Opting Out - 1-Nov-2008 - AlbertaVenture.com

Opting Out

Posted On November 1, 2008 @ 10:12 am In Executive Compensation Report, Human Resources | No Comments

Stock
options help glue top talent to a company, right? But as their value
increases, aren’t they just as likely to aid a quick exit?

by Anthony A. Davis

When Don Gray had the chance to exercise his stock options back in
2006, they weren’t just “above water,” as the term goes. They were
above the clouds. Gray didn’t hesitate. The maverick founder, CEO and
president of Peyto Energy Trust who had, in a mere eight years, built
his natural gas producer from puny to powerhouse, up and quit, aged 41.

“The bottom line,” he says, “is we made a ton of money for our
shareholders. We had our share price go up 30,000%.” Before the company
went public, Peyto’s board had voted Gray a healthy number of stock
options to supplement his salary of about $200,000 a year. (Other Peyto
employees got options as well, from the engineers right down to the
company’s first receptionist who, says Gray, subsequently became a
millionaire.) Multiplied by Gray’s options and share units, that
mind-boggling 30,000% worked out to around 100 million bucks. Enough
that even somebody used to life’s little comforts need never have to
work again. What blue-collar workers who play the lottery call “F.U.
money.”

“I don’t crave being in the public arena,” Gray, 43, says now. “I
never wanted to be a CEO. I wanted to make financial freedom.” Now he’s
enjoying the kind of homey life that he suspects a lot of A-types in
the oil biz would go spinny trying to live. “Going from your office
tower and your job downtown to [a life] where you’re picking up your
son from kindergarten and you’re helping out with the groceries, it’s a
different world, and most of those guys couldn’t handle that change in
lifestyle. Me, I enjoy it,” says Gray, adding that he still serves as a
director of Peyto, does his own investing and occasionally helps others
start up oil companies.

Gray’s departure, like some others in the Alberta oil and gas
sector, raises a niggling question about the value of stock options as
a corporate retention tool. It may not be an issue right now, when
stock values are headed due south, but can those golden handcuffs turn
into a golden chariot straight to retirement when those options
eventually turn into hard cash? Like, say, if we had a cold winter and
natural gas prices staged a long-predicted comeback?

Out in the patch, amongst executive compensation experts, board
members and C-suiters themselves, the answer seems to be, “Maybe. Not
usually. And why worry about it?”

As a board member at a half dozen companies,
including chair of biotech firm CV Technologies, where he is a member
of the compensation committee, Gord Tallman has plenty of experience
trying to cobble together compensation packages. So much so that
Tallman, a member of the Institute of Corporate Directors and a mentor
at the University of Alberta School of Business, lectured on the
subject in 2006 at the Telus Centre for Professional Development.
Tallman sees stock options as necessary in Alberta’s continued tight
race to reel in and keep the best and brightest. Big salaries and fat
bonuses simply don’t cut it here, where risk-and-reward style
compensation – meaning options – reflects the wager mentality that
prevails in the patch. Bonuses? How boringly predictable. Moreover,
they don’t reward people for making long-term contributions to a
company. But options that can inflate like a blowfish to preposterous
size, now that’s something that motivates people.

“You can give someone an option package that vests over five years,
and hopefully you are going to retain them for five years,” opines
Tallman. “And if they’ve created sufficient value which enables them to
retire, obviously they created loads of value for the other
shareholders also.” For the company and its shareholders, that’s a
reasonable trade-off. But Tallman can’t recall anyone he knows scoring
big on their options and then taking early retirement. (A more common
problem is executives and their families raising their standard of
living based on options that are in the money now, but may not be by
the time they vest.)

Luis Navas, the Toronto-based head of
compensation in Canada for Hay Group, an international human resources
firm heavily involved in designing executive compensation packages,
says Alberta’s “strong working culture” discourages suddenly wealthy
managers from cashing out. “People really live to work in Alberta. They
just keep going at it. The average bank CEO has over $100 million of
wealth accumulated during their tenure. Why don’t they just quit?
Because they love it.” It’s no different with oil and gas types.

Options are issued at a strike price, approximately the market value
of the company’s shares at the time of issuance. They entitle the
grantee to purchase a specified number of shares at that price after a
certain vesting period, usually three to five years. If the stock has
risen above the strike price, the holder profits by the difference in
value. If the stock is lower than the strike price, the options are
worthless.

Elsewhere in the country, and in other sectors, attaching
restrictive performance criteria to the issuance and vesting of stock
options – known as restricted share units or performance share units
(PSUs) – is becoming more common, says Navas. PSUs are given to an
executive outright provided that, thanks to his or her efforts, a
company trumps certain objectives, such as beating the earnings per
share of a peer group of companies. With the multiplier factors built
into them (i.e., the number of shares granted can go up depending on
how much the company’s performance exceeds a particular measure), PSUs
can generate astronomical income for their owners. And, even if they
sink below the price of the shares when they were granted, they still
have some value and can be sold on the market. But in Alberta, and
especially among oil and gas juniors free from the executive
compensation scrutiny of institutional investors, the simple,
old-fashioned stock option holds sway. “In organizations where the
valuation might be more volatile or there are expectations of fairly
high growth in valuation, stock options can be more attractive to the
employees than whole share plans,” says Navas.

If anything, Peyto founder Gray sees options as helping to inject
new blood into what he sees as the oilpatch’s stagnant talent pool. He
used his millions as an opportunity to step aside and let a hungrier
colleague, Darren Gee, take over as president and CEO. Still, he
recognizes the flaws in option-based compensation, “primarily because
it ties [compensation] to the [stock] market, and the market itself
isn’t that efficient.” In other words, just because an oil company’s
stock price rises when oil prices go up doesn’t mean company executives
have necessarily done a great job creating long-term value. It’s the
old saying: a rising tide floats all boats. Even the leaky ones.

That’s why Peyto restricted the vesting of options to certain
performance factors. Each year the company hired an independent
engineering firm to look at its proven and producing reserves and
measure the difference between the value of those reserves and new
finds with the value of their assets the year before. Peyto also used
the same commodity price year over year to valuate those reserves, so
that wild spikes in oil or gas prices didn’t excessively inflate the
final bonuses and options given to employees. “So we weren’t paying
people for an uptick in commodity prices,” Gray explains.

But that Peyto secretary who became a millionaire, what happened to
her? “Now she’s at home raising her children,” answers Gray. “Is that a
bad thing? No, that’s not a bad thing. That’s the way it goes.” And
sure, Gray concedes, occasionally, rarely, a CEO or other top-flight
exec at a junior firm who suddenly finds him or herself with a Jed
Clampett-like fortune after options vest might leave or “choose to work
for their own capital down the road and not somebody else’s. But
they’ve got capital now and I think that is a positive for everyone.”

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