PSP) is a bonus system based on the company’s average expected performance. The Covestro PSP is designed in such a way that an average payout level of 100% can be achieved over a period of up to 10 years. Effective January 1, 2022, a sustainability component is for the first time included in addition to the financial performance indicators.
• In very successful years, high payout percentages are achieved (such as 239.5% for fiscal 2021), while in challenging years they are significantly lower, or no short-term variable compensation is paid at all (such as for fiscal 2022).
• The Prisma share-based compensation program for long-term variable compensation is based on the absolute performance of Covestro AG shares, including the dividend, as well as the relative performance compared with the STOXX Europe 600 Chemicals* index; since fiscal 2021, it has also included a sustainability component.

The determination of variable compensation is simple, transparent, and based on objective criteria:

• The relation between target attainment and payout has been defined for the criteria used and documented in the Compensation Report.
• The payout is calculated on the basis of financial criteria and sustainability targets that are also included in the company’s Management Report; the calculation is also documented in the Compensation Report.

Compensation system and structure at a glance

Basic Principles for Determining Compensation

Determining Target Compensation

The Supervisory Board determines the total target compensation for the upcoming fiscal year for each Board of Management member in accordance with the compensation system. This compensation is appropriate in view of the Board of Management member’s duties and takes into account Covestro’s financial situation, performance, and future prospects.

As of January 1, 2022, the fixed compensation of Board of Management members was increased based on the change in the previous year’s consumer price index (2.21% from November 2020 to October 2021). The target compensation of individual Board of Management members based on the compensation system in effect is outlined below.

Compliance with Maximum Compensation Limit

Pursuant to Section 87a, Paragraph 1, Sentence 2, No. 1 of the German Stock Corporation Act (AktG), the Supervisory Board stipulated maximum total compensation for the Board of Management members for the first time for fiscal 2021. The absolute amount in euros for the maximum possible payout includes fixed compensation, fringe benefits (e.g., mobility allowance, payments toward the cost of security equipment, screening examinations, etc.), capped variable compensation components, and pension expenses. As a result, the maximum total compensation for a full fiscal year for the Chair of the Board of Management amounts to €9.0 million, while this amount for the regular Board of Management members is €5.5 million.

A report cannot be provided on compliance with this maximum compensation limit until fiscal 2025, when the Board of Management members are entitled to receive a payout from the 2021–2024 tranche of the Prisma long-term variable compensation program. The possible maximum compensation for fiscal 2022, taking into account the respective caps of 250% for short-term and 200% for long-term variable compensation, is outlined below. Based on these two caps and the fact that fringe benefits do not normally exceed an amount of €30 thousand, the aforementioned amounts are guaranteed not to exceed the maximum total compensation for Board of Management members.

Target compensation and maximum compensation for the Board of Management for fiscal 2022 (€ thousand)¹

Review of Appropriateness

The Supervisory Board commissioned an expert opinion from an independent third-party consultant firm to ensure the compensation is appropriate compared to other companies. Since on the basis of relevant KPIs (sales, employees, and market capitalization), Covestro is positioned in the bottom quartile of DAX-listed companies and was included in the MDAX prior to its admission to the DAX in the year 2018, the entire group of DAX and MDAX companies was used as the peer group. Banks and insurance companies were, however, excluded because of their limited comparability. Based on these equally weighted KPIs, Covestro ranks 37th (out of 84), or in the 57th percentile of this group. The following Board of Management compensation components were compared with the market value for each, i.e., the compensation of board of management members in the peer group:

• Fixed annual compensation
• Target cash compensation = Fixed annual compensation + Target value for short-term variable compensation
• Target direct compensation = Target cash compensation + Target value for long-term variable compensation
• Total target compensation = Target direct compensation + Company pension plan

The costs of the company pension plan were determined by using actuarial methods to calculate a company pension plan premium. This premium indicates the amount that would have to be paid to a third-party pension plan to purchase the relevant pension benefits. Using the same parameters for the calculation, the premium amount, and therefore the costs, can be compared to the pension benefits of the board of management members of other companies.

Based on the expert opinion, the target and maximum compensation of the Board of Management was deemed to be in line with the market standard on the whole and therefore appropriate within the meaning of the AktG.

Furthermore, the Supervisory Board reviewed the company’s compensation structure and, for this purpose, compared the fixed annual compensation, target cash compensation, and target direct compensation of the Board of Management members with the corresponding compensation components of the Executive Leadership Team (executives at the two highest contract levels below of the Board of Management) and the workforce as a whole (employees subject and not subject to collective bargaining agreements, including the Executive Leadership Team) at Covestro in Germany. The internal compensation structure was also determined to be appropriate in view of this comparison, which covered the period from the year 2016 to the year 2022. No adjustment was therefore made to the compensation structure or maximum compensation, except for the aforementioned increase in fixed annual compensation.

