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NFPCC’s Thoughts on SailingStone’s Governance & Compensation Memo

SailingStone Capital Partners recently shared a memo» outlining key changes to their proxy voting guidelines relating to governance and incentive compensation practices. Below we share our thoughts on each of the changes they will implement in the 2020 proxy season.

Governance

INDEPENDENT CHAIR:

  • SailingStone Guideline: Vote against the entire board of a company if the roles of chairperson and CEO are not separated. We will also vote against the chairperson if he or she is not independent.
  • NFPCCmp;A Opinion: NFPCCmp;A believes this is a strategic decision. Although there are strong arguments either way, if combined, then a strong lead director is key. While independence is critical, context is everything. A board should be free to select the leadership structure that is best suited for the company, taking into account the history of the company, experience of the CEO, board/management relations, who one does business with, and the pool of qualified candidates.

ENGAGEMENT:

  • SailingStone Guideline: We will vote against the directors of a company if that company has not adopted a formal shareholder engagement program which allows large owners to speak directly with independent directors at least once per year.
  • NFPCCmp;A Opinion: It is NFPCCmp;A’s belief that directors and management teams are primarily intending to drive shareholder value creation and an overall sustainable business model. With this in mind, NFPCCmp;A believes companies should devote adequate time and resources to understand the strategic vision and viewpoints of shareholders. NFPCCmp;A understands that not all shareholders share the same visions or desires; however, it is important to understand their varying points of view, as this may yield positive interaction and/or allow for a more robust discussion to relay the strategic vision and purpose of the compensation programs.

Director Compensation

CASH V. EQUITY MIX:

  • SailingStone Guideline: At least 50% of director compensation should be made in the form of shares, not cash.
  • NFPCCmp;A Opinion: NFPCCmp;A believes it is a Director’s responsibility to act as a steward of the Company and as a sound fiduciary. As such, NFPCCmp;A believes providing at least 50% of director compensation in stock is a best practice to continue director and shareholder alignment.

SHARE RETENTION:

  • SailingStone Guideline: Directors should not be allowed to sell their shares until they have resigned or have been removed from the board.
  • NFPCCmp;A Opinion: Most organizations provide the ability for directors to sell vested shares so long as their respective stock ownership guidelines are met/maintained. NFPCCmp;A does not support “hold until retirement” type arrangements. NFPCCmp;A does not believe these arrangements link directors to shareholders nor create alignment/equality between directors and shareholders. Specifically, shareholders have the ability to sell shares at any time and under any condition. Further, NFPCCmp;A believes the establishment and maintenance of the current ownership guidelines, in addition to the majority of the industry’s compensation being provided in equity, provides for sufficient shareholder alignment and “at risk” compensation for directors. Lastly, NFPCCmp;A believes this type of arrangement potentially could result in the loss or resignation of valuable directors in order for these directors to diversify their personal portfolios. NFPCCmp;A does not recommend implementing a “hold until retirement” policy; however, NFPCCmp;A does recommend reviewing the current ownership guideline levels to ensure market alignment. Additionally, consideration may be given to implementing a 10b5-1 program which allows for the sale of a predetermined number of shares at a predetermined time as a means of providing for liquidity and avoidance of accusations of insider trading.

CLAWBACK MECHANISMS:

  • SailingStone Guideline: Clawback mechanisms should be in place in the event of fraud or negligence.
  • NFPCCmp;A Opinion: Many organizations have established a Clawback policy whereby cash or equity-based compensation provided can be recovered due to a restatement caused by negligence and/or fraud. The proposed SailingStone guideline for director Clawbacks is not equally aligned with the management Clawback policy; specifically, the management policy includes “subsequent value destruction”. NFPCCmp;A believes that Clawback policies should be identical for directors and management. However, at this time, SailingStone’s definition of “subsequent value destruction” is vague and requires additional color/context to understand the intent and measurement/definition to be utilized. NFPCCmp;A does not recommend adjustment to current Clawback policies in place at this time until discussion with SailingStone occurs regarding “subsequent value destruction.”

Change of Control Provisions

CHANGE-IN-CONTROL MULTIPLES:

  • SailingStone Guideline: Implement a change of control provision with a minimum payout of 3x the current salary and bonus.
  • NFPCCmp;A Opinion: Over the preceding twenty-four months, discussions with institutional investors has maintained a constant tone of a desire to incentivize management teams to seek accretive transactions for shareholders. As such, NFPCCmp;A supports the positioning of providing multiples of 3x base salary and bonus. However, 280(g) implications must be considered and tax mitigation strategies employed to make this a positive change.

STOCK TRANSACTIONS:

  • SailingStone Guideline: In stock transactions, a significant portion of the provision should be made in the form of restricted stock in order to tie the compensation to the returns associated with the combination. Additionally, provide a vesting period of at least one year for stock rewards associated with a change of control.
  • NFPCCmp;A Opinion: The current most typical arrangement of change-of-control payments are to be provided in cash with no vesting requirement. In the event of termination, NFPCCmp;A does not support providing change-in-control payments in restricted stock. NFPCCmp;A notes, this practice is not prevalent nor market competitive in the exploration and production market. Further, the company and their management are not who the respective executive “signed on” with. This is a significant disconnect.

