Is This Company's CEO Worth It: Chesapeake Energy

CEO compensation is a hot topic, especially now that the Dodd-Frank Act requires say-on-pay votes at public companies. Here is just one example of a company where pay and performance seems to disconnect; judge for yourself whether this company's CEO is worth it.

When I don't understand something, I tend to get fascinated by it. This typically happens with absurd things like the mindset of Raj Rajaratnam, the widespread fraud in Chinese reverse-merger stocks, and TLC's Extreme Couponing.

Thanks to lavish pay packages and a seeming band-of-thieves mentality on the board of directors, you can add Chesapeake Energy (NYSE: CHK  ) and CEO Aubrey McClendon to that list.

Co-founded by McClendon and current SandRidge (NYSE: SD  ) CEO Tom Ward (who appears to have brought Chesapeake's pay practices with him), Chesapeake is a pretty interesting business. The company is one of the industry giants when it comes to natural gas. Though natural-gas prices have been in the dumps for a while, many have high hopes that it will have a bright future thanks to its relative abundance and cleanliness.

Not convinced? Just ask energy superpower Exxon Mobil (NYSE: XOM  ) why it was willing to cough up $41 billion to buy the gas-focused XTO Energy.

And although Chesapeake is primarily known as a nat-gas player, it's also aggressively moving toward producing more oil -- which isn't a bad plan, given the high price that crude is commanding. Take all of this together, and it's not surprising that my fellow Fools at Motley Fool Alpha have made Chesapeake a recommendation.

The pay
However, even in light of the positives for Chesapeake, I still find myself uncontrollably dry-heaving as I look at the pay packages that the company has given McClendon. In 2010, McClendon's total compensation was $21 million, which included a $975,000 salary, a $2 million cash bonus, $17 million in stock awards, and roughly a million more in perks that included personal use of the company jets, retirement contributions, and personal security services.

The total package puts McClendon's pay in the same league as -- or above! -- the CEOs at Chevron (NYSE: CVX  ) ($16 million), GE (NYSE: GE  ) ($21 million), and ConocoPhillips (NYSE: COP  ) ($18 million). And that's pretty outrageous, considering that those companies are, respectively, 10, 10, and five times the size of Chesapeake.

And this is far from a fluke. For the five years ending in 2010, Chesapeake handed over $193 million in total pay, including a gargantuan $112 million jackpot in 2008. And if all of this isn't enough to make your blood boil, consider that the massive 2008 payday was during the same year that McClendon got battered for idiotically stacking up his stock holdings on margin. It was also in 2008 that the company infamously spent $12 million to buy a set of historical maps from McClendon and became a founding sponsor of the Oklahoma City Thunder -- an NBA team that McClendon owns nearly 20% of.

The performance
If the stock had produced outstanding returns over the past five years, perhaps we could shake all of this ickiness off and explain why some shareholders have put up with this. Well, it hasn't. During the five-year stretch that Chesapeake shoved nearly $200 million (not including map money) in McClendon's direction the stock lost 17% of its value.

At the beginning of 2006, $1,000 would have done better if it was invested in an S&P 500 index.

But I get it. Try as he might, McClendon can't control the stock price. And as a long-term investor myself, I understand that some of the best investments take time to play out from a stock-price perspective.

So let's leave stock price aside for a moment and look at some fundamental metrics.

Metric

Fiscal Year 2006

Fiscal Year 2010

Change

Revenue $7.3 billion $9.4 billion 29%
Operating profit $3.5 billion $2.7 billion (23%)
Shareholders' equity $11.3 billion $15.3 billion 35%
Simple free cash flow* ($3.8 billion) ($4.1 billion) NM
Return on capital 14.3% 6.4% (7.9%)

Source: Capital IQ, a division of Standard & Poor's. *Calculated as cash flow from operations less capital expenditures and net acquisitions.

Again, I get that natural-gas prices have fallen, an uncontrollable factor that has a huge impact on the company's financial performance. I also understand that there's a definite "the best days are yet to come" flavor to the Chesapeake story. But at least for me, nothing excuses that fact that the metrics we've reviewed simply don't justify the slap-yourself-to-see-if-you're-dreaming pay that Aubrey McClendon has received over the past five years.

What now?
I obviously have some strong feelings about the governance practices at Chesapeake. A big part of my interest stems from the fact that I believe in the natural-gas story and I really want to like this company. However, I just don't feel that I can trust a company that appears to be run primarily for the benefit of its CEO -- who, by the way, is a relatively small shareholder these days.

If you are a shareholder, there are a few things that you can do. The Chesapeake annual meeting is on June 10. Before that date, if you're not planning to attend, you need to grab the proxy card that was mailed to you or use the telephone or online voting options (more info in the proxy here) to show how you feel about the company's governance practices. You can:

  1. Vote against in the advisory vote on compensation.
  2. Vote for an advisory vote on compensation every year.
  3. Vote for an advisory vote on director compensation.
  4. Withhold your vote for the directors up for re-election.

No. 3 is particularly important. Though I've focused on McClendon, the compensation for Chesapeake directors is also ludicrous. In 2010, they were paid an average of $527,000. That's just … wow. Unsurprisingly, the board recommends that shareholders vote against this proposal and backs up its stance with a ridiculous "Total Non-Employee Director Compensation vs. Enterprise Value" graph.

