Investors take stock of incentive options

Kevin Hart, chief executive at AIM-listed oil and gas explorer BowLeven, had been forwarded a rather troubling thread from Fool.co.uk, an online financial forum. One small shareholder, a "WShak", had reacted angrily to the announcement that directors were to receive shares worth up to 80 per cent of their basic salary.

"I've no problem with directors buying stock but today's announcement is pretty outrageous," the writer ranted. "The directors have just handed themselves 4 per cent of the company when the shares are down 92 per cent from their highs! That shows quite staggering chutzpah." The furious shareholder left a message on Mr Hart's voicemail. The stock announcement was made on 12 December last year; within three days, Mr Hart had returned WShak's call, explaining the rationale behind the action.

The shareholder was unconvinced, and told the financial forum: "Kevin Hart rang me back this afternoon and engaged in a passionate defence of his board's actions. I told him they were taking the piss."

Shares in BowLeven, which focuses on Africa, were worth more than £4 in May, but by the time of the announcement were just 35p. Under the company's long-term incentive plan (LTIP), BowLeven annually awards senior directors and key staff shares worth up to 200 per cent of salary. They mature after three years. The idea is that staff will reap any profits from share price gains, thus encouraging them to improve operational performance. Shareholders approved the LTIP in 2006.

However, three years ago shareholders could not possibly have foreseen the devastation that the credit crunch would wreak on the value of their stock. Energy companies have been particularly hard hit s the dramatic collapse in the oil price has put further pressure on their shares.

At 33p a pop, BowLeven's directors were getting shares – 775,758 in Mr Hart's case – at very close to the company's historic low. In three years' time, it is almost certain that the shares will move dramatically skywards once the current turmoil ends. One industry observer says BowLeven directors are not incentivised to improve the share price of the company, as that improvement is inevitable: "The directors have in essence awarded themselves a bonus."

BowLeven is unusual among oil and gas firms in that its year-end is in September rather than December. Mr Hart and sector analysts believe that BowLeven's peers will detail similar plans following their full-year results announcements later this quarter. And this could lead to angered shareholders throughout the sector: "Investors often frown upon companies that issue share options [and LTIPs] at low-level prices," says Toby Pierce, oil and gas analyst at Tristone Capital.

There is no suggestion of dodgy dealings, but WShak sums up many shareholder's feelings when he says: "There is a world of difference between doing what you are entitled to do and doing the right thing." Mr Hart argues that the board is doing "the right thing" as it needs to incentivise skilled staff to stay with the company. Many of his staff have a basic in the bottom quartile of the industry, but schemes such as the LTIP ensure that they stay with the company rather than go to BP or Royal Dutch Shell.

Staff get the shares if the company performs median or better in a peer group of 10 to 13 companies. The LTIP shares awarded in 2006, for example, are supposed to vest this November, but the expectation is that BowLeven will not have performed well enough for staff to receive them. Mr Hart says directors could have awarded themselves shares worth up to 200 per cent of their salary, but only took between 60 and 80 per cent in December.

Antrim Energy, a Calgary-based oil explorer that is listed in both Toronto and London, has caused a similar stir among its investors. Last month company directors, employees and consultants were granted options to purchase nearly 2.6 million shares at C$0.31 each (£0.17). That was the share price on 11 December; nine months earlier it topped C$4.50.

The shares can be sold from 2013, and the low level of last month's share price means that those entitled to the options should make a very healthy profit. A leading fund manager with a stake in Antrim sighs: "This seems like opportunistic pricing. The level [price] of the share options is outrageous. It doesn't set the right tone."

Douglas Olson, Antrim's chief financial officer, says the company "hasn't had much of a reaction" to its announcement, and that the move is simply part of "a programme to retain employees".

Also, earlier stock options were priced at what now seem historically high levels. If directors and staff exercised those options today, they would make a loss. "Options from the past couple of years are under water," says RBC Capital Markets analyst Nathan Piper. Another sector analyst says: "Most oil executives' options are worth absolutely nothing at the moment."

Antrim has also annoyed some with the introduction of a "poison pill" in late 2007. As share prices tumble, so oil and gas companies become more affordable targets for cash-rich predators. Antrim is one of many in North America that have introduced what is known as a "shareholders' rights plan" to guard against cheap takeover approaches. Nasdaq-listed BreitBurn Energy Partners adopted a rights plan late last month.

This plan allows shareholders to convert their rights into additional shares should a predator build a substantial stake in the company. This dilutes the predator's stake in the company and makes it more costly for it to buy the target company. At least one private equity-backed energy company is understood to have been put off buying Antrim because of this poison pill.

Investors seem divided over the rights plans. Many shareholders say that the plans simply buy management time to find other bidders for the company. This stirs competitive tension and thus helps shareholders get a better price. There is also some dispute over whether the poison pill is legally enforceable in certain jurisdictions, including Canada.

However, one senior sector figure describes the prevalence of shareholders' rights plans as "monstrous". His colleague argues that they could also allow failing management teams to hold on to their jobs, when the best thing for the company could be a change of ownership. Nanes Balkany Partners is one major investor that has openly criticised poison pills.

The company last month wrote to Toreador Resources Corporation, in which it holds a 5.3 per cent stake, with a number of concerns, one of which was the board's adoption of a rights plan for one year. The letter stated that poison pills "are contrary to the guidelines for corporate governance best practices" and the plan "only serves to entrench the incumbent board and management".

The Toreador board replied that the "stock price was significantly undervalued due to the turbulent financial market conditions". The poison pill had only been implemented to protect the company against a low bid while the stock market is in freefall. Toreador also said that many other companies were using the same measure.

To the boards of energy companies so hurt by oil and stock market collapses, the granting of incentive plans and poison pills appears vital to help rebuild the value of their stocks. There are plenty of shareholders who are sympathetic to these arguments. However, a significant number of investors are becoming ever more vocal in their criticisms, and more complaints should be expected. Nor will WShak, the forum writer, go quietly: "We need to make sure that this isn't going to happen across the board in the new year and make some noise now. There's no point whingeing about it afterwards."