ABSOLUTE TSR:

  • SailingStone Guideline: Change of control rewards should be tied to the absolute total shareholder returns (TSR).
  • NFPCCmp;A Opinion: NFPCCmp;A believes M&A activity, at its core, is intended to pursue opportunities that are accretive, and are only considered in the event a potential transaction would generate a positive result to shareholders. Additionally, in the event a transaction is pursued that does not generate appropriate returns to shareholders, lawsuits typically follow. As such, NFPCCmp;A believes any M&A should result in positive absolute returns over the current market. However, NFPCCmp;A would further like to understand SailingStone’s position on absolute total shareholder return. Specifically, guiding questions would include but are not limited to: i) what is determined to be the acceptable threshold level of return, ii) measurement date/price, iii) would there be an expectation of a sliding scale of management payout opportunity at varying absolute TSR levels, and iv) would there be plan maximums.

CLAWBACK MECHANISMS:

  • SailingStone Guideline: Clawback mechanisms should be in place in the event of fraud or negligence.
  • NFPCCmp;A Opinion: As previously mentioned, many organizations have a stated Clawback policy whereby cash or equity-based compensation provided can be recovered due to a restatement caused by negligence and/or fraud. However, SailingStone’s guideline for executives includes “subsequent value destruction” which is vague and requires additional color/context to understand the intent and measurement/definition to be utilized. NFPCCmp;A does not recommend adjustment to the current Clawback policy in place at this time until discussion with SailingStone occurs regarding “subsequent value destruction.”

Short Term Incentive Plans

DRILLING RATE OF RETURN:

  • SailingStone Guideline: Drilling rate of return target should be the most heavily weighted component in short-term incentive plans. Further, minimum required rate of return should be set at a threshold of 20%.
  • NFPCCmp;A Opinion: NFPCCmp;A believes this is a great point. However, due to the differences in every company – strategy, life cycles, debt, positions, hedges, etc. – this is again, a determination of the board and leadership as they act as fiduciaries. This granular level of direction by a shareholder eliminates leadership ability to do what is best for the long-term success of the company.

PRODUCTION TARGETS:

  • SailingStone Guideline: We will not support incentive plans that include absolute production or reserve targets.
  • NFPCCmp;A Opinion: This too should be a determination of the board and leadership. Although an over-reliance on these metrics historically occurred, most programs have evolved to create better balance. However, production is the foundation of every energy company and cannot be overlooked as a key metric.

Long-Term Incentive Plans

TIME-VESTED RESTRICTED STOCK:

  • SailingStone Guideline: Vote against all incentive compensation plans that provide time-based incentives, including restricted stock grants that are not tied to performance targets.
  • NFPCCmp;A Opinion: NFPCCmp;A believes it is generally a best practice to diversify long-term incentive grants due to the nature and intent of varying types of awards as part of the total rewards strategy. Specifically, long-term incentives are intended to attract (value of award), retain (provide some level of retention), and motivate (provide larger rewards for value creation). Each award type of long-term incentives plays a factor to this theory. Restricted stock is intended primarily to retain management in the event performance shares underperform and the resulting payout would hold minimal retentive value to key management members, resulting in potential loss of management talent and share value preservation.

PERFORMANCE SHARES:

  • SailingStone Guideline: Will only support plans that use performance metrics that are tied to absolute value creation. Examples include absolute TSR, return on capital employed, and debt-adjusted, per-share changes in production or reserves. Further, “large” payouts should not be made unless returns exceed the cost of capital and absolute total shareholder returns are at least 10%.
  • NFPCCmp;A Opinion: NFPCCmp;A can understand the frustration here, but oil and gas is still heavily dependent on the price of the commodity, which can be significantly influenced by world events. As with any good compensation plan, the goals are to attract, retain and motivate top talent to get the best returns. One still needs to motivate and retain in down times, and replacing top talent usually is a multiple of what your investment originally was. Again, context is critical and each and every company has differences.

SHARE RETENTION:

  • SailingStone Guideline: Management should not be allowed to sell their shares until they are no longer employed by the company.
  • NFPCCmp;A Opinion: As previously mentioned above in relation to directors, NFPCCmp;A does not support “hold until retirement” type arrangements. Further, NFPCCmp;A believes the establishment and maintenance of ownership guidelines, in addition to more than 50% of the compensation being provided in equity, provides for sufficient shareholder alignment and “at risk” compensation for management. Additionally, this could go against all financial planning in that an executive might have too much in “one basket” which in turn could create poor behavior versus not. NFPCCmp;A does not recommend implementing a “hold until retirement” policy; however, NFPCCmp;A does recommend reviewing the current ownership guideline levels to ensure market alignment. Furthermore, consideration may be given to implementing a 10b5-1 program which allows for the sale of a predetermined number of shares at a predetermined time as a means of providing for liquidity and avoidance of accusations of insider trading.

As always, don’t hesitate to contact us below if questions arise from any of the topics discussed here.

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