And if that's not enough action for you, you can always contact the company's investor-relations department and let the people there know how displeased you are with the company's compensation practices.

Bottom line: There's an interesting business case here at Chesapeake, but the company is badly in need of more accountability at the top.

Motley Fool newsletter services have recommended buying shares of Chevron and Chesapeake Energy. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

Fool contributor Matt Koppenheffer owns shares of Chevron but has no financial interest in any of the other companies mentioned. You can check out what Matt is keeping an eye on by visiting his CAPS portfolio, or you can follow Matt on Twitter at @KoppTheFoolor on Facebook. The Fool's disclosure policy prefers dividends over a sharp stick in the eye.


Read/Post Comments (9) | Recommend This Article (26)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On May 30, 2011, at 2:31 PM, TripleWhiskey wrote:

    OK,so you gut the company of these guys...

    Where are you going to find that experience , knowledge and the many connections they have with the big boys.?.. I don't like it,but I also think the business would suffer greatly under unfamiliar hands..

    Cut the pay packages...

    Didn't Aubrey's Gift come with a claw-back if he didn't perform?

  • Report this Comment On May 30, 2011, at 8:12 PM, CTProgrammer wrote:

    5 stars from the CAPS crew, huh? Wow.

    I have bobbed in and out of CHK quite a few times over the past several years. Typically, when everyone was down on it I'd buy, and when everyone had nothing to say but great things, I'd sell. It worked and I made quite a bit off of them.

    But to go long on CHK is (pardon the pun) foolish. If you give money to crooks, don't be surprised when you get ripped off. I still can't believe the whole thing about Aubrey getting paid millions in bonuses after he lost everything on margin... and people were using the fact that he was an insider buying the stock as justification for buying CHK.

    Lots of other gas companies. I wouldn't touch CHK with a ten foot pole now.

  • Report this Comment On May 31, 2011, at 8:25 AM, rockhat wrote:

    How many hours a year does a director work for $527,000?

    But TripleWhiskey has a point. These guys are very good at lining up Republican congressmen to let them do what they want.

  • Report this Comment On May 31, 2011, at 9:55 AM, trin6810 wrote:

    CHK mangement style typical of industry out of control - massive expenses - continuing price decreases - more debt - environmental disaster - no accountability from anyone - man at the top who can't get enough - perfect fit for disaster.

  • Report this Comment On May 31, 2011, at 12:15 PM, NattyGas wrote:

    One statement and one statement only explains how wrong this whole article is:

    "Co-founded by McClendon and current SandRidge (NYSE: SD ) CEO Tom Ward (who appears to have brought Chesapeake's pay practices with him), Chesapeake is a pretty interesting business."

    Keywords: Co-founded by McClendon. He has BUILT this company from the ground up to a 19 BILLION dollar shale powerhouse, and he is getting slammed for getting paid? He has dedicated his whole life to this company... Could you really say that about any other major oil and gas company's CEO?

    Yes he is a bit extravegant, but he made Chesapeake what it is today, literally. And make no mistake, Chesapeake is the leading shale player in the world. It's a bumpy ride with Chesapeake, but you can't deny Aubrey's dedication to his company.

  • Report this Comment On May 31, 2011, at 4:24 PM, GreatestPakiQB wrote:

    I hate you but loved the article.

  • Report this Comment On May 31, 2011, at 5:56 PM, TMFKopp wrote:

    @GreatestPakiQB

    Get in line and thanks.

    Matt

  • Report this Comment On May 31, 2011, at 6:08 PM, TMFKopp wrote:

    @NattyGas

    "He has BUILT this company from the ground up to a 19 BILLION dollar shale powerhouse, and he is getting slammed for getting paid?"

    Here's how this works: When you build a company like this, you end up with a sizable ownership stake which grows in value as the company grows. In other words, you get wealthy the same way other owners do.

    When you get greedy and use margin to supersize your stake and end up losing it all because the stock tanks, that's it, you blew it. Your fellow owners who weren't as stupid are (or at least should be) under no obligation to make you whole.

    In other words, McClendon has had two distinct roles at this company: 1) As a founder and major shareholder and 2) As a CEO who is running the company (or at least should be) for the benefit of all shareholders (and stakeholders for that matter).

    McClendon should get rewarded for founding the company through the value of his ownership stake (oops!). For his CEO role he should be rewarded in a fashion similar to like-sized companies and with an eye towards the company's performance.

    If the best is yet to come for CHK, then let McClendon stick around to see that happen. As CEO, I will be happy to see him get rewarded when shareholders are also getting rewarded. But the pay packages that he receives *today* on the prospect of what will happen *tomorrow* is gross -- particularly because you know that this isn't a down payment on what he'll receive tomorrow if the company does start killing it.

    I know I do more than my share of parading Buffett around on just about any matter, but he built the Berkshire Hathaway empire from the ground up. Where does his reward come from? It's certainly not his salary and stock bonuses...

    Matt

  • Report this Comment On June 09, 2011, at 12:55 AM, jekoslosky wrote:

    Followed the advice in my shareholder voting Thursday. That's for the work, Matt.

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