978-0077862213 Chapter 3 Case Exxon XTO Merger

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Case 3-7

Exxon – XTO Merger

ExxonMobil Corporation (Exxon) is the world’s largest corporation in terms of revenue and one of the

largest in market capitalization. It had sales of $486 billion in 2011giving it the #1 position on Fortune 500

in that category. In recent years Exxon has expanded its operations into hydraulic fracking. By pumping

water, sand, and chemicals into a well at high pressure cracks develop in the stone where gas is trapped and

the process allows more of it to flow. There were more than 493,000 active natural-gas wells across 31

states in the U.S. in 2009, almost double the number in 1990. Around 90 percent have used fracking to get

more gas flowing, according to the drilling industry. By 2015 the United States will produce more oil from

unconventional methods like fracking than conventional means, according to a 2012 report from the

economic forecasting firm IHS Global Insight.

Nationwide, residents living near fracked gas wells have filed over 1,000 complaints regarding tainted

water, severe illnesses, livestock deaths, and fish kills. Fracking is controversial because the chemicals,

mixed with water, may find their way into aquifers which supply drinking water. Oil companies say that

fracking is safe and poses no threat to drinking water. Right now, few groups are calling for an outright ban

on fracking. However, shareholders want companies to issue full disclosure about individual fracking

operations and the chemicals used during the process. Some companies counter that they already abide by

environmental laws and regulations and that further disclosure is not necessary.

On June 24, 2010, Exxon completed a $41 billion merger with XTO Energy in large part to buy the

company’s hydraulic-fracking expertise and gain access to its 45 trillion cubic feet of gas. The terms of the

merger called for Exxon to issue 0.7098 common shares for each common share of XTO. The merger

augments Exxon’s total production of energy resources by increasing natural gas production to 50 percent

of the total and its reserves will go up 50% as well.

Breach of Fiduciary Duties

The merger was not without its critics in part because of the way the deal was structured and the role of

XTO’s management and board of directors. On December 17, 2009, the Shareholders Foundation, Inc.1

filed a lawsuit in Tarrant County (Texas) District Court on behalf of current investors in XTO Energy, who

purchased their XTO shares before December 14, 2009, over alleged breach of fiduciary duty by the board

of directors of XTO Energy.

The plaintiff alleged breaches of fiduciary duty by the board of directors of XTO Energy arising out of

their attempt to sell XTO Energy to Exxon Mobil. The plaintiff claims that the XTO management and

directors agreed to sell the company through “an unfair process” and that XTO Energy is worth more

because of likely future global warming regulations that could curtail carbon emissions.

Previous investigations by law firms examined the following: (1) whether the XTO Energy board of

directors breached their fiduciary duties to XTO shareholders by agreeing to sell XTO at an unfair price

thereby harming the company and its shareholders; (2) whether the directors of XTO may have breached

their fiduciary duties by not acting in XTO shareholders’ best interests; and (3) whether the company may

not have adequately shopped itself around before entering into this transaction and, pursuant to this

proposed transaction, Exxon Mobil may be underpaying for XTO thereby unlawfully harming XTO

shareholders. Exxon’s shares fell 4.3 percent to $69.69 after the announcement, while XTO shares jumped

more than 15 percent to $47.86 on the New York Stock Exchange.

Payments Made to Officers and Members of the Board of Directors of XTO

An important part of the merger agreement was payments made to officers and members of the board of

directors at XTO. Given the distaste for large payout packages to corporate insiders during the period of the

financial crisis in 2008–2009, there was some concern whether Congress would approval the merger. The

issue was the arrangements detailed in Exhibit 1. At the end of its investigation Congress approved the

merger although it raised concerns about disclosures to shareholders.

Exhibit 1

11The

Shareholders

Foundation, Inc., is an investor advocacy group that does research related to

shareholder

issues and

informs

investors

securities class

actions, settlements,

judg

ments, and other legal

news

to the stock/financial market. The group offers help, support, and

assistance

for every

shareholder, and

investors

find

answers

to their questions and equitable solutions to their problems.

Form 8-K Filing with the SEC on Officer/Board Member Payments

Consulting Agreements & Amendments to Share Grant Agreements

In connection with the Merger and pursuant to negotiations with Exxon Mobil, Messrs.

