How are small-cap E&P companies' executives compensated? Irvine, California-based investment-banking boutique C.K. Cooper & Co. set out to answer that. It looked at compensation of the top three officers of nine small, publicly held producers from 2000-02, which includes a period of depressed oil prices. The companies studied are those covered by the firm in research analysis: ATP Oil & Gas, Berry Petroleum, Canadian Superior Energy, Goodrich Petroleum, Parallel Petroleum, Petroleum Development Corp., The Exploration Co., The Meridian Resource Corp. and Wiser Oil Co. CEO compensation In general, the chief executive officer is the person to whom the entire company looks for leadership, decisiveness and vision. Many CEOs have been increasingly responsible for predicting economic recovery times in addition to industry cycles. This requires CEOs to make projections allowing them to manage risk effectively, while trying to grow their respective companies. In part, a CEO's ability to not only properly run his company, but anticipate future events within the industry and the economy, will make a huge difference in the company's future performance. With such a huge amount of responsibilities it can be justified that a CEO should be reasonably compensated. The past several years have shown volatile commodity prices, coupled with a slowing economy, so a CEO's job has become increasingly difficult. With that in mind we have seen salaries and total compensation rise on average by more than 10% year-over-year since the bottoming of the cycle in 2000. In looking at this study's results, it seems that CEO pay has returned to historical norms, with anticipated growth in the 10% to 15% range annually. The total compensation pay scales of these CEOs are now more than ever tied to overall company performance. By no coincidence, those CEOs whose stock outperformed during the study period also, on average, earned greater total compensation. Total compensation should be directly tied to a CEO's ability to increase total reserves in place and to stock-price performance. Given these parameters, investors should monitor closely the correlation between the rise in a CEO's salary and his company's stock performance and reserve growth. It is often the case where poor management rewards itself before thinking of shareholders. Identifying the companies that don't abuse shareholders will protect investors in the long run and provide better returns. CFO compensation As a research-oriented firm, we place significant value on the chief financial officer position. The oil and gas industry has seen increased volatility in commodity prices to the point that natural gas has now become the most volatile of all commodities. Given this, a CFO's job has become increasingly difficult. It was once said that the road to hell is paved with people trying to predict the prices of oil and natural gas. Most CFOs are now constantly forced to identify, adapt and overcome the extreme volatility in these commodities with the difference being making money and losing money. The CFO has been forced to become savvy in the business of oil and gas hedging, in addition to financial management of the organization, establishing and managing long-term financial budgets, evaluating financial tools to minimize risk and/or maximize profit, and determining when and how to raise necessary capital. Hedging has become increasingly prevalent due to the violent swings in commodity prices combined with highly leveraged balance sheets that must meet certain debt and dividend payments. These hedges have allowed companies to better predict future cash flows and promote growth. At the same time, these individuals must stand ready to answer to shareholders, management and analysts with specific and exact data. The compensation of CFOs varies with each company and in our opinion, reflects the varying scope of their responsibilities. On average, we have seen the compensation for CFOs returning to the average levels seen before the 1998 bottom. Additionally, total com pensation soared as a result of stock-option-based packages set in place during the downturn in 1998, which have become profitable due to the higher commodity-price environment. EVP compensation The executive vice president portion of this study has been the most difficult to define. In some cases, E&P firms utilize a chief operating officer in place of an EVP. Others have a vice president of corporate development, or in some cases, an active chairman or other executive is utilized. In an attempt to maintain some type of uniformity, we have made certain judgment calls on which executives to include in this portion of the study. The role of EVP can and will vary depending upon each issue. In certain cases, this can be a role responsible for identifying acquisition and key growth opportunities for the issue. Others utilize an executive to oversee field operations and the execution of development and/or exploration strategies. Others serve in market or public relations roles, attempting to attract wider investor attention, or develop industry relationships. As a result of the varying roles that an EVP may serve, the range of compensation also varies. Average salaries in 2000, again, reflected cost-cutting moves implemented by smaller E&P issues. Total compensation on average continues to slowly improve. In general, EVPs can be more goal-oriented and as a result, can enjoy bonus and compensation packages to reflect in part the achievement of these goals. Total compensation, like in every other category, shows a very strong rebound in 2000 well in excess of 1998 levels, however it would seem total compensation packages have begun to peak. Value generation The initial study results demonstrate total compensation of executive officers of smaller oil and gas companies without comparing overall size and corporate performance. As a result, these figures must be compared with certain operating criteria to demonstrate what type of value is in fact being generated by executives. It is not absurd to assume that officers of certain oil and gas issuers would be compensated greater than their peers at smaller companies, based upon the overall size of the enterprise, their scope of operations and levels of responsibilities. We took total compensation by key executive officers of oil and gas issuers within our analysis peer group and determined how much value was generated for each dollar paid. While the definition of value is subject to interpretation, for simple comparison we looked at revenue, net income, EBITDA (earnings before income taxes, depreciation and amortization) and barrels of oil equivalent (BOE) produced for each executive versus the total amount of compensation paid to the individual in 2002. What was the largest value produced by an executive? For instance, for every dollar paid, if an executive for one issuer generated $343.39 in EBITDA for 2002, while another only generated $1.82 in EBITDA for the same period, obviously the first executive provided more value to shareholders. This value is greater, even though this executive may have been paid substantially more than his peer. As a result, in looking at total values versus total compensation, a better comparison is provided, based upon corporate performance. Conclusion Overall, we have seen executive compensation packages increase in parallel with the rising commodity-price environment. Ironically, the increased volatility associated with higher commodity prices has increased the scope and difficulty for these executives when preparing forecasts and budgets. This study is just one piece in the puzzle of analyzing oil and gas companies, but it is value added in that it offers a brief glimpse into similar companies in the same industry. We have attempted to bring a standardized methodology to the information that is provided via public sources to enable investors and current management of these companies as well as their corresponding boards of directors to become more informed in regards to industry trends for compensation. Going forward this should allow them to make better decisions, providing benchmarks in relation to compensation for their leaders. Additionally this will allow investors to make prudent investment decisions when analyzing these companies. Philip J. McPherson is director of research for C.K. Cooper & Co., an investment-banking boutique based in Irvine, California, that covers small-cap E&P companies. He can be reached at 949-477-9300.