NFPCC Original Article: Q&A with Highlights from Tudor Pickering Conference
NFPCC was recently invited to participate in Tudor Pickering’s 2018 Hotter N’ Hell Conference. Dan Pickering quizzed NFPCC’s Chris Crawford on recent executive compensation trends in the energy sector. Here are just a few highlights from that “fireside chat”.
Q: It is a hot topic among shareholders, but does executive pay really matter to stock performance… isn’t it a rounding error?
A: Executive Pay matters a lot. Companies that error on the high side, or egregious side, lose investors and investor confidence. These compensation programs have also invited shareholder activism to become increasingly more involved in setting compensation programs.
On the other side of that equation, we have witnessed first-hand, executive compensation programs that are below market, do not retain key talent, and these executives take other opportunities in a competitive labor market.
Q: Is there any evidence that shareholders that get on the executive comp bandwagon actually ask for the right components of an incentive package?
A: 70% of the institutions who jump into compensation, are not asking for the right things, or are pushing agendas that don’t serve the long-term interest of shareholders. They may be well-intentioned, but misguided. 30%, who truly know the business, are asking for the right things.
Q: It seems like there is a change in incentive plan design in energy. Why is this? Is the change good, and will it stick?
A: NFPCC conducted an analysis of E&P companies to look at the alignment between shareholder performance and CEO short-term payouts over the past 3 years. There are a lot of conclusions that can be drawn, but in short, many companies not in the Permian, who lost shareholder value ended up paying above target bonuses.
The reason for this is that investors wanted incentives that paid for production growth and reserve replacement. By the way, even though there was a disconnect on pay and performance due to misaligned metrics, there were some benefits such as the huge advances in E&P technology over the past 5 years. However, nobody predicted oil to drop $25 and gas to drop to $2. As a result, many shareholders dropped out of the business. As this change has occurred, many investors are asking for, and many E&P companies are adopting “return on” incentive metrics. This incentive plan change may be slow, but it will likely create more attraction for investors who have dropped out of the E&P market. We don’t think it will have a dramatic impact on short-term incentive payouts in 2018 and 2019, as these returns are only 2 of 6 metrics on average, but the change is starting. We do believe these metric changes will stick over the longer-term, and overall will be helpful for the industry and the market.
Q: What are the most common mistakes that companies AND shareholders make when thinking about compensation?
A: There are a number of mistakes companies will make, but one of them is process. We believe great process produces great compensation programs. Companies get into habits. Process habits, policy habits, legacy agreements, etc. When the board, compensation committee or the advisor stops questioning the compensation process, policy or plans, bad habits become bad compensation with unanticipated outcomes. We have seen this play out many, many times.
Q: Does director compensation matter?
A: We believe director compensation is one of the single most important elements of corporate compensation to get right. You need the best and brightest governing the company, asking hard questions, and upholding the fiduciary responsibility to represent shareholders. Many times, this is an afterthought for companies, but in reality, it should be first. Further, the pay should be pay for governance, not pay for performance. Management should be heavily weighted to pay for long-term performance of the company. If board members have too much at risk, it may tempt good directors to not ask the hard questions.
Q: What inning are we in as it relates to the major sea change in energy compensation?
A: 2nd inning. Companies are constantly refining how to provide the most efficient way to attract, retain and motivate the best talent. These advances in compensation are not dramatically different than advances in technology. There are a number of moving parts to compensation in the energy sector: from balancing supply and demand of labor to formulaic vs. discretionary bonuses, to tax and accounting mitigation, to motivating long-term performance. They are in constant flux, and finding the right balance with the most efficient currency takes real work. While the current changes are healthy, it will take some time for the industry as a whole to adopt leading edge compensation and incentive practices.