(Bloomberg Opinion) -- The dream in the oil business is to own a piece of real estate from which you extract fantastic profits just because you’re lucky enough to own it. Unfortunately, all too often that piece of real estate is a corner office.
Just before Occidental Petroleum Corp. leaped into the fray this week against Chevron to win Anadarko Petroleum Corp., it emerged that, whoever ended up owning the company, the big winners would be the guys currently running it. As first reported by the Wall Street Journal, Anadarko’s compensation committee tweaked severance terms for its senior bosses, including CEO Al Walker, the day before the agreed deal with Chevron Corp. was announced. The committee even approved removing a provision that would have reduced Walker’s payout because he isn’t 65 yet. The timing was impeccable.
When the deal was announced, I pointed out the implied price of $65 a share was where Anadarko traded only six months before. Oxy’s scathing letter to the board accuses it of agreeing to a $1 billion break-up fee “without even picking up the phone” to discuss a materially higher offer. Granted, there are bigger risks attached to Oxy’s bid (see this). Still, along with news of the sweetened severance packages, this risks tainting the deal in the eyes of investors.
That’s especially when you consider Walker’s package was generous even before the changes and that the company’s track record of aligning executive pay with investment performance was poor already. In his last review of this for large oil companies, published last summer, Doug Terreson of Evercore ISI gave Anadarko a score of just 31 out of 100 – and that after Anadarko had made some improvements.
But this episode is just the latest example of a wider problem in the oil industry, and it isn’t even the most outrageous. Last year, I wrote about Comstock Resources Inc., a woeful investment(1) but a solid performer for its top executives, where the board once authorized paying out cash to the CEO and CFO for their minority stakes in the corporate jet — just before suspending dividends to “preserve liquidity.” And who can forget Chesapeake Energy Corp.’s board, and its almost Pythonesque offer to buy an antique map collection from late co-founder Aubrey McClendon for millions of dollars in the middle of the financial crisis in late 2008.
In general, E&P bosses are often paid their full bonus even when their stock sinks or lags benchmarks (see this). They also tend to be rewarded for the sheer good luck of rising oil prices while being relatively shielded from the drops (see this). And pay targets too often emphasize growth rather than returns, encouraging wasteful investment (see this).
Investors have noticed, including some activists. On the same day news of Anadarko’s extra-golden parachutes emerged, Kimmeridge Energy Management Co. filed a presentation in connection with its proxy campaign to win board seats at PDC Energy Inc. It focused on executive pay and its apparent misalignment with performance (PDC screens badly on overheads and total shareholder return).
One area where PDC has left itself open concerns how it determines bonuses for its top executives. The proxy lays out a methodology incorporating seven financial, operational, and “non-quantitative” metrics. Yet, in contrast to many other companies, there are no weightings given for these, which rather undercuts the “method” bit of the methodology. Plus, somehow, despite missing four out of the five financial and operational objectives in 2018, PDC’s executives were awarded bonuses at 115 percent of their target level. One can only surmise they really knocked it out of the park on the qualitative stuff.
Kimmeridge’s campaign and Anadarko’s bowing out reflect a chronic problem of misalignment of interests in the industry, with management too often having little real skin in the game and getting rewarded for the wrong things.
Chris Crawford, president of compensation consultant Longnecker & Associates, says he has noticed some improvement since I last spoke with him on this topic last summer, particularly in terms of companies adopting more returns-based metrics for assessing bonuses and being more conservative with stock awards. Intriguingly, he says he attended a recent meeting with 15 managers of large funds investing in the energy sector and was “stunned” to find virtually all expressing concern there wasn’t enough incentive for managers of exploration and production firms to do deals.
Before Anadarko’s board (or any other E&P boards) take heart from that, it’s worth noting two things. First, that sentiment fits with a justified view expressed by the likes of Kimmeridge that consolidation is needed in a fractured sector burdened by too much overhead. As such, it’s actually not surprising fund managers wish more E&P executives would merge themselves out of a job. However, I doubt that equates to a green light for boosting generous severance packages even further (if it is, then this sector needs more activists). Second, Crawford found one of the measures Anadarko’s compensation committee approved, whereby the company will make most of the executives whole if they face an excise tax on their parachute payments,(2) particularly “unusual.” He says perhaps 70 percent of large companies had a “tax gross-up” measure like that on the books pre-2005 but most had removed it since.
The deep unpopularity of oil-related stocks today owes something to the experience of the recent crash as well as, perhaps, gathering clouds around issues of climate change and long-term demand. More important, though, is the corrosive effect of investors too often finding themselves on the wrong side of a loaded deck.
(1) Comstock's total return over the past 10 years clocks in at a negative 96.2 percent, the investing equivalent of a frying pan to the face.
(2) Parachute payments above a certain level are subject to an excise tax under Section 4999 of the Internal Revenue Code. The relevant change in Anadarko's treatment of this noted in the second bullet point on page 4 of this filing with the Securities and Exchange Commission.
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Liam Denning is a Bloomberg Opinion columnist covering energy, mining and commodities. He previously was editor of the Wall Street Journal's Heard on the Street column and wrote for the Financial Times' Lex column. He was also an investment banker.
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