Key Takeaways from TPH’s Proxy & Governance Conference
Recently, some of the team at NFPCC was afforded a great opportunity to participate in TPH’s Energy Roundtable discussion with multiple constituents involved in the corporate governance landscape within the industry. TPH (Tudor, Pickering, Holt & Co.) is an integrated investment and merchant bank providing high quality advice and services to the energy industry and NFPCC was honored to participate.
We listened and contributed to thoughtful discussions on the current state of the industry, changes that could be put into effect to “right the ship” for the future, and how external stakeholders might view decision-making going forward on compensation. NFPCC finds these events informative and constructive in our role as independent compensation and governance advisors to energy companies (both private and public), as information and insights gleaned help inform our data landscape when providing advice to clients.
BELOW ARE SOME HIGH-LEVEL TAKEAWAYS FROM THE DAY THAT WE THINK OUR READERS AND CLIENTS MIGHT ENJOY:
1. The Focus On Diversity Should Continue – But Not Necessarily In The Way You Think
In a vein similar to broader corporate governance trends, there is considerable energy behind the idea that more diversity at the top levels of organizations is needed. Going beyond gender and race diversity initiatives that have made great progress in the S&P 500 (with work still to do in Russell 3000), there was focus on the idea of “thought diversity.” Whereas companies in the energy industry have historically constructed boards with members of similar backgrounds (generally current/former executives from industry), would it be accretive to corporations and their shareholders if boards engaged in a shift in their demographics to include expertise from outside the industry? While there are pitfalls to be mindful of, too much diversity leading to an over-reliance on the CEO for operational education or lack of necessary expertise in M&A situations serving as two examples, today’s environment warrants additional discussion on this topic and an honest self-assessment of boards by its members to determine if any underlying issues might persist.
2. Compensation At The Board Level
While there has been, and will continue to be, much discussion around the structure of compensation for executives, the level of discussion on board pay has been minimal at best. With recent changes to policies by various entities in the corporate governance environment (ISS and institutional investors) serving as the backdrop, there was good discussion on the philosophical approach to compensating board members for their service as fiduciaries for shareholders. NFPCC appreciated the discussion, including reasons for adjusting pay practices to ramp up the alignment of board interests with those of shareholders, and will continue to take stock of such thinking going forward as it advises clients on such matters. While the thought-provoking questions are warranted as investors look for ways to encourage improved performance going forward, transitioning from a model of “pay for governance” to “pay for performance” carries risks, including a blurring of the lines of governance vs. management. Finally, paying boards in both cash and stock is a solid practice. If paid only in stock, it puts pressure on how taxes will get paid. The cash received by boards usually goes to pay the tax of the stock the vest in, ensuring better alignment with shareholders.
3. Compensation At The Executive Level
As a surprise to no one, there was lots of discussion on executive pay. While the topics and questions ranged, there seemed to be the biggest focus on the following:
- ANNUAL INCENTIVE METRICS
Key issues noted here were two-fold. First, as the industry moves away from outright growth measures for incentives in response to investor concerns, numerous participants inquired on the potential for a “whipsaw effect” on incentive structures. While it is virtually a requirement in today’s industry environment to adopt returns-focused metrics that will encourage management to strive for such behaviors, we note it is similarly critical that companies manage their short-term incentives to accomplish short-term objectives. Volatility has become the norm in the energy industry, and companies need to be mindful of changing dynamics and adjusting incentives to reflect changing strategies.
The second key issue noted on annual incentives was the proper setting of performance hurdles relative to payouts. The average level of performance achievement of annual incentive goals during the current bear market has some investors concerned that performance objectives are too easily achieved. NFPCC noted, as it does with all clients, that aligning pay outcomes around appropriate probabilities of achievement is paramount to setting up an effective incentive system that ultimately will drive value to shareholders. 50% – 65% probability of achievement of target level performance hurdles is a common starting place.
- LONG-TERM INCENTIVES
Not surprisingly given the bear market, participants noted growing concern with the structure of long-term incentives and the reality of management teams earning compensation when shareholders are hurting. Many commented that the use of relative total shareholder return, or TSR, was problematic in and of itself. Such questioning is warranted, as from a logical standpoint long-term shareholder loss should not correlate to manager gain. There was general consensus that long-term incentives to management teams should include some degree of influence from absolute total shareholder return performance. There are varying thoughts to how that can be accomplished, and NFPCC notes the facts and circumstances of each issuer will dictate the best approach.
Also relevant to long-term incentives was ample discussion on the levels of “skin in the game” of management teams. While some statistical studies might be warranted on this, and likely to come from us in the future, many participants found the level of ownership (as a percent of common outstanding) to be underwhelming. It was generally agreed by those in the room that increases in such ownership levels, combined with tweaking of stock retention rules, would be a positive move for the industry.
Consider the above a cliff notes version of the roundtable event. Curious to hear more? » Questions come to mind from this brief? » Please reach out to the NFPCC team at (281) 378.1350 as we would love to chat more.
