Sheila McNulty Occidental changes its succession plans – so it should

Occidental Petroleum’s move this week to address corporate governance issues raised by shareholders is the way many investors would like their companies to react. While history has shown that numerous companies simply ignore issues raised by shareholders (and maybe that is what they should do), Occidental decided its investors had some valid points.

All in one day, the company established a seccession plan with Steve Chazen, president and chief operating officer, set to become chief executive at the May 2011 annual shareholders meeting. It ended the exemptions for those past the retirement age of 75 on the board, leading two directors to say they would step down at that same meeting.

In addition, Occidental responded to calls for new faces on the board by immedately appointing Howard Atkins, chief financial officer of Wells Fargo. And, perhaps most importantly for shareholders, it approved a new compensation programme that brings executive pay down to the levels of those in the company’s peer group.

Spencer Abraham, chairman of the Compensation Committee, said in an interview the board began working on these issues as soon as the matters came up in the form of a proxy vote at last year’s meeting. The goal was to come up with a plan that rewarded superior performance and attracted strong leaders but within the range of the company’s peers.

Last year, Occidental’s outgoing ceo, Ray Irani, earned almost double the salary of Rex Tillerson, chief executive of ExxonMobil, the US’ biggest oil company, who received $27.2m in 2009. Mr Irani was paid $52.2m in 2009.

The new compensation programme, which applies to all senior Occidental executives, uses long-term incentives, most of which are performance-based Total Shareholder Return Incentives (TSRIs). They are measured against a 12-company peer group. If Occidental performs in the bottom 25 per cent over a three-year period, Mr Irani and Mr Chazen will not receive any TSRI-related compensation.

In the 2009 program, there was no payout if company performed in the bottom third. In the middle third, it ranged from 0 to 200 per cent, up to 200 percent if in the top third. In the new programme, payout will be on a sliding scale: 0 if Occidentaly finshes 10th-12th versus peers, 10 per cent if it is No 9, 20 per cent if No 8, 40 per cent if No 6, up to 100 percent if No 1.

Maximum payout of TSRIs will occur only if Occidental’s cumulative three-year TSRI performance ranks first and outperforms the S&P 500. The most Mr Irani could receive under this plan, if Occidental ranks first among its peers, would be $20m.

Under the previous system, he could have received $90m on top of base pay of $1.3m and a bonus of $2.2m. The base pay and bonuses for Mr Irani and Mr Chazen will be only narrowly adjusted when they take on their new roles, given that they were among the bottom of the peer group.

The rest of the long-term incentives will be tax-qualified Restricted Shares, with a minimum vesting period of three years. They are valued, as of the grant date, at $5m for Mr Irani and $4m for Mr Chazen.

Mr Chazen said in an interview he felt good about the changes, that what is good for shareholders is good for management. Sounds like a good attitude in taking on his new job. He also said he is pleased Mr Irani will be staying on as executive chairman, given that the two men have worked together for so many years and have managed the business as a team for the past 16 years and made Occidental into a strong company:

I’m hopeful Ray will want to stay forever. Ray is a great leader, a good person.

That does not mean Mr Chazen will continue with business as usual. While he said not to expect any big changes from him, he did hint he planned to leave his mark on the company:

There may be evolutionary type changes as our personalities are different.

A recent report by Doug Leggate, research analyst at Bank of America Merrill Lynch, explains:

Our discussions with Steve suggest he is broadly happy with the portfolio. That said, there will inevitably be some trimming around the edges. One area where he appears less comfortable is with the management of the assets where he appears significantly less accepting of mediocrity. Accordingly, we expect Steve’s influence to be focused more on the efficiency, costs and a sharp focus on delivering the production targets ladi out at the May strategy presentation.

The board has responded to shareholders by putting Mr Chazen in charge. It will be up to him to keep them happy from here on in and prove the board was right to move so aggressively in responding to shareholder concerns.