Simpson, Hutton, Vennerberg, Baldwin, and Petrus (each an “Officer” and collectively, the

“Officers”) have agreed to waive their employment and change in control protections under

their existing arrangements with the Company and enter into consulting agreements with the

Company and Exxon Mobil which were executed on December 13, 2009, and will become

effective at the time of the Merger. Pursuant to their existing employment agreements (for

Messrs. Simpson, Hutton and Vennerberg) or the Third Amended and Restated Management

Group Employee Severance Protection Plan (for Messrs. Baldwin and Petrus), upon the

occurrence of a change in control transaction, which would include the Merger, each of the

Officers was entitled to receive a lump sum cash payment, within 45 days after the change in

control, generally equal to three times (2.5 times for Messrs. Baldwin and Petrus) the sum of

his (1) annual base salary, (2) annual cash bonus, and (3) for Mr. Simpson only, annual grant

of the Company’s common stock. Each Officer, other than Mr. Simpson, was also entitled to

receive a gross-up payment for any excise taxes imposed under Section 280G of the Internal

Revenue Code (“280G Excise Taxes”). In connection with entering into the Consulting

Agreements, each Officer generally agreed to (i) waive his right to receive a portion of the

Change in Control Payments; (ii) subject all or a portion of the remainder of his Change in

Control Payments, as retention payments, to the continued performance of consulting services

and continued compliance with agreed restrictive covenants (relating to confidentiality,

noncompetition, and nonsolicitation) and (iii) relinquish his right to any Gross-Up Payment

due.

The waiver of the existing arrangements and effectiveness of the new Consulting

Agreements among the Officers, the Company, and Exxon Mobil will be contingent on the

closing of the Merger. Under the Consulting Agreements, the Officers will retire as employees

of the Company upon completion of the Merger and continue to serve the Company thereafter

as consultants on a full time basis. The initial term of the Consulting Agreements will end,

unless earlier terminated, on the first anniversary of the Merger. The Consulting Agreements

are each renewable for an additional one-year period upon the mutual agreement of the Officer

and ExxonMobil, in consultation with the Company.

The Company will provide each Officer with an annual consulting fee equal to one-half of

the Officer’s current base salary. Each Officer will also be entitled to receive an annual cash

bonus equal to one-half of the Officer’s current base salary, generally subject to the Officer’s

continued service to the payment date (for reference, the Officers’ current base salaries are:

Simpson—$3,600,000; Hutton—$1,400,000; Vennerberg—$900,000; Baldwin—$500,000;

Petrus—$475,000). Also under the Consulting Agreements, ExxonMobil has agreed to provide

each Officer with a one-time grant of restricted ExxonMobil common stock or stock units

having a grant date fair market value equal to 100% of the Officer’s current base salary. -One-

half of the Restricted Equity will vest on the first anniversary of the Merger and one-half will

vest on either the second anniversary of the Merger, or, if the Initial Term is extended, on the

third anniversary of the Merger, in either case subject to service requirements and the Officer’s

continued compliance with the applicable restrictive covenants through the applicable vesting

date.

In lieu of the payment Mr. Simpson otherwise would have received in connection with the

Merger under his existing employment agreement, Mr. Simpson will receive a lump sum cash

payment within five days after the Merger in an amount equal to $10,800,000 (which equals

three times his current base salary). In addition, Mr. Simpson will be entitled to receive a

retention payment, payable in equal installments at six and twelve months after the Merger,

generally subject to Mr. Simpson’s continued performance of consulting services through the

payment date. Mr. Simpson’s retention payment, which relates to his annual grant of the

Company’s common stock, will equal up to $24,750,000.

In lieu of payments each of the Officers, other than Mr. Simpson, would have received in

connection with the Merger under either an existing employment agreement or the terms of the

Third Amended and Restated Management Group Employee Severance Protection Plan, each

of the Officers (other than Mr. Simpson and Mr. Petrus) will be entitled to receive a retention

payment, payable in equal installments at six and twelve months after the Merger, generally

subject to the Officer’s continued performance of consulting services to the payment date. The

payment for the Officers, which relates to the amount of the Change in Control Payments, will

equal an amount up to the following: Mr. Hutton, $10,913,662; Mr. Vennerberg, $6,172,817;

and Mr. Baldwin, $2,591,527. Mr. Petrus will not receive a retention payment.