Application of the Compensation System in the Reporting Period

The application of the compensation system in fiscal 2022 is presented below.

Nonperformance-Related Components

Fixed Annual Compensation, Fringe Benefits

The adjustment to fixed annual compensation at the start of the fiscal year was described above in “Determining Target Compensation.” Fringe benefits mainly comprise a mobility allowance, maintenance and repair of security installations, as well as reimbursement of the cost of an annual screening examination. Sucheta Govil additionally received reimbursement of the cost of tax preparation by an external consulting firm. Fringe benefits are reported at cost or the amount of the taxable benefit gained.

Post-Employment Benefits

Dr. Markus Steilemann and Dr. Klaus Schäfer, who were appointed to the Board of Management in the year 2015, will receive lifelong pension benefits after they step down from the Covestro Group, but not before they reach 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 an additional amount of three times the personal contribution chosen by the Board of Management member. This contribution is limited to a maximum of 9% so that the matching contribution by the company can be no higher than 27%. The total annual contribution is converted into a pension module according to the annuity table for the applicable tariff of the Rheinische Pensionskasse VVaG, Leverkusen (Germany), pension fund. The annual pension entitlement upon retirement is the total amount of the accumulated pension modules, including an investment bonus.

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 pension trust, 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.

Since April 1, 2021, Sucheta Govil and Dr. Thomas Toepfer have earned pension benefits under a defined contribution plan. Covestro and the Board of Management members will each contribute 3% of their fixed annual compensation up to the social security contribution ceiling to a statutory pension plan. For the portion of compensation exceeding the contribution ceiling, Covestro will provide a basic contribution of 6% and a match of up to 30%, three times the Board of Management member’s own contribution of up to 10%. Covestro invests the capital contributed on the capital market according to an age-based lifecycle model. The contributions made are guaranteed. On leaving the Board of Management, but not before the age of 62, the accumulated capital is paid out to the Board member, normally as a one-time payment. The aforementioned pension arrangement, which continues to apply for Dr. Markus Steilemann and Dr. Klaus Schäfer, applied to these two members for the period from the date they joined Covestro to March 31, 2021.

Short-Term Variable Compensation

The target value of the short-term variable compensation is currently 100% of the fixed annual compensation. The award is based on the four criteria of profitable growth, liquidity, profitability, and sustainability, which are used as part of Covestro’s management system to plan, manage, control, and report on business performance. This means that short-term variable compensation is directly linked to the Covestro Group’s success.

These performance indicators are applied to the Group-wide short-term Covestro Profit Sharing Plan (Covestro PSP). The Covestro PSP was introduced in fiscal 2016 and is applicable to all of Covestro’s employees worldwide (with a few exceptions due to stipulations in collective bargaining agreements). Board of Management members also currently participate in the Covestro PSP. The four components are taken into account in this process on an equally weighted basis: Profitable growth measured in terms of EBITDA (earnings before interest, taxes, depreciation and amortization), liquidity measured in terms of free operating cash flow (FOCF), profitability measured in terms of return on capital employed (ROCE) above the weighted average cost of capital (WACC), and sustainability measured in terms of selected environmental, social, and governance (ESG) criteria. In the year 2022, the sustainability component was determined by direct and indirect Scope 1 and 2 greenhouse gas (GHG) emissions (CO₂ equivalents, CO₂e) of the main sites. Other components relating to social criteria and corporate governance are also to be incorporated in the future.

• See “Key Management Indicators.”
• See “Scope 1 and Scope 2 GHG Emissions.”

Components of short-term variable compensation

In fiscal 2021, the Supervisory Board defined the global values for the threshold, 100% payout, and the maximum amount for each performance indicator, which are applied for a multi-year period from the year 2022 to the year 2024. Between these values, linear interpolation is used to determine the payout. There will be no adjustment after the fact.

Relation between payout and profitable growth (EBITDA), liquidity (FOCF), profitability (ROCE above WACC), and sustainability (greenhouse gas emissions)

For each individual performance indicator, the payout can be between 0% (failure to meet minimum requirements) and 300%. The total payout is the arithmetic mean of the individual payouts for all four components. However, it is limited to 250% of the target value corresponding to a maximum payout of 2.5 times the fixed annual compensation. This wide bandwidth ties the short-term variable compensation to the normally cyclical course of our business and ensures that successful years result in attractive payouts, while in challenging ones, it can be lower or even zero.

On the basis of the values achieved for the reporting year 2022, a payout percentage of 75% would have been calculated; the table below shows how it was determined. However, since the thresholds of the three financial indicators (ROCE above WACC < 0) were not reached and the capital costs were therefore not earned in the reporting year, the Supervisory Board used the discretion it was given by the last criterion mentioned and reduced the payout to 0%. Following a resolution of the Board of Management, this figure was also used to calculate the bonus payout for employees, with the result that neither the Board of Management nor employees receive short-term variable compensation for the year 2022.

