Chesapeake Energy: Accounting Theory of Financial Misreporting

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Company Cvervlew .................................................................................................................................. 4
Case summary ......................................................................................................................................... 4
LvenL SLudy Analysls ................................................................................................................................ 3
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Larnlngs erslsLence .......................................................................................................................... 12
CuallLy of Accruals ............................................................................................................................. 13
roved 8eserves ................................................................................................................................ 14
lracklng .............................................................................................................................................. 14
CompensaLlon SLrucLure ........................................................................................................................ 13
Moral Pazard ......................................................................................................................................... 19
CaplLal MarkeL lncenLlves ...................................................................................................................... 22
8eporLlng of Lhe 1ransacLlons ln Lhe llnanclal SLaLemenLs ................................................................... 24
8elevance and 8ellablllLy Concerns ....................................................................................................... 26
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Conference Call: osL-Class erlod ........................................................................................................ 26
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See Appendix A for all candidate company summaries.
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Chesapeake Energy Corporation is the second largest producer of natural gas and the
most active driller of new wells in America. The Companys operations are focused on
discovering and developing unconventional natural gas through horizontal drilling and oil fields
onshore in the U.S. The Company also offers marketing, drilling, and other oilfield services, and
holds interests in various natural gas resources. Chesapeake has a market capitalization of over
10 billion USD ($13.04 billion as of Feb 7
th
, 2013) (About Chesapeake). Headquartered in
Oklahoma City, it was formed in 1989 with just 10 employees by former CEO Aubrey
McClendon and former President and COO Tom. L. Ward. The Company has been a natural gas
producer ever since, with up to 99% of revenues coming from the sale of natural gas (Meerten,
2012). In 1993, the company completed its IPO at a split-adjusted price of $1.33 per share and
shortly thereafter in 1995, moved from the NASDAQ to the NYSE, changing its stock symbol to
CHK (NYSE Euronext).
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On February 25, 2009, shareholders of Chesapeake Energy Corp filed a proposed securities
class action lawsuit against Chesapeake in regards to a July 2008 secondary public stock offering
of over 25 million shares. The Company is accused of issuing materially false and misleading
Registration Statements (Stanford Law School). Chesapeake failed to address numerous required
facts, including:
1. A substantial increase in its hedge position, from 20% to 80%.
3
2. Failure to report that a significant portion of the hedging contracts created to protect
against falling prices were made with the underwriters at Lehman Brothers, despite the
fact that Lehmans was experiencing rapidly declining financial conditions at the time.
3. Unreported knockout provisions that eliminated the counterpartys financial obligation
once the price of natural gas fell below a certain benchmark (Understated Financial
Obligation).
4. Failure to report proper write-down of impaired goodwill on the assets it was acquiring,
resulting in artificially inflated balance sheet information.
5. Failure to report lease and royalty agreements with its lease brokers, causing unnecessary
lease transactions above par price.
As these omitted facts were revealed to the market throughout 2008 and early 2009, the price of
Chesapeakes stock declined to less than $12 per share, 80% below the offering price, creating
substantial damage to investors finance.
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The presentation of the event analysis is separated into 3 main periods: the pre-class
period (January 15

to July 14, 2008), the class period (July 15, 2008 to January 27, 2009), and
the post-class period (January 28 to July 27, 2009). Chesapeakes business model and operations
are similar to 3 of its competitors: British Petrolium (BP), Anadarko (APC) and Encana (ECA),
where the latter company also exclusively focuses on natural gas exploration.
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From January 15, 2008 to July 15, 2008, Chesapeakes stock price appreciated by
50.46% (Appendix B-1). During this period, CHKs stock experienced a steady increase well
above the market, from $39.54 to $59.49, while trade volume remained relatively stable.
Competitors APC, BP, and ECA were not far behind CHK, though stock price for all 3 more
6
closely resembled the market trend. The Dow Jones stability throughout the period leads to the
conclusion that the increase in Chesapeakes share price was likely a result of firm-specific
factors.
Subsequent to the release of Chesapeakes Q1 results on April 28
th
, 2008, there was a
noticeable increase in the companys share price. Chesapeake CFO Marc Rowland stated that
CHK earned $1.09 per share on an adjusted basis, the highest in the companys 15-year history
(Audio call 1). Quarterly earnings beat analysts mean estimate, thus investors adjusted their
prior expectations of the firms future performance and purchased more shares. As a result of
higher demand, CHK saw an increase in stock price.
Chesapeakes May 20
th
, 2008 announcement to increase an offering of convertible notes
from $500 million to $1.2 billion resulted in a substantial decline in stock price. CHKs trade
volume nearly doubled from the week prior, coming in at over 30 million shares by May 22
nd
,
2008 (Appendix B-1). Such a notable increase in trade volume validates the significance of
unexpected bad news, triggering a revision of prior beliefs that lead to differences in investors
interpretation of current financial information (Scott p.154). Investors revised their priors
downward, sold their shares and ultimately, caused a drop in stock price.