Under pre-existing Amended and Restated Agreements with the Company, each of the

Officers was entitled to certain additional lump sum cash payments in the event of a change in

control transaction, which would include the Merger. On December 13, 2009, the Grant

Agreements were amended to provide that the lump sum cash payments due thereunder in

connection with the Merger will be made in the form of shares of the Company’s common

stock immediately prior to completion of the Merger. The number of Shares is as follows: Mr.

Simpson, 833,333 Shares; Mr. Hutton, 687,500 Shares; Mr. Vennerberg, 583,333 Shares; Mr.

Baldwin, 166,667 Shares; and Mr. Petrus 156,250 Shares.

Each Officer has agreed pursuant to the terms of the Consulting Agreements and the Grant

Agreement amendments that, instead of receiving a Gross-Up Payment for any 280G Excise

Taxes that might apply to the amounts the Officer is entitled to receive in connection with the

Merger, the combined amount of the Shares and the retention payment will be subject to an

added reduction, if necessary, so that the total value of this combined amount, when added to

the value of other equity awards granted to the Officer which are vesting in connection with

the Merger and, for Mr. Simpson, his lump sum payment, does not exceed 90% of the amount

that could be provided to the Officer without the imposition of 280G Excise Taxes.

Upon termination of an Officer’s services as a consultant either by the Company without

“Cause” or by the Officer with “Good Reason” (each as defined in the Consulting

Agreements) or upon an Officer’s death or disability, the Officer will be entitled to receive (1)

a lump sum cash payment equal to the unpaid portion of the Consulting Fee, and the

Completion Bonus for the current term, and the unpaid portion of the retention payment and

(2) in the case of all Officers other than Mr. Simpson, accelerated vesting of any unvested

equity awards which were granted prior to the Merger.

SEC Financial Disclosures Rule

In 2011, shareholders of Exxon voted not to require company officials to disclose more information

about fracking, although 30 percent of the shareholders voted to increase disclosures indicating some

concern whether investors receive sufficient information for their decision-making needs.

The SEC requires that publicly-traded companies release and provide for the free exchange of all

material facts that are relevant to their ongoing business operations. From an ethical perspective, the

general need in business transactions is for both parties to tell the whole truth about any material issue

pertaining to the transaction.

The SEC requires full disclosure from public companies that wish to be publicly traded on the major U.S.

exchanges. By enforcing this rule, the SEC attempts to instill confidence in investors that the financial

marketplace is efficient and transparent so that individual investors can take part in it for material profit.

The rule is often referred to as providing “full and fair disclosure.”

Waiver of Rights under Outside Directors Severance Plan

The Outside Directors Severance Plan provides that, upon a change in control, each nonemployee director

will receive a lump sum cash payment equal to three times the sum of the annual cash retainer and value of

the company’s common stock most recently granted to the nonemployee director. In February 2009, each

nonemployee director received a grant of 4,166 fully vested shares of the company’s common stock. The

nonemployee directors received an annual cash retainer of $180,000 in respect of services performed in

2009.

On December 13, 2009, each nonemployee member of the company’s board of directors voluntarily

waived his right to receive the payments that otherwise would have become payable to him upon the

completion of the merger under XTO Energy. Absent such a waiver, based on the closing price of the

company’s common stock on December 1, 2009 ($42.93), each nonemployee director was entitled to

receive a lump sum cash payment of approximately $1,000,000 upon completion of the merger.

Questions

1. The lawsuit filed by the Shareholders Foundation alleged that the board of directors of

XTO breached its fiduciary duties. What are the fiduciary duties of the board? Identify

the duties allegedly violated in the XTO case. Do you think the board acted in

accordance with a shareholder or stewardship perspective?

The board of directors is elected to act in the best interests of the corporation and owe a fiduciary duty to

the corporation and its shareholders. The fiduciary duty entails operating with loyalty to the shareholders’

interests and exercising due care in board decision-making. The alleged breach of fiduciary duty includes

XTO management and directors agreeing to sell the company through an “unfair process;” underselling the

company when it is worth more than the selling price; not acting in the best interests of the shareholders;

2. Much has been said during the recent financial crisis about top executive salaries being

way too large, especially in those companies receiving a government bailout. The Obama

administration sought to rein them in through threats of taxation or other forms of

“moral suasion.” Do you believe the government has an ethical right to intervene in a

company’s executive compensation program? Support your answer with reference to

ethical reasoning. Review Exhibit 1. Do you believe that the agreement in the Form 8-K

about payments to officers and board members raises any ethical issues? What is the

role of the business judgment in such decision?