Long-Term Variable Compensation

The Prisma share-based compensation program for long-term variable compensation (LTI) takes into account the performance of Covestro shares, including the dividend (total shareholder return) and outperformance against the STOXX Europe 600 Chemicals* index over a period of four years. In fiscal 2021, the LTI plan was expanded to also include a sustainability component. The long-term variable compensation is geared toward the sustained, future-oriented, and continuous growth of the company’s value and guarantees the implementation of Covestro’s Sustainable Future corporate strategy, particularly since the introduction of the sustainability component. Prisma is applicable to both members of the Board of Management and to Covestro executives. The LTI target value amounts to 130% of fixed annual compensation for members of the Board of Management, and participation requires that they fulfill the share ownership guidelines applicable to them.

A new Prisma tranche with a four-year performance period is issued for each fiscal year. At the beginning of this performance period, the Supervisory Board stipulates the performance criteria for outperformance and sustainability as well as the relative weighting of these two criteria, which are linked to the overall criterion of total shareholder return (TSR) as multipliers.

Prisma performance periods

The payout is determined by calculating three factors: the TSR factor, the outperformance factor, and the CO₂ factor.

The TSR factor is the return generated by a share expressed as a percentage (total of the final price of the Covestro share and all dividends distributed per share during the four-year performance period divided by the initial price).

The outperformance factor is based on the performance of Covestro shares during the performance period relative to the performance of the STOXX Europe 600 Chemicals index. For the tranche beginning in fiscal year 2022, the following was determined:

• The outperformance factor amounts to 100% if Covestro’s share performance (in %) matches the performance of the index (in %).
• The outperformance factor is 0% if the performance of Covestro shares (in %) underperforms the index by 100 percentage points or more.
• The outperformance factor increases in proportion with the deviation if Covestro’s share 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.

Relation between the outperformance factor and Covestro’s share performance

Starting with the tranche issued in fiscal 2022, the sustainability component applied is a reduction target for annual greenhouse gas (GHG) emissions (CO₂ equivalents) classified in Scope 1. The CO₂ factor amounts to 100% if these emissions are reduced by 400 kilotons (kt) by the end of fiscal 2025 in relation to the baseline year of 2020. This corresponds to an emissions reduction of 32%. If the annual emissions are reduced by less than 250 kt, the CO₂ factor is 0%. Starting with a reduction of 550 kt, it reaches the maximum value of 200%. Between these values, linear interpolation is used to determine the factor. The Supervisory Board considers the defined reduction targets as significant in relation to the company’s actual Scope 1 emissions.

Relation between emissions and CO₂ factor

In order to calculate the total payout for the tranche beginning in fiscal 2022, the LTI target opportunity is multiplied by the TSR factor, the outperformance factor weighted at 75%, and the CO₂ factor weighted at 25%. The total distribution is limited to no more than 200% of the target opportunity. With the target opportunity being defined as 130% of the fixed compensation, the maximum payout is therefore 260% of the fixed annual compensation.

Components of the long-term variable compensation

In the case of tranches before the year 2021, which did not include a sustainability component, the payout factor is determined by multiplying the TSR factor and outperformance factor. The total payout in this case is also capped at a maximum of 200% of the target opportunity.

2018–2021 and 2019–2022 Prisma Tranche Payouts

In January of the reporting period 2022, Dr. Markus Steilemann, Dr. Klaus Schäfer, and Dr. Thomas Toepfer received payouts from the 2018–2021 Prisma tranche. The payout factor amounted to 17.7%. Sucheta Govil was entitled for the first time to participate in the 2019–2022 Prisma tranche, which ended on December 31 of the reporting year 2022 with a payout factor of 27.0%.

The following chart and table illustrate how the aforementioned payout factors are calculated.

Calculation of the 2018 – 2021¹ Prisma tranche

The dividend payments for individual years can be accessed on Covestro’s website.

• Additional information is available at: www.covestro.com/en/investors/stock-performance/dividends

The amounts calculated for these two tranches, including those for former CEO Patrick Thomas, are shown in the following table.

At the time of preparing this Compensation Report, the company is verifying whether and to what extent Covestro Deutschland AG and companies affiliated with Covestro Deutschland AG can or will take advantage of relief benefits under the German Electricity Price Cap Act (StromPBG) or the German Gas and Heating Price Cap Act (EWPBG). The acts specify prohibitions on bonuses, starting from a certain level of relief, and this could have an impact on the granting of variable compensation components to members of the company’s management. In order not to restrict any of the scope for action of Covestro Deutschland AG and companies affiliated with Covestro Deutschland AG, given that the verification process is currently under way, and to enable any unresolved issues relating to both acts to be clarified with the appropriate due diligence, the Board of Management members in office have agreed to postpone the payouts from the 2019–2022 Prisma tranche until April 2023 for now.

