As Charlie Munger has told us, "The most important rule in management is to get the incentives right." But Chesapeake's board appears to be transferring wealth from shareholders to McClendon in order to help offset losses which were the result of McClendon's own risk-taking: during 2008, McClendon purchased Chesapeake shares on margin, and was forced to sell these shares at a loss on October 10th. McClendon's $75 million bonus and the map collection purchase took place at the end of the year. While McClendon would likely have been the sole beneficiary of his margin position had Chesapeake stock soared, his downside risk appears to be subsidized by Chesapeake's shareholders!
A perverse incentive situation such as this encourages reckless and risky behaviour on the part of managers. Managers are more likely to take undue risks, due to the rewards that come with positive outcomes and the muted financial punishments that come with negative outcomes. It is also not surprising that the company had positive earnings of over $700 million for 2008 (showing strong results while it released the details of McClendon's compensation), but declared almost $10 billion in unusual expenses in the first quarter of 2009. You have to aggregate the company's earnings for the last 5 years in order for Chesapeake's earnings to top its CEO's 2008 compensation!
This is not the kind of company you want to own. But if you own the S&P 500 index, you do own this company.
Disclosure: None
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