The following is based on a conversation with energy sector compensation expert Ed McGaughey. He is the founder of Pearl Meyer’s Houston office and has more than 30 years’ experience in the oil and gas industry.
Q. We have seen the overall challenges the oil industry has been facing over the past couple of years. What are some of the compensation-specific challenges your clients are experiencing?
A: Attracting and retaining the right talent for a particular company is just as much of a challenge in a down market. Long- and short-term incentive plans may have to serve different roles in a down market and be sufficiently nimble to adapt, at least somewhat, to realistic goals and outcomes that focus on longer term objectives. It requires more of a holistic perspective of compensation.
Annual plans’ structures, which address near-term financial and operational strategy, should be sufficiently nimble to address realistic performance outcomes—outcomes that may not trigger a payout or may trigger more conservative payouts. Long-term awards granted during these times are at a premium cost due to share price, but provide a significant carrot (at an expense to be financed or amortized by the company). They replace over the long haul (via capital accumulation in the grant) what was not realized due to the outcome of P&L focus of the annual bonus. Don’t discount the value of equity grants during downturns!
Q. With such a cyclical market, how do you structure compensation plans in a way that addresses an energy company’s strategy?
A: Understanding the client’s strategy is absolutely critical. Each has a unique value proposition and approach to their business that’s different. The fact is operating challenges and resulting strategy vary significantly—not only across, but even within a sector of the industry.
Variances can be based on geography, geology, product mix or service offering, and operation locations. Operating and financial strategies will vary by the financing structure of the company, its ownership, its phase of growth or acquisition, product and services mix, the size or age of its plants or fleet, or the level of technological solutions employed. Major capital campaigns will also have an impact on incentive compensation, both long- and short-term, and should be factored into their design or carved out with their own metrics layered into the incentive structure.
Growth strategies will vary in market cycles and compensation solutions from a holistic perspective must address and recognize performance outcomes including the shareholder’s return. Strive to maintain the line-of-sight in all plans, keeping a consistent basic plan structure and focus, and maintain that important link between pay and performance at all levels in your incentive plans.
