#payfail at Chesapeake Energy

There was some blowback at last Friday's annual meeting when Chesapeake Energy (CHK) shareholders sent a strong message to management and the board about excessive compensation and inadequate oversight. Too bad the company still appears to be deep in denial.

Even though 42 percent of the shareholders voted against the pay plan and more than 20 percent voted against the two directors up for re-election, including CEO/founder Aubrey K. McClendon, the company is trying to spin it as a win and to distract unhappy investors by increasing the dividend. They'll need to do much more to win the vote next time.

Still lost despite the antique maps
I've been waiting for this ever since Michele Leder of the indispensable Footnoted blog broke the story about board's decision to use $12.2 million of corporate funds to purchase McClendon's collection of antique maps. Leder located this lulu of a disclosure in the company's 2009 proxy statement. That valuation, it turns out, was provided by someone intimately familiar with the collection; he was the dealer who advised McClendon on the purchases.

And the justification for this asset allocation? The maps serve the purpose of "complementing the interior design features of our campus buildings and contributing to our workplace culture" and because "it was not appropriate to continue to rely on cost-free loans of artwork from Mr. McClendon."

That proxy came out in 2009, the same year that McClendon headed up the list of the highest paid CEOs in the country. In addition to the side payment for his maps, he received more than $114 million in realized compensation for the year, including a bonus just shy of $80 million, despite a 40 percent decline in stock price for 2008.

Co-investing with the company's money
It gets worse. The bonus was paid pursuant to the company's Founder Well Participation Program. That means McClendon acts as on his own behalf as an owner of new natural gas and oil wells explored by Chesapeake Energy. The bonus was applied as a credit to this program, to make sure McClendon could continue to co-invest with the company.

According to the Motley Fool's Matt Koppenheffer:

In 2009, the future net revenue of McClendon's interests, discounted at 10% per year, was valued at $108 million. In 2010, that value had grown to $308 million.

Equity grants: The ties that don't bind
In addition to the lucrative co-founder side deal, Mr. McClendon has received enormous equity grants in the company as compensation. In 2008, his restricted stock profits were more than $34.5 million and he received additional restricted stock grants worth almost $33 million.

This might be worth something to shareholders if it increased his holdings. However, the board allowed him to amend his employment agreement to reduce his required equity ownership when he had a margin call. And his $1.8 million in perquisite payments included $577,113 in personal accounting support and $648,096 in aircraft use, among other benefits. In 2010, he received more than $21 million, plus the aircraft and other perks.

No means no, no is always no
So I was delighted that both leading proxy advisory firms, Institutional Shareholder Services and Glass Lewis, recommended "no" votes on McClendon's pay this year. They also took the unusual step of recommending a "no" vote on McClendon himself, because he was up for re-election as chairman of the board, and against former Sen. Donald Nickles, who chairs the governance committee.

The company's response was weak. It said it was unfair to "penalize" these directors because they were not on the compensation committee. But one of them chairs the governance committee and one of them is the recipient of the compensation. And every director is responsible for this comprehensive failure of oversight.

Chesapeake managed to get majority support this year by making some concessions in response to shareholder concerns. It eliminated some of the most offensive elements of the play plan and agreed to retain an independent compensation consultant. It agreed to implement majority vote requirements for directors.

And, most important, it added longtime Warren Buffett associate Lou Simpson to the board at the "suggestion" of its largest shareholder, Southeastern Asset Management. I'm guessing that means that in exchange, Southeastern agreed to vote its shares for the directors and the pay plan this time. But if things don't improve, that 12 percent block could swing the vote the other way a year from now.

So the directors -- especially the compensation committee members Gov. Frank Keating (Chairman), Charles Maxwell, and Kathleen Eisbrenner already thrown under the bus by the company as the appropriate targets for concerns about pay -- would do well to heed the warning they might find on some of those antique maps: Here be dragons.

Related:

• Chesapeake Energy's Shift to Oil Won't Work Without Higher Natural Gas Prices
• Chesapeake Energy Turns Tail on Natural Gas, Looks for Oil Instead
• Chesapeake Energy Dismisses Earthquakes and Dead Cows -- Says Company Still "Clean and Green"
• Chesapeake's Joint Venture Strategy Hooks Another Foreign Energy Company
• Another Spending Spree at Chesapeake Energy?