Thursday, August 8, 2019

Birchcliff Energy With A Really Jerky Move

Birchcliff Energy held its annual meeting on May 16th, with shareholders set to vote on four items. But on the day of the meeting, only three of the four items were actually voted on, and the meeting was postponed by a week "in order to allow as many shareholders as possible to review and consider the Performance Warrant Resolution". In other words, the vote was not going management's way, so it gave itself time to drum up votes and get it over the hump.

Sure enough, a week later, management won the vote 50.2% to 49.8%!

This points to a number of problems that stack the deck against shareholders, some specific to this company, and others related to how capital markets currently function.

It's unfair that companies get to see the results of voting in real-time, rather than at the same time as everyone else: when the results are announced. Imagine if only one political candidate got to see the results of a vote ahead of time. They would have an unfair advantage, allowing them to pour resources into areas that maximize their advantages.

In this case, management is looking to change the expiry date of options that have been exercisable since 2005. Amazingly, these options have been in the money for most of the last 14 years, including as recently as earlier this year.

As a form of compensation, options are bad enough as it is. They give their owners all the upside of owning a levered stock, without the commensurate downside: the company went bankrupt? no biggie, I didn't invest a dime! This encourages huge risk-taking on the part of managers, which is usually bad news for shareholders.

But this case is even worse, as management has had opportunities to buy in at a profit (i.e. when the market price is well above the exercise price, which has happened repeatedly in the last year) and participate alongside shareholders, but they have chosen not to! By continuing to want to participate in the upside without putting any money down, they continue their misalignment of incentives with those of shareholders.

There appears to be a big corporate governance problem at Birchcliff Energy.

Disclosure: No position


Anonymous said...

Hi Saj,

Long time reader.

I'll agree that options may be a bad way for compensation. But what's a better alternative?

Your "fund" is run through a corporate structure. How would you organise a performance-based fee/compensation around an entity like this?


Saj Karsan said...

Hi Bill,

Restricted shares can offer the same upside, but also involve downside risk, so that's a better alternative. Over a long period of time, management's ownership stakes can become much larger than their salaries, and that's the best way to align incentives in my opinion.

In Birchcliff's case, these guys have been running things for a very long time, and yet they are still insignificant shareholders.