It is common knowledge among business circles that aligning executives’ financial incentives with company strategy can help inspire management to deliver superior results. However, pay packages are not always commensurate with actual business performance. One such package is stock-based compensation. A Morgan Stanley research has found that stock-based compensation has nearly fully replaced cash bonuses as a way to reward company employees. Stock options are viewed as an incentive for employees to deliver results; a tool for retaining workers, a means to foster an overall sense of ownership and also as a way to finance growth for the firm. But this form of compensation has its downside. Whereas stock-based compensation has become increasingly popular in corporate America, it can frequently lead to rewarding company leaders disproportionately in times of crisis.
And that’s exactly what happened with America’s oil and gas executives during the Covid pandemic.
A Reuters analysis of stock-based pay granted to CEOs at 20 U.S. oil and gas companies in 2020 found that they were paid much more in the first year of the pandemic than previously estimated. Indeed, stock-based payouts to CEOs at 20 U.S. oil and gas companies in 2020 more than doubled by 2023 when shares were vested, effectively richly rewarding the business leaders amid mass layoffs, refinery closures and slashed capital spending.
To be fair, stock-based pay values shrink when stock markets go south. However, most energy CEOs have some form of built-in protection that gives them some immunity from steep declines. For instance, CEOs can receive 100% or more of the payout on stock grants tied to total shareholder return even if investors lose money. That’s the case because ~90% of energy companies use a metric called relative total shareholder return (TSR) and benchmark it against a predetermined group of peer companies. This way, oil and gas executives can get big payouts even if their companies’ stocks lose value.
“Compensation committees need to do a better job of rewarding executives for true out-performance and not just necessarily where the commodity price is,” Aeisha Mastagni, a portfolio manager at the $307 billion California State Teachers’ Retirement System told Reuters in an interview.
Bankrupt Oil Company Executives Snag $50 Million Payday
But richly rewarding executives with convoluted stock-based payouts is not the only idiosyncrasy that exists in the oil and gas sector. When public oil and gas companies are doing relatively well, many are happy to adopt a pay-for-performance model to reward CEOs and executives. However, the tables are quickly turned when things go to the dogs. When these companies go bankrupt, the misery is shared by employees who lose their jobs; retirees see their benefits and pensions go up in smoke, while shareholders and bondholders get wiped out.
In sharp contrast, it’s very common for blue-chip executives who preside over bankruptcies to receive multi-million dollar golden sendoffs. Indeed, top executives of oil and gas companies going through Chapter 11 frequently receive very fat payouts in the form of cash bonuses, stock grants and other benefits that often exceed payments during the good times.
That’s exactly what happened during the pandemic.
At a time when hundreds of thousands of employees in the U.S. shale industry lost their jobs, Bloomberg reported that some 35 executives at Whiting Petroleum Inc.(NYSE:WLL), Chesapeake Energy Corp.(NYSE:CHK) and Diamond Offshore Drilling Inc.(OTCMKTS: DOFSQ) received nearly $50 million in bonuses after their companies declared bankruptcy.
The board at Whiting, an oil and gas producer that filed for Chapter 11 in April, approved a $6.4M bonus for CEO Brad Holly just days before the company went under, exceeding his previous annual compensation package by nearly a million dollars.
In May 2020, California Resources Corp. (NYSE:CRC) warned investors about “…a substantial doubt about the company’s ability to continue as a going concern…” but still went ahead and guaranteed company executives their 2020 bonuses.
These are hardly the exception: Over the past decade, leaders of 15 large E&P companies collected more than US$2 billion in aggregate compensation despite their companies posting negative returns.
So, what’s the justification for this bizarre and perverse practice?
According to Kelly Mitchell, analyst at corporate watchdog group Documented, companies do it so as to incentivize these executives to stick around because they understand the company better and, ostensibly, have better odds of pulling them through. Never mind the fact that their decisions are often to blame for the company’s sorry situation in the first place. They also do it in a bid to cut costs and maximize value for creditors using tools such as tax credits or untapped resources.
They have a willing accomplice though: judges tend to sign off on these fat payouts more often than not despite laws introduced in 2005 to limit their size.