Overview of Current Prisma Tranches

The three currently running Prisma tranches with their starting prices and fair values calculated as of the reporting date (market value of the relevant tranche determined with a Monte Carlo simulation) are explained below. For the 2023–2026 Prisma tranche, the annual reduction target for annual GHG emissions (CO₂ equivalents) for the sustainability component has been extended from Scope 1 emissions to cover Scope 1 and Scope 2 emissions.

Share Ownership Guidelines and Shareholdings

As a rule, the members of the Board of Management are contractually obligated to acquire Covestro shares equivalent to 100% of the fixed compensation (as set at the start of their term) 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. If their contracts are extended, this obligation is increased to the amount of the new fixed compensation. The Board of Management member in question must acquire Covestro shares equivalent to the difference within four years of starting the new period of service. The aforementioned rule has been applied since fiscal 2021. The previously applied share ownership guidelines are currently still applicable to Dr. Klaus Schäfer. They required him to purchase Covestro shares to the value of half of his LTI target by a predefined date, and he has already fully met this requirement. He has to hold the shares he purchased for the duration of his Board of Management activities.

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

Malus and Clawback Clauses

According to the malus and clawback rules introduced in the year 2021, the Supervisory Board can withhold short-term and/or long-term variable compensation or request the return of variable compensation already paid out, either in whole or in part, at its discretion in the event of serious breaches of duty or compliance violations. Moreover, a clawback is possible when the calculation and payout was based on incorrect data.

The Supervisory Board has not exercised the right to claw back variable compensation, because no circumstances arose either before or during the reporting year 2022 that would have triggered this provision.

Benefits Associated with Ending Board of Management Service

If the term of Board of Management service is terminated early without good cause, the company fulfills its commitments up to the time the member leaves the company. In this case, payments to the Board of Management member, including fringe benefits, may not exceed two times annual compensation and may not compensate more than the remaining term of the employment contract (severance cap). Outstanding variable compensation components are paid out at the originally agreed times and conditions, i.e., they are not paid out in advance.

In the event of a change of control that results in a material change of status of an individual Board of Management member – e.g., change in company strategy or change in the Board of Management’s job responsibilities – the Board of Management member has the right to terminate the employment contract within 12 months of the change of control. When this right of termination is exercised or if the employment relationship is ended by mutual agreement on the company’s initiative within 12 months of the change of control, the Board of Management member is entitled to payment of severance of 2.5 times the fixed annual compensation. The amount of the severance payments, including fringe benefits, is limited to the remaining compensation up to the expiration of the employment contract and is subject to the severance cap.

Third-Party Benefits

In the reporting year, the Board of Management members were not promised nor did they receive, any benefits from third parties for their activities on the Board of Management.

Board of Management Compensation in the Fiscal Year

Compensation Awarded and Due

The compensation for the fiscal year awarded and due is outlined below in accordance with Section 162, Paragraph 1 AktG. The amounts of short-term and long-term variable compensation are given for the fiscal year in which the activity for which the compensation is paid was performed in full.

Even if the pension expense for the company pension plan is not classified as compensation awarded and due within the meaning of Section 162 AktG, to ensure transparency, we additionally disclose the pension service cost according to IFRSs in the table below.

Prisma Long-Term Variable Compensation

The fair value when granted of the long-term variable compensation (2022–2025 Prisma tranche) is €3,743 thousand (previous year: €4,176 thousand for the 2021–2024 Prisma tranche).

Provisions amounting to €5,626 thousand (previous year: €5,391 thousand) were recognized as of December 31, 2022, for all current tranches of long-term variable compensation in which active Board of Management members participate. No provisions were recognized for former Board of Management members (previous year: €202 thousand).

Pension Entitlements

The current pension service cost for the members of the Board of Management recognized in the reporting year totaled €1,761 thousand (previous year: €2,174 thousand) according to IFRSs. The service cost depends on the actuarial assumptions made, in particular the relevant discount rate. The contributions to pension commitments actually made are recognized as cash outflows in the operating cash flow. The service cost, present value of the pension obligations, and contributions made in accordance with pension plan rules are shown in the table below.

Compensation of Former Members of the Board of Management

The compensation awarded and due to former Board of Management members for the fiscal year is outlined below in accordance with Section 162, Paragraph 1 AktG.

A provision of €5,447 thousand (previous year: €7,696 thousand) is recognized in the Consolidated Financial Statements as of December 31, 2022, for current pensions for former Board of Management members. The settlement value of direct and indirect pension obligations in the Financial Statements of Covestro AG amounted to €7,048 thousand (previous year: €6,921 thousand).