Last week’s release of a new Ontario Teachers’ Pension Plan (“OTPP”) study is another example of an institutional shareholder setting out industry-specific concerns related to executive compensation, together with suggestions for improvement. Specifically, this report questions whether the oil & gas industry’s existing incentive structures are properly designed to reward desired behaviour from a shareholder perspective.
OTPP’s review of incentive structures and performance of 45 mid- and large-cap North American exploration and production (“E&P”) companies between 2012 and 2017 builds on the growing trend of investors commenting on companies and boards in the North American resource sector. Recent commentary from other investors includes Paulson & Co., Macquarie Group, and SailingStone Capital Partners, who covered these topics and raised related questions about corporate governance and board oversight.
The OTPP study reviews whether compensation programs in the E&P industry have been designed to reward the right behaviours, and how incentives may influence company performance and valuation. The review finds that stock market performance among E&Ps lagged the broader market, while operations have continually grown to the detriment of returns. The report suggests several compensation design alternatives for consideration, including:
- changing short-term growth incentives to include production and reserve metrics that are per share and debt adjusted,
- focusing management on achieving company-wide return on equity (“ROE”) or return on capital employed (“ROCE”) targets,
- replacing relative total shareholder return (“TSR”) with absolute TSR for long-term compensation targets, and
- including a greenhouse gas or other related emission target.
While the OTPP report is focused on the oil and gas industry, some of the observations can be applied more broadly across the market. We suggest Boards review the report and be prepared to address, where applicable, these concerns in 2018 proxy circular disclosure or through engagement with shareholders. Management incentive design remains a key concern for many institutional shareholders, particularly in the context of a lower-for-longer commodity cycle, potential industry disruption, and heightened scrutiny of corporate social responsibility.
Read the full report here.
If you have any questions on this study and its potential implications, then please let us know.