The Advisors' Blog

– Professor Jay Brown

Below is something I recently blogged on “The Race to the Bottom” Blog:

With say on pay for top executives about to become law (something we will examine, along with the other corporate governance provisions in Dodd-Frank, over the next series of posts), we note some growing sentiment for say on pay director pay.
As we have noted time and time again, directors in many companies are well paid, sometimes receiving in the vicinity of $700,000 in total compensation. These amounts have become clearer with the compensation reforms in 2006 that now require companies to disclose “total compensation” paid to directors. The amount of compensation can be large enough to create an economic incentive to support the policies of the CEO (particularly the ones governing his/her compensation) and avoid risking the lucrative sinecure on the board.

Ted Allen at RiskMetrics has reported on the latest batch of companies where shareholders have voted in favor of a say on pay proposal. It has happened at Target (52%) and TJX (53.9%) and, most recently, at Chesapeake Energy (56%), the 12th company so far this year to see majority support for such a proposal. It is evidence of the growing desire by shareholders to have a greater voice in the compensation process. Of course, these votes are advisory and the board can ignore them. That will change when the financial reform bill passes. After that, it will be mandatory say on pay.

The most interesting thing about this spate of approvals, however, concerns the one at Chesapeake. In addition to the usual say on pay proposal, a second one called for annual shareholder approval of the compensation paid to directors. As the proposal provided:

Resolved: That the shareholders of CHESAPEAKE ENERGY CORPORATION request its Board of Directors to adopt a policy that provides shareholders the opportunity, at each annual meeting, to vote on an advisory resolution, prepared by management, to ratify the compensation of named-executive officers listed in the proxy statements Summary Compensation Table and compensation awarded to members of the Board of Directors as disclosed in the proxy statement.

It passed. The vote totals for Chesapeake can be found in the Company’s current report. Why? Chesapeake has a well paid CEO (total compensation in 2008 of around $112 million, a more modest $18.5 million in 2009). See Summary Compensation Table of 2009. They also have well paid directors, with total compensation somewhere around $530,000 in 2009 and somewhere in the vicinity of $700,000 for 2008.

How many times did the board meet in 2009? Four in person and six by telephone. To the extent that this looks meager, the proxy statement did point out that “management frequently discusses matters with the directors on an informal basis.”

Moreover, that is not all. As the proxy statement discloses:

In assessing director independence, the Committee considered the business the Company conducted in 2007, 2008 and 2009, including payments made by the Company to National Oilwell Varco, Inc. (NOV), for which Mr. Miller serves as Chairman, President and Chief Executive Officer, and payments made by the Company to BOK Financial Corporation (BOK), for which Mr. Hargis served as Vice Chairman until March 2008 and since then has served as a director. The Companys business transactions with NOV and BOK were all conducted in the ordinary course of business.

Payments made to NOV represented approximately 1% of NOVs gross revenues during each of the last three years, well below the NYSEs 2% of gross revenues threshold, and the Companys payments to BOK were nominal during the review period. The Committee also considered transactions and relationships with Oklahoma State University, for which Mr. Hargis has served as President since March 2008, including contributions and support for scholarships and faculty chair endowment, university athletics and various sponsorships and training programs. The Committee specifically considered the employment by the Company of Governor Keatings son and daughter-in-law during 2009 in non-executive positions. The Committee determined that all transactions and relationships it considered during its review were not material transactions or relationships with the Company and did not impair the independence of any of the affected directors.

This is a well paid board that does not meet in person very often. How does it respond to shareholder initiatives? In 2009, shareholders voted to recommend majority voting for directors and the elimination of the staggered board. How did the directors respond?

The Company and our Board take seriously shareholder proposals, especially proposals that receive majority votes from our shareholders. As a result, over the past year our independent Nominating and Corporate Governance Committee and the Board have consulted with outside experts and actively considered the proposals. The Board believes strongly that it is not advisable, in light of the unique circumstances of our industry, to adopt majority voting or to declassify our Board. The oil and natural gas industry is highly cyclical due to short term volatility in commodity prices, which are outside our control.

For a number of reasons (some apparent and some not apparent) the volatility in energy prices is magnified in the stock price for independent exploration and production companies, such as us. The Board believes that the resulting cyclical nature of our business exposes independent exploration and production companies, more so than companies not operating in extractive industries, to short-term opportunism that arises from the divergence between the shorter term focus of the stock market and the longer term focus of industry participants. The Board believes the risks from implementing these proposals far outweigh any benefits and that implementing these proposals would be detrimental to the long-term interests of the Company and its constituencies. For these reasons, the Board has decided to implement neither annual elections nor a majority voting standard.

As say on executive pay becomes more common, pressure for the right to have a say on director pay will likely grow. If past patterns are any evidence, widespread adoption will have to wait for the next instance when Congress dips into the corporate governance area.