On the contrary, during the 2008 Annual Meeting of Shareholders held June 6
th
,
McClendon commented on Chesapeakes drilling activity in the Haynesville Shale play to
generate production growth and capture outstanding financial returns on rising natural gas prices
(L. Mobley, 2008). This good news regarding results of the Haynesville drilling analysis
triggered a steady rise in stock price in the first two weeks of June 2008.
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Appendix B-2 shows that during the class period, CHK's stock started at approximately
$53, its peak during the class period, only to fall by 73% to $15 by the periods end. On the first
7
day of the class period, Chesapeake completed a secondary public offering of 28.75 million
shares at $57.25 per share. Subsequent to the release of this new information, share price fell by
17% in one week. During the period leading up to the Q2 earnings report, average increase in
analyst estimates was $0.004 per share (Appendix B-3). Competitors returns in the same week
validate that a portion of the drop was an industry trend caused by falling natural gas and oil
prices (See Appendix B-4). While ECA and APC had only suffered a 10% loss in stock price
from the reduction in commodity prices, BPs diversified structure allowed the company to
report a 1% increase in stock price. This leads to the conclusion that the portion of CHK's falling
share price above the industry average was due to the release of new information regarding the
firms issuance of shares to the market. Evidently, this dilutes future earnings amongst the new
ownership pool and signals CHKs inability to borrow with debt tools.
Chesapeake released its earnings for the period ending June 30
th
, 2008, only a penny a
share above average analyst estimates (Earningsprice.com, 2013). A major part of the losses
incurred during this quarter stemmed from a decrease in the mark-to-market hedge value of $3.4
billion, although Chesapeake was able to report a gain by July 25
th
. At this point, natural gas
prices were still in decline due to "...growth in onshore production and robust storage
inventories, as well as a declining economy" (Teller, 2013). Such information initiated the
markets expectation of negative growth throughout the industry, devaluing the stock price by
9.78% over the weekend following the announcement.
At the Lehman Brother's Energy Conference on September 2
nd
, 2008, Chesapeakes CEO
clarified the use of hedging instruments, specifically knockout swaps, that rendered hedging
contracts null if the price of natural gas fell below a given level. Although the knockout
derivatives were quantified and valued in all previous 10-Q and 10-K filings with the SEC (SEC
10-Q filings, p. 36), analysts only reacted to the knockout price as it drew dangerously close.
8
Investors limited attention caused a bias to such risks in the quarterly earnings reports prior to
this news, thus an under reaction to the implications of the knockout provision in CHK's
information system (Scott, Financial accounting theory, p. 201). Investors then factored this
news into CHK's share price, resulting in a 23% decrease in value. The stock was
underperforming the industry for 2 weeks following the conference, while APC and ECA lost
approximately 16% and 13% respectively (Appendix B-2).
On September 23
rd
, 2008, a conference call was held to update investors on Chesapeakes
operational and financial situation, wherein analyst Bradley Tease raised concerns regarding
hedging counterparties credit worthiness. The conference call was 6 days after Lehman Brothers
had declared bankruptcy, while a slew of other financial institutions were potentially facing the
same situation. The question prompted Chesapeakes CEO to answer that he was quite
confident, and ended the call abruptly (Audio call 2). With natural gas prices at an ultimate low,
analysts recognized the inefficiencies of CHKs hedges and as a result, foresaw poor future firm
performance. The conference call also unveiled Chesapeake's plan to reduce capital expenditures
and sell off a portion of assets due to ongoing liquidity issues. The markets were also on a
downward slope, attributable to an economy-wide credit crunch that was limiting growth. As a
result, there were "...increasing fears of a prolonged economic downturn that could sharply
curtail energy demand" (Jacobs, 2008). The DJI went from 11022 points on September 25
th
to
8451 on October 10
th
, 2008. Essentially, the market's overall performance was part of investors
downward stock price revision, as well as CHK's inability to properly protect itself against
natural gas price volatility.
On November 27
th
, 2009, CHK deposited another filing with the SEC to raise close to
$1.8 billion by issuing shares. The stock price suffered a 44% decline to hit its lowest mark in 5
years at $11.32 on December 5
th
(Appendix B-2). Thus, the market factored in the dilution as
9
soon as the registration was filed (Gammel, Wilson, & Shilpa, 2008, p. 2), confirming the
market's concerns over CHK's liquidity. The perspective of lower production volumes that would
be generated by the reduced capital program effectively drove analysts to revise estimates
downwards (Gammel, Wilson and Shilpa 1). All the while, the DJI and Chesapeakes industry
peers fell by only 1% during the same period (Appendix B-2).
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On February 26
th
, 2009, Chesapeake restructured its Eastern Division headquarters by
unexpectedly announcing job cuts of 80%, amounting to approximately 215 employee positions
(Price, 2009). As tightening credit markets and declining energy prices dictated a reduction in
capital spending, CHK consolidated the Divisions management with the companys corporate
offices in Oklahoma City. The public recognized the negative effects of the announcement, as
CHK saw a 3.62% drop in share price.
