A bonanza for Pacific Rubiales Energy executives

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Much of the talk about the proposed buyout of Toronto-based Pacific Rubiales Energy Corp. has the whiff of missed opportunity: After all, the $6.50-per-share offer from Alfa SAB and Harbour Energy is about 80 per cent below the stock's highs of a few years ago.

The company's four top executives, however, haven't missed out entirely: They made $126-million in stock-option profits from 2012 to 2014, before the steepest part of the Pacific Rubiales decline.

For years, Pacific Rubiales made stock options the dominant part of its executive-compensation program, claiming it was the best way to align its executives' interests with the shareholders'. The company had a change of heart, however, moving away from options a year ago to a new kind of stock award that it said better linked pay to performance.

That last proposition may well have been true, for the long term. However, in the short term, we can only say with certainty that the change will give the executives millions more as the merger closes.

I first took a look at Pacific Rubiales' pay practices in May, 2012 , as it tweaked its board structure in response to shareholder complaints about independence and excessive pay.

What the company was not willing to change at the time, however, was its love of options. I noted that the four top executives held 14 million stock options at the end of 2011 that were worth around $250-million when Pacific Rubiales shares peaked a few months later. The company said in the spring of 2012 that its compensation committee had considered other forms of long-term compensation, such as restricted stock, but "concluded that the focus on stock options has been very successful in ensuring proper alignment between executive officer performance and corporate strategy."

At the time, Pacific Rubiales had a track record that might silence many critics. The company, which owned properties concentrated in Latin America, achieved an annual average return of 258 per cent from the end of 2008, the year it joined the TSX, to the end of 2011.

But, as has been seen before, executives with stock options can exercise them and lock in profits, while shareholders who hold on to the stock end up losing.

The specifics: Serafino Iacono and Miguel de la Campa, the company's executive co-chairmen, made $33.7-million and $38.7-million in options profits, respectively. CEO Ronald Pantin made $36.8-million in profits, and company president José Francisco Arata made $16.8-million. (All numbers are based on the difference between the option's exercise price and the market price on the day the shares were acquired, not when the stock was sold. Mr. Iacono, for example, held on to more than one million shares acquired via options, rather than selling them, securities disclosures say.)

The profits came from options granted from 2007 to 2009, so they match neatly with gains realized by shareholders who bought – and sold – over the same period. Those who held on fared less well. Since the end of 2012, Pacific Rubiales fell sharply.

As a result, for the 2010 to 2014 period it underperformed the S&P/TSX composite oil & gas exploration and production index.

As it happens, in 2014, the company's board had second thoughts about whether stock options really were the right way to motivate the executive team. Pacific Rubiales "would move away from this form of long-term compensation" and toward a new deferred share plan "as a way to better align compensation with the interests of shareholders," the company's compensation committee said in the annual proxy circular.

Bravo, I guess. It certainly would have been a far gutsier move if the executives still had hundreds of millions of dollars of potential profits, instead of millions of unusable, out-of-the money stock options. (Each of the four men lost 1.2 million options earlier this year when they expired worthless.)

Asked about the switch from options to the share plan, Pacific Rubiales general counsel Peter Volk offered a written statement: "We have shown a responsiveness to shareholder concerns on compensation … Our board and management have created tremendous wealth for shareholders, including paying out $1.4-billion in dividends since 2007 and [are] now presenting them with an 81-per-cent premium, $6.50-per-share all-cash offer."

As part of the new plan, Pacific Rubiales gave the four men a total of one million deferred shares valued at more than $20-million in August, 2014, when the company's stock was much higher.

If they'd been granted options instead, those would be expiring worthless with the merger's $6.50 offer price. But coupled with a 2015 award, each of the men will now receive more than $8-million for their share units when the merger is complete.

Consider it a token payment for all that missed opportunity from unused and ungranted stock options.