Chesapeake board does too little, too late

May 1, 2012

By Christopher Swann and Robert Cyran
The authors are Reuters Breakingviews columnists. The opinions expressed are their own.

Chesapeake Energy’s decision to do the right thing shouldn’t impress investors. Its directors are only doing so under duress. Stripping Chief Executive Aubrey McClendon of the chairmanship and ending his personal investments in the firm’s wells are obvious and very belated moves. But McClendon’s deal-making and borrowing have accompanied lagging returns. Shareholders deserve more radical changes in the boardroom.

Many of Chesapeake’s woes may have been exacerbated by allowing McClendon to take a slice of each of the company’s wells. Sure, he shared the costs of drilling but the way he borrowed reduced his personal risk, giving him an incentive to push Chesapeake into a perpetual spending spree. Furthermore, as a risk-taker by nature, McClendon pushed the firm to take on far too much debt – close to half of which resides off the balance sheet. The firm’s monstrous complexity, thanks to dozens of side deals, also looks to have been driven partly by a desire to fund this empire-building.

Unfortunately, the board’s moves don’t amount to enough. Chesapeake’s long underperformance meant the board had plenty of time to consider the impact of the well program’s perverse incentives. Even accounting for dividends, Chesapeake investors have lost about 40 percent over the past five years, against positive returns of more than 50 percent for rival EOG Resources and 85 percent for Range Resources.

Yet directors didn’t act until a media firestorm consumed the company. What little steps they have taken so far reinforce their unwillingness or inability to rein in McClendon’s risk-taking unless they have a gun to their heads. They virtually admit as much by allowing him to stay on as chairman until they identify his replacement, rather than having one of them take on the role, if only temporarily. In any event, one outsider is going to find it tough indeed to stand up to the firm’s founder and chief executive backed by a supine board.

At the very least, additional board members are needed, in addition to the two seeking reelection who shareholders can vote against in the upcoming annual meeting. McClendon has at least amassed an impressive energy portfolio. But he increasingly looks to be the wrong man to harvest these resources. His financial legerdemain has left the firm highly vulnerable and means investors may never get to reap the full benefits from Chesapeake’s most promising businesses.

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