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Industry Consolidation and Its Effects on Compensation

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The corporate structure over the past 30 years has been predicated mainly around the regulations necessitated by actions taken by corporations that have ultimately resulted in negative consequences. A constant balancing act of an open-market economy vs. necessary regulation has seen corporations combat the forces of what they can and cannot do. Now, as we endure yet another macro-economic financial crisis beyond our control, the worry of consolidation, primarily within the energy industry, as well as an evolving work environment, creates concern about the future of the American labor market.

Senator John Sherman, the author of the Sherman Antitrust Act, was worried about merging companies’ abilities to control wages without having to deal with the forces of a free market. However, businesses aren’t new to consolidation, mergers are commonplace during times of financial distress. In the 2000 Dot-Com bubble, overvalued, underperforming tech companies, blew through their venture capital money. They were subsequently snatched up by functioning, more profitable and established firms. Again, in 2008, big banks’ excessive risk-taking in subprime mortgages resulted in failure for some of the biggest banks on Wall Street. Now in 2020, a lack of demand for oil and gas, coupled with OPEC overproduction, had oil prices hit lows never seen before (negative WTI for a short period). We still haven’t recovered.  This has caused the balance sheets of many American energy companies to be tested as they fight to survive in a challenging energy sector being dominated by supermajors like Exxon, Shell and Chevron.

When thinking about consolidation one really doesn’t take into consideration the workers that are mainly affected by the merger. A company’s organization structure, employees, and compensation/benefits require proper due diligence for a complete understanding of the value of the employees. As with any newly structured business, problems often will occur. Mainly the fundamental issue is what exactly is being merged into the existing business. Headcount of the business can be seen as one of the more fundamental processes. A danger most commonly ignored, is if a merger can cause an anti-competition effect in the labor market, thus negatively affecting employee market value. Similar to how a firm with a significant amount of market presence/concentration has the ability to set the price of a good or service, the same structure applies to the labor market. A firm that gains power/control in the sector’s labor market has more control over the wages compared to other peers in the industry. In its heyday, Chesapeake Energy set the market in Oklahoma City, causing not just energy industry competitors to chase ever-increasing wages, but also every other industry in OKC competing for similar positions. This can be either good or bad but often results in over-payment for services simply to fill necessary roles.

As the energy market continues to concentrate, the lack of supply of job choices for the worker dwindles. Demand for workers decreases, as increased mergers push workers out of the workforce and into the open market. Not only does this apply to the general employee population, but executives as well. Fewer companies, less competition, less need for employees, less pay – simple economics. Lenient antitrust laws among regulatory forces have seen some unconstitutional mergers that were once an obvious break for the Sherman Antitrust Act and the Clayton Antitrust Act. While some figured that both employees would work together after the merger, that is rarely the case. The law of diminishing returns says otherwise as well as the determination of who will be joining the final workforce of the merger. Ultimately it comes down to finding efficiencies and cutting costs, a strong focus of today’s energy industry.

Specifically, executives are normally highly skilled workers with transferable skills across various industries, but sometimes transferring across industry boundaries proves difficult. This in turn can limit executive value or require substantial time to find similar employment. It all comes down to whether the acquiring company, or in cases of bankruptcy – the new board, desires to retain the acquired executives. In these cases, some potential alternatives businesses can put in place to make the most of their situation are transition and retention incentives. Transition awards can be set up as checkpoints in dealing with the merger/acquisition cycle, while retention awards can be seen as a means of mitigating decisions to voluntarily terminate due to perceived risk of future employment. Another consideration is to develop executive compensation plans alongside changes in pay philosophy, addressing any issues dealing with base salary, annual incentives, and long-term incentives that don’t align with the new views of the company as a means to ensure a smooth transition. As mentioned before, a close examination of pay levels on a relative internal basis is the foundational step in ensuring proper programs survive and that executives are retained and motivated to succeed in the post-M&A entity.

A big acquisition can drastically change the perceived value of competitive pay. There have not been many of these in recent years, but the Xerox/HP and Broadcom/Qualcomm mergers resulted in significant changes in the competitive landscape, flooding the technology market with executives. The oversupply/under-demand in executive talent resulted in a reduction in the short-term value opportunities for many of these executives. On the flip side, other companies reacted to the deal by ensuring pay levels were adequate to retain executives they viewed as at-risk. Market movers can shape a new norm for compensation, necessitating others to correct in order to maintain competitive pay levels. The old process of comparing peers in the same market may no longer be enough and utilizing different market reference points might be required for correct benchmarking.

For the companies involved in the M&A process, the internal equities between acquired executives and acquirer executives must be properly dealt with as well. Occidental’s acquisition of Anadarko is an example of the difficulties associated with combining cultures and pay plans. Chevron may very well run into the same situation with Noble. Pains associated with the M&A process typically stem at the employee level, so making sure a solid plan is developed and implemented often reduces the flow of unwanted turnover and aids in the short-term consistency necessary post-deal.

Often times there are trade-offs when businesses combine. Having a clear understanding of the economics and demands of the effects on consolidations can provide insight into the pros and cons of labor and business as a whole. The large independent E&P sector is a shrinking space, with Newfield, Anadarko and Noble all being acquired within a two year period. The outlook for continued acquisitions in the sector is high and there very well may be a scenario where more acquisitions occur within the next year, further consolidating an already small space. This will result in change. Changes in compensation, benefits, and severance will all be a part of the big picture of M&A. It will be necessary to continually monitor what is happening in the market and plan for inevitable adjustment to normal practice.

Longnecker & Associates’ leadership team has over 70 years of combined experience working with executives and boards of directors to achieve successful mergers and acquisitions. If your organization is considering a merger or acquisition, or currently in the process of one, contact Longnecker & Associates today. Our consultants will provide a personalized evaluation to discover the nuances that set your company apart and provide a strategic, tactical path forward.