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The luck factor in oil executives' pay

Newly published research finds that luck plays a role in oil-and-gas executives' compensation — and one author says it's time to rethink how C-suite pay is structured.

Reproduced from a chart by The Conversation; Data: Standard & Poor's Compustat; Chart: Axios Visuals

What they did: Professors from UC-Berkeley and University of Michigan broke down 1992–2016 of data for hundreds of executives at 80 oil-and-gas producers, for their working paper (not peer-reviewed).

What they found: Executives' pay rises when oil prices do. A 10% increase in oil prices leads to a 2% rise in compensation.

  • That's where luck comes in. These execs don't influence the commodity cycle. But its upward swings juice the value of their packages of bonuses, incentives, stocks and options, and other compensation. Per the paper:
"Reflecting the size of this industry, the dollar value at stake in executive pay is substantial: total compensation of all energy executives in the latter part of our sample is almost $1 billion per year."

Why it matters: One of the authors, Lucas Davis, says the results should prompt changes in pay decisions. Davis, a professor at the Haas School of Business at the UC-Berkeley, tells Axios:

"Let’s make pay depend on relative performance. Not absolute. Let’s compare you to a group of peer companies."
"I would love for the boards of directors of oil and gas companies to think a little bit harder when they are negotiating the next pay package for executives."

The intrigue: Execs' compensation rises more when oil prices are going up than it falls when prices are heading down.

  • Add it all up and the paper sees "rent extraction" rather than maximizing shareholder value. It suggests that executives have "co-opted the compensation process" to increase their pay during periods of "windfall profits."

One level deeper: The authors describe it this way a new blog post:

"[A]t least to some degree, executives are exercising influence over the board of directors — extracting compensation packages that exceed what would be expected in a competitive labor market."

The big picture: The paper has corporate governance ramifications. It finds less "pay for luck" at companies where fewer executives sit on the board.

  • The paper looks back at a 2001 study by other researchers that introduced the term, and finds that "executives continue to be rewarded for luck despite the increased availability of more sophisticated compensation mechanisms."