Chesapeake Energy (CHK) just can’t catch a break. Natural gas prices have slumped to levels where exploration companies must wonder whether it makes sense continuing to extract the stuff. Fitch Ratings cut its outlook for the company’s debt to negative from stable, citing the fact that it has continued to spend heavily in spite of those ultra-low prices. Meanwhile, public opposition to “fracking” – the hydraulic fracturing process in which chemicals are injected into shale rock along with other substances in order to extract fuel trapped in those formations – is mounting, and the Obama administration is launching plans for tougher oversight on federal lands.
And now it seems as if some regulators and politicians believe that Chesapeake might be the next Enron. Certainly, an aide to Sen. Bill Nelson (D - Fla.) said the senator plans to ask the Justice Department to probe the possibility that Chesapeake manipulated commodity prices and committed fraud. At the heart of the storm is Aubrey McClendon, the company’s co-founder and CEO – and its former chairman. In the wake of revelations that McClendon was awarded the right to buy 2.5 percent of every well that Chesapeake drills – and that he had taken out more than $1 billion of loans on those ownership stakes – Chesapeake has been hit with an SEC investigation and shareholder lawsuits. And last week, the board finally told McClendon to give up the chairman’s job.
All of this hit the headlines in the same wake that media tycoon Rupert Murdoch was lambasted by a British parliamentary committee as being unfit to run a publicly traded media company. McClendon and Murdoch have quite a bit in common. Both men are slightly larger than life; both men played the key role in founding the companies they now run; both largely shaped the terms of their employment to their own wishes. Hubris? Yes, combined with poor corporate governance.
It’s always a challenge to instill best practices within companies whose founders have large egos when those founders are still large owners and play a critical role in the operations of the business. In the case of Murdoch, it has long been clear that he calls the shots; he handpicks his managers and demands that they get results. Little in the structure of the company enables anyone to challenge Murdoch: Even the company’s board has a history of going along with whatever the media baron decrees. How many truly independent boards of publicly traded companies would be content with an 81-year-old chairman and CEO and no clear succession plans? How many independent boards would respond to accusations of massive corporate misconduct and cover-ups with a bland statement that they retain “full confidence” in the “fitness” of their leader?
At least Chesapeake’s directors have taken a step to rein in McClendon, however belatedly. True, they should probably never have signed off on a co-founder combining the twin roles of chairman and CEO – a red flag for many governance experts. And they certainly should have challenged that questionable perk giving him the right to profit personally from the company’s operations, above and beyond his salary and the value of his ownership stake in the business. To the extent that they also were aware of him participating in a commodity hedge fund that may have been run from Chesapeake’s own offices – well, that’s a graver matter.
Chesapeake shareholders already have paid the price of this poor governance, so directors shouldn’t think they can rest easily after stripping McClendon of one of his titles. The stock has fallen more than 50 percent from its 52-week high, slipping from $35.75 to just above $17 a share. While natural gas prices have certainly weighed on the company’s profits, that can’t explain the magnitude of the discount applied to its assets. Analysts at SunTrust Robinson Humphrey calculated they are worth at least $42.2 billion; its current market capitalization is a mere $11.57 billion.
Chesapeake’s board has an opportunity to demonstrate they have the kind of backbone that those at News Corp. (NWS) seem to be missing. They have taken the first step; now they need to ensure that management doesn’t allow itself to be distracted by the kerfuffle over McClendon’s personal dealings. The company can’t control natural gas prices, but it can manage its capital spending levels and it can do everything in its power to ensure that upcoming asset sales go smoothly and generate maximum value for the company and restore confidence among investors and debt holders.
It’s no coincidence that Fitch cited corporate governance as a concern in its comments on Chesapeake. In some cases, when examples of poor governance hit the headlines, they can simply be distractions. In other cases, they can signal much more serious problems and abuses that expose the company and its executives to civil or criminal penalties – we just need to look back to companies like WorldCom, Tyco (TYC), Enron and too many others to mention to understand just what can transpire when corporate ethics are AWOL and directors fail to exercise their responsibilities.