The Editorial Board read with interest the October 29, 2010 Edgar-Online article Occidental Petroleum tweaks executive compensation policy that indicated that “The company plans to use more long-term incentives to compensate its top executives. Specifically, it will rely on so-called Total Shareholder Return (TSR) Incentives, which grant bonuses to executives based on how Occidental’s stock performs relative to those of 12 peer companies.”
A little background – Occidental’s top executives (in particular Messrs. Irani and Chazen) have long been among the highest paid executives in their industry, if not in the world. Critics have argued its rewards programs have dramatically overcompensated Mr. Irani in particular.
Yet a quick inspection of Oxy’s most recent proxy suggests the company has performed well since 2000, trouncing both its peer group and the S&P 500 Index in cumulative TSR over 3, 5 and 10 year periods. So why are its two largest shareholders- Relational Investors and the California State Teachers’ Retirement System” pressuring the Company to change the compensation design? Well, the same proxy statement also indicates that for 2009, Irani’s and Chazen’s maximum compensation levels were approximately $97.4 million and $42.8 million, respectively. So Oxy Pete may be another example of the potential excessive compensation abuses many believe is inherent in the U.S. business.
But how much is too much pay?
While the answer to that question is elusive, no one can argue that at Oxy-Pete, Messrs. Irani and Chazen have been paid very well. Irani’s equity holdings are currently valued at $665 million (March 2010 proxy statement), while Chazen’s are approximately $188 million. At these levels, there is significant debate in the compensation world regarding whether and how much more equity an executive actually needs to receive to be “incentivized”.
So while there is nothing magical or groundbreaking about Oxy’s Total Shareholder Return design, the Company’s statement that “the compensation for Occidental’s chairman and chief executive officer is expected to be lower than that of one or more peer companies” (which include the likes of Anadarko, Apache, Chevron, Conoco and Exxon) signals a significant departure from past practice.
Regarding the plan itself, “Total Shareholder Return Incentives” are currently used by roughly 40% of the companies that use long term incentive plans. These programs typically use 36-month returns, though some companies use shorter periods and very few use 5-year return. The challenge with these programs from the Company’s perspective is that it can be difficult to set performance criteria for longer time periods, and plans are often “way up” or “well under” water, neither of which may create the incentives the company was attempting to achieve. The strength of the relative TSR design is that performance metrics aren’t determined solely by the Compensation Committee, they are determined relative to how the company’s stock price (including dividends) compares to peer companies during the same period. This works well in an up market, but not necessarily in a down market, where executives can “perform well” even though the stock may have fallen in price – and the shareholders have suffered losses. How much executives should be compensated for “damage control” is a hotly debated topic both in and out of the Board room, and takes on additional complexity in today’s current climate where risk management has become increasingly important.
Perhaps the Oxy Compensation Committee acquiescence to shareholder demands is a sign of things to come, as the compensation market continues to evolve and assimilate incentive pay with risk management. It will be interesting to see how some of the company’s competitors both in energy and in the aggressive pay arena – respond to similar challenges.
Contact Garry Rogers at Garry.Rogers@grahall.com
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