Chesapeake Energy Battles CEO Compensation Furor

Oil and gas producer Chesapeake Energy (CHK) is one of the 100 best U.S. companies to work for, according to Fortune magazine. If you are Chesapeake CEO Aubrey K. McClendon, that's certainly the case.

On Apr. 21, the Oklahoma City-based company disclosed what may turn out to be the largest CEO pay package of 2008. In a year when Chesapeake shareholders saw their stock fall nearly 60% and the company's profits drop by 50%, McClendon's pay soared fivefold to $100 million. And as they say in late-night TV commercials, that's not all. The company also agreed to purchase McClendon's personal art collection—vintage maps that had been hanging in Chesapeake's corporate office—for $12.1 million. In addition, the company's proxy filing notes that Chesapeake paid $4.6 million to sponsor the Oklahoma City Thunder, a National Basketball Assn. team in which McClendon owns a 19% stake. The filing says the company received TV air time and other sponsorships in return.

McClendon, 49, ran into financial trouble last October with the market's steep slide. He had borrowed money to buy Chesapeake's once high-flying stock and had become the company's largest individual shareholder. With Chesapeake's shares tumbling along with commodity prices, McClendon received margin calls and was forced to sell nearly all of his shares over three days. A stake that was worth $1.9 billion just a few months earlier vanished almost overnight, and McClendon said in an Oct. 10 press release that he was "very disappointed" by having to sell. But McClendon's board supported him and in December offered him a new pay package. According to public filings, the company designed his new plan to keep McClendon from leaving and to reward him for four large deals he negotiated last year. Chesapeake sold interests in four of its fields to BP (BP), StatoilHydro ASA (STO), and Plains Exploration and Production (PXP) in transactions that raised $10.3 billion.

Still, Chesapeake's largesse in these tough times turns off some on Wall Street, especially given the 58% plunge in company shares last year, to 16. (The stock is now just below 20.) "Will Chesapeake's Board please stand up?" Alliance Bernstein (AB) analyst Ben P. Dell titled an Apr. 23 report on the company. "Following last year's disastrous performance for shareholders, Chesapeake awarded its CEO a generous pay package, unparalleled in the industry," Dell wrote.

a most "shameful document"

Investor Jeffrey Bronchick, whose Los Angeles-based asset management firm Reed, Conner & Birdwell owns 1.18 million shares of Chesapeake, told Chesapeake directors in an Apr. 23 letter that the company's proxy statement shocked him. "I sat in silence for ten minutes contemplating my 25-year career in the investment management business," Bronchick wrote. "I have never seen a more shameful document." Bronchick added that he plans to vote against all the directors up for election at the company's June 12 annual meeting.

Chesapeake declined to comment on the compensation controversy and said McClendon and other officials were not available for comment. In response to an e-mail, McClendon said "Our [SEC filing] speaks for itself we believe."

McClendon's pay has already dragged the company into court. In March the Louisiana Police Employee Retirement System, which owns 85,000 Chesapeake shares, filed a lawsuit in state District Court to acquire all company documents regarding McClendon's compensation. That filing—an initial effort to gather information—also says the Louisiana investors may file a shareholder lawsuit alleging that the board breached its fiduciary duty to shareholders by signing a lucrative new employment contract with McClendon when his old contract hadn't yet expired. The art purchases simply add fuel to the fire, says attorney Marc I. Gross, who represents the police pension fund. "There's no purpose served by an oil company buying art," Gross says. "It's not a museum."

In an Apr. 16 response to the police pension fund suit, the company asked the judge to deny the investor's request for documents. The court filing said that McClendon's employment agreement was "the product of a carefully crafted exercise of business judgment that could not possibly support any inference of probable wrongdoing."

Well-drilling investment option

McClendon and former partner Tom L. Ward founded Chesapeake in 1989. Through canny acquisitions and a big bet that new reserves could be found under thick shale deposits, the pair turned Chesapeake into the nation's largest producer of natural gas. Ward has since left the company, but McClendon continues to be part of an unusual arrangement Chesapeake calls the Founder Well Participation Program. McClendon is allowed to invest his personal money for an up-to-2.5% interest in any wells the company drills. That program was a big part of McClendon's compensation package last year. Rather than have him pay out of his own pocket, Chesapeake paid $75 million to cover McClendon's share of the well investments.

Chesapeake's three-member compensation committee includes former Oklahoma Governor Frank Keating. (His son and daughter-in-law also work for Chesapeake, each earning just under $140,000 a year.) The company says in public filings that its compensation committee members qualify as independent directors, according to New York Stock Exchange guidelines. Keating was traveling outside of the country Apr. 28 and could not be reached for comment.

Corporate art collections are always a prickly topic for investors. Shareholder lawsuits prompted Occidental Petroleum (OXY) to eventually wean itself from a Los Angeles art museum sponsored by former chairman Armand Hammer. Casino magnate Steve Wynn leases his personal collection to his company Wynn Resorts (WYNN) for $1 a year, although the company pays for insurance and security. As for Chesapeake, its public filing says that it got a deal. A private appraiser figures the collection is worth $8 million more than what the company paid.

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