Using utilitarianism one could argue that the greatest good could be achieved by having the government set

all salaries. However, that quickly abandons the free market concept of executive compensation and adopts

Exhibit I shows that the top executives and management of XTO are being handsomely rewarded in the

merger with Exxon. The rewards seem to be egoistically towards the top executive to the harm of the

3. One aspect of being an ethical corporation is to operate in a socially responsible way. The

Corporate Social Responsibility Initiative at Harvard University2 defines corporate social

responsibility strategically. “Corporate social responsibility encompasses not only what

companies do with their profits, but also how they make them. It goes beyond philanthropy

and compliance and addresses how companies manage their economic, social, and

environmental impacts, as well as their relationships in all key spheres of influence: the

workplace, the marketplace, the supply chain, the community, and the public policy realm.”

The ethics of fracking is an issue raised in a number of articles and in the blog of one of the

authors of this book. According to Mintz3, “From an ethical perspective we might look at the

harms and benefits of fracking. In other words, do the potential dangers of fracking,

including contamination of water supplies, outweigh the potential benefits of producing

badly needed oil and gas resources at a time when our national security may be in jeopardy

because of our continued reliance on unreliable sources of energy? Is U.S. energy

independence more important than the potential for harm to those affected by fracking

procedures? Do jobs and economic growth trump health and safety concerns?”

Fracking, which is short for ‘hydraulic fracturing,’ refers to a method of recovering oil and gas from shale

rock. Here is how it works. An oil company would drill down and then push under great pressure liquids

sideways into oil and gas-rich shale rock. Millions of gallons of water, mixed with brine or chemicals, is

2 www.hks.harvard.edu/m-rcbg/CSRI/init_define.html.

3 www.ethicssage.com/2011/12/the-ethics-of-fracking.html

According to the Interstate Oil and Gas Compact Commission, 90 percent of all oil and gas wells in the

Fracking is controversial because the chemicals, mixed with water, may find their way into aquifers which

supply drinking water. Oil companies say that fracking is safe and poses no threat to drinking water. Right

now, few groups are calling for an outright ban on fracking. However, shareholders want companies to

Shareholders of two large gas producers — ExxonMobil, and Chevron – voted not to require company

officials to disclose more information about fracking. Exxon and Chevron had urged shareholders to vote

The public has a right to be concerned about fracking. In 2010 thousands of gallons of fracking fluid

spilled following an accident at a natural gas well in Pennsylvania. The well blew near the surface, spilling

The EPA found that compounds likely associated with fracking chemicals had been detected in the

groundwater beneath Pavillion, a small community in central Wyoming where residents say their well

water reeks of chemicals. The fracking occurred below the level of the drinking water aquifer and close to

There are those who support fracking including landowners who have the most to lose if royalties stop

flowing because of restrictions on fracking. Some landowners — such as a group with more than 10,000

There can be no doubt that additional studies are needed, more tests must be done, and the industry should

be better regulated. In the meantime, why not release all available information to the public about safety

Energy decisions abound where safety versus economic benefits are pitted against each other. We have

been debating the issue for years with respect to offshore oil drilling and now the debate focuses on

The bottom line on these issues, including practices such as fracking that has transformed the U.S. energy

industry, is that energy independence comes at a cost. Increasingly, we as Americans, will be faced with

tradeoff-decisions between sacrificing some health and safety concerns in the name of providing economic

4. Evaluate the ethics of fracking from a moral reasoning perspective using the methods

discussed in this chapter. Going forward, do you believe fracking should continue without

regulation? Why or why not?

Much of this question is closely tied to the answer above. First, a short list of stakeholders in the issue of

fracking include the environment, property owners, users of energy, taxpayers, regulators, investors, energy

companies, and drilling companies. Using rights theory the property owners, users of energy, taxpayers,

regulators, and investors need to understand and have full disclosure of the chemicals, long-term and short-

term consequences, costs and benefits of fracking. The energy and drilling companies have an obligation to