Chesapeake Energy: Perverse Incentives

Much has been made of the $100 million salary of Chesapeake Energy (CHK) CEO Aubrey McClendon in 2008. This salary would be high even for a company providing phenomenal returns for its shareholders, but is particularly shocking considering that the company endured a 56% loss in market value during the year. Even more infuriating for shareholders is the fact that the company recently purchased McClendon's historical map collection for over $12 million. The most disturbing aspect of this situation, however, is how these transactions came to be and the resulting dangerous incentive system at Chesapeake which will likely cause the company material harm for years into the future.

As Charlie Munger has told us, "The most important rule in management is to get the incentives right." But Chesapeake's board appears to be transferring wealth from shareholders to McClendon in order to help offset losses which were the result of McClendon's own risk-taking: During 2008, McClendon purchased Chesapeake shares on margin, and was forced to sell these shares at a loss on October 10th. McClendon's $75 million bonus and the map collection purchase took place at the end of the year. While McClendon would likely have been the sole beneficiary of his margin position had Chesapeake stock soared, his downside risk appears to be subsidized by Chesapeake's shareholders!

A perverse incentive situation such as this encourages reckless and risky behaviour on the part of managers. Managers are more likely to take undue risks, due to the rewards that come with positive outcomes and the muted financial punishments that come with negative outcomes. It is also not surprising that the company had positive earnings of over $700 million for 2008 (showing strong results while it released the details of McClendon's compensation), but declared almost $10 billion in unusual expenses in the first quarter of 2009. You have to aggregate the company's earnings for the last 5 years in order for Chesapeake's earnings to top its CEO's 2008 compensation!

This is not the kind of company you want to own. But if you own the S&P 500 index, you do own this company.

Disclosure: None

Comments

[prairiedog555:]

I am a conservative, but I must admit that I support Pres. Obama on the idea of CEO/ Board of trustees of publicly traded companies compensation being limited. No man is worth $100M or more. That is money that should go to shareholders and bond holders who take risk.
As a shareholder I feel cheated by these CEO's compensation, and lavish perks, don't you?
The only people who deserve outrageous compensation are people who start and manage their own companies.

Jun 18 08:53 AM

[Ozarker:]

He did.


On Jun 18 08:53 AM prairiedog555 wrote:

> I am a conservative, but I must admit that I support Pres. Obama
> on the idea of CEO/ Board of trustees of publicly traded companies
> compensation being limited. No man is worth $100M or more. That is
> money that should go to shareholders and bond holders who take risk.
>
> As a shareholder I feel cheated by these CEO's compensation, and
> lavish perks, don't you?
> The only people who deserve outrageous compensation are people who
> start and manage their own companies.

Jun 18 09:01 AM

[john s. gordon:]

another case where the board of directors was in the pocket of the chief, & failed to do its job which is to look after the shareholders interest. corporate governance fails again.
> jack

Jun 18 09:18 AM

[Mmarrkk:]

prairiedog555

"The only people who deserve outrageous compensation are people who start and manage their own companies."

Or, sports stars who can jump high, run fast or shoot a ball, providing an immeasurable amount of value for humanity!

Or actors/actresses who live lavish lifestyles and make crappy movies, again providing immeasurable value for humanity!

Look, the CHK CEO compensation was voted on by the BOD. The BOD was just recently re-elected by a large majority of the shareholders of the company. So, if the shareholders disagreed with the compensation, why didn't they FIRE the guys who awarded it? Reason: the large majority of the shareholders AGREED with the action and understand that Aubrey orchestrated 4 deals for the company, raising $12 Billion in asset sales with a profit marging of 75%. That's real money my friend, not "Net Income" which is fictictious at best.

Jun 18 09:42 AM

[Mmarrkk:]

Jack, If what you say is correct, why did a large majority of shareholders recently VOTE TO RE-ELECT these board members? Could it be that the shareholders, the ones with money invested in the company, APPROVED of this compensation? If they did not approve, why did they re-elect the folks that created this mess??

We don't need the gov't meddling in this. Just let the shareholders vote on BOD's and hold them accountable. If you are in the minority of shareholders that disagree with the majority, just sell your shares and invest somewhere else.


On Jun 18 09:18 AM john s. gordon wrote:

> another case where the board of directors was in the pocket of the
> chief, & failed to do its job which is to look after the shareholders
> interest. corporate governance fails again.

Jun 18 09:45 AM

[January Thaw:]

There are times when the CEO is the guy that makes a company worth owning...and personally, I feel this is one of those times. If Aubrey goes...I go. In the oil patch you have to have a guy at the helm that understands the business, and I for one am a little upset at the demonization going on around this deal. There are a few big guns out there who would just love to bring him down.

Jun 18 08:39 PM

[prairiedog555:]

You guys who approve of the lavish perks and outrageous salaries for Corp CEO's have really drank the cool aid.
I have worked as an executive for a number of small publicly traded companies. My boss's have for the most part been competent. All were well educated, MBA, CPA ect. credentials. No corp debt, no golden parachutes and got 3-500K compensation. I believe most of these guys could run a mega corp, with a few competent VP's and would be happy to for a little more in salary.
And don't even get me started about the CEO's that tank a company and still get paid well.
NO MAN IS WORTH THAT MUCH, except for the person who starts his own company, he deserves as much as he can get.
As a shareholder that lavish salary and perks belong to ME and YOU, they just work for us.

Jun 19 08:18 AM