By Ed Hirs, Energy Economist
The spate of bankruptcies among oil and gas producers has reached epic proportions — more than 69 since January 2015 by one count. And the bankruptcy of Energy Future Holding Corp., a group of electricity companies undone by the low price of natural gas, and the recent filing of solarenergy company SunEdison, Inc., illustrate that financial crisis and questionable management is not confined to oil and gas.
In all of these recent bankruptcies, not only are the shareholders wiped out, but bondholders and banks that provided senior debt have lost money. So what happens to the directors and senior management in those companies, the people who made the decisions that ultimately led to financial crisis and bankruptcy? In the United Kingdom, leading a company into bankruptcy generally leads directors and management team to jail. In the United States, that almost never happens.
History suggests that for many U.S. energy companies, life after bankruptcy may be temporarily uncomfortable, but it seldom leads to exile.
The great bankruptcy of Texaco in 1987 came after the company lost a $10.5 billion judgment in litigation resulting from its acquisition of Getty Oil, breaking a prior deal Getty had made with Pennzoil. The Texaco management and board remained relatively intact after the company emerged from bankruptcy a year later, following a $3 billion payment to Pennzoil.
Northeast Utilities NU +% barely averted bankruptcy in the late 1990s, another case unprecedented in size and scope and threat to the public — company management pursued aggressive cost-cutting, finally to the point of the Nuclear Regulatory Commission declaring its operations unsafe. Nuclear power plants were shut down, costing the company billions in losses; the corporation pled guilty to 25 felony counts. The management was removed, but no one went to jail.
The failure of Enron in 2001 broke ground, with members of the management team convicted of felony charges and the Enron board of directors ordered to personally pay to settle charges brought by the U.S. Department of Labor. The business model of Enron, a Houston-based energy trading and utility company, ultimately failed to produce ever-growing profits. Management hid the true performance from shareholders and debt holders for four years, while board members professed their profound ignorance. The ex-CEO is still in prison.
What do these textbook cases of energy companies on the brink and beyond tell us about their corporate governance?
The late Paul W. MacAvoy, former dean at the Yale School of Management, described the failure of corporate governance in syllogism: The CEO sets the strategic direction of the company in consultation with the board of directors. The board is then tasked with monitoring the CEO’s execution and implementation of the strategy. If the company does not meet its performance metrics, there are two possibilities with one common outcome: 1) The strategy is sound, but the CEO is ineffectual and must be fired, or 2) The strategy is bad, and the CEO who is responsible for the strategy must be fired.
In my experience, the directors of failed companies do not think critically about their companies’ business models. It is usually a matter of incompetence, negligence, gross negligence (as the law defines it) or laziness — exacerbated by being cronies of the CEO and not having the personal integrity to act independently on behalf of the shareholders. In the 2012 shakeup of Chesapeake’s board of directors — a full 10 ½ years after Enron — I pointed out, “It’s like they at last realized that no one on the board had ever leased an acre or drilled a well.”
No one on the Chesapeake board was competent in the company’s business.
Looking at the energy bankruptcies now in process, the management teams and boards appear so far to have been relatively unscathed. If removed from one company, they enter the revolving door to reappear as part of a newly reconstituted management team or board for another company. The notion that the same CEOs and boards of directors that steered the companies into bankruptcy and wiped out shareholders — who now can no longer vote to change out the board directors — remain in place for the company’s new owners seems preposterous. Is there any accountability? The decline in oil and gas prices is not an act of God but a real business risk faced in the normal course of business. These companies’ strategic plans should have adequately managed that risk.
We know where these boards of directors were. The question is: Why are they still here?
Ed Hirs teaches energy economics in the University of Houston’s College of Liberal Arts and Social Sciences. In addition, Hirs is managing director for Hillhouse Resources, LLC, an independent exploration and production company. He founded and co-chairs an annual energy conference at Yale University.