Chesapeakes Q1 earnings announcement on May 4
th
, 2009 reported impairment charges
of more than $6 billion as a result of the sharp decline in energy prices. Net losses to common
shareholders were over $5 billion, operating cash flows $1 billion, and EBIDTA at a loss of $8.7
billion. The Q1 report, together with an announcement to cut capital expenditures by 8%, caused
CHKs stock to experience declining demand, resulting in a depreciation of 10.64% in share
price (Appendix B-5).
On April 1
st
, 2009, the New Alternative Transportation to Give Americans Solutions
Act was passed for review to Congress in support of efficient natural gas transportation. This
particular bill introduced tax credits for manufacturers and buyers of Natural Gas Vehicles
(NGV) as well as for businesses that build natural gas refueling infrastructure, in order to
incentivize installation of natural gas facilities and promote production of NGVs. As such news
10
encouraged optimism in regards to US demand for natural gas, CHKs stock increased by 13%
(Boren, 2009).
Chesapeake signed a 15-year contract on January 7
th
, 2009 with Energy Transfer Partner
(ETP) to build a pipeline at a cost of $1 billion. Its purpose was to create significant
transportation capacity and a system of natural gas produced from the Haynesville Shale. ETP
announced two binding contracts to transport natural gas via its proposed Tiger Pipeline system
on May 8
th
, 2009. At the time, Chesapeake believed the Haynesville Shale play to have the
potential to become the largest producing field in the country, as it was one of the fastest
growing natural gas fields. This new contract with ETP made a positive impression on investors
in regards to Haynesvilles future prospects (ETP Chesapeake, 2009). Following the
announcement, the share price increased by 23% (Appendix B-5).
On May 28
th
2009, US energy information administration reported lower inventory than
expected. Despite ample supplies and a forecast of favourable weather, traders were viewing the
storage data as a facilitator to increase prices that had plunged due to the recessionary impacts of
weak demand. After the report was released, CHKs stock increased by 17% over a period of 3
days (Dow Jones Newswires, 2009).
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Simons risk calculator is a useful tool to assess a companys risk exposure and is divided
into 3 components: growth, culture and information management (Simons, 1999). CHK's score
on Simons risk calculator is 32, which is in the high range of the caution zone. This raises
11
concern, as shareholders fear that the company could fall into the danger zone, resulting in the
classification of CHK as a risky company.
For the growth component, Chesapeake scored a total of 12, with 4 in pressure for
performance, 4 in rate of expansion and 4 in inexperience of key employees. Explaining
this is the fact that Chesapeake is planning on continuing to grow and to outperform competitors:
What will drive Chesapeakes strong growth in the future? It will be our industry-leading
position in the Big 6 major natural gas shale plays in the U.S.the Barnett,
Fayetteville, Haynesville, Marcellus, Bossier and Eagle Ford shalesplus our emerging
unconventional oil plays. (Chesapeake Annual report 2009 p.5)
Furthermore, Chesapeake employees are distinctive, in that they are much younger than the
industry average, with 50% of the Oklahoma City-based headquarters employees being under the
age of 35. According to the 2009 Annual Report, their enthusiasm and willingness to learn
creates an atmosphere of vitality and energy at Chesapeake, important ingredients of
[Chesapeakes] unique culture (p.11). Implied by this is that firm is not able to retain its
employees for a long period of time and as a result, employee turnover must be high. A company
with a majority of young employees can be cause for concern, as employees are generally less
experienced.
For the culture component, Chesapeake scored a total of 11, with 4 in rewards for
entrepreneurial risk taking, 4 in executives resistance to bad news and 3 in level of internal
competition. Even during the financial crisis of 2008, Chesapeake executives did not adjust
their way of doing business, as the goal remained to maximize year-end bonuses. With this in
mind, management strove to report high earnings, resisting and effectively, hiding the
implications of any bad news (Chesapeake Annual reports, 2009).
12
The company scored a 9 for the information management component of the calculator,
with 4 in transaction complexity, 3 in gaps in diagnostic performance measure and 2 in
degree of decentralized decision-making. As the company is consistently growing and merging
with other companies via joint ventures, transactions can be very complex. Also, since the
performance of the company is based on estimates of reserves, numbers are subject to a high
degree of manipulation. In terms of decentralization, Chesapeakes executives only have
decision-making power at the top. That is, authority to influence the companys future prospects
remains centralized at higher-level management (Chesapeake Annual Report 2009).
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The companys financial reports show that since 2002, revenue has been growing
consistently. Since then, the greatest increase was in 2009, where the company experienced a
49% increase in revenue. However, these same financials show that net earnings are not
persistent (Appendix C-1). The percentage change in net earnings, gross profit and EPS between
2007 and 2008 show decreases ranging from 40% to 70%. Given the effect of the financial crisis
on the price of gas, these decreases are most likely a result of overall market performance. The
following year, the company experienced exacerbated abnormal decline of almost 1000% in each
of net earnings, gross profit and EPS. The impairment charge recorded in 2009 certainly had an
impact on the numbers, but regardless, such substantial changes demonstrate Chesapeake's low
earnings quality. The $11 billion impairment loss increased operating costs for the year and in
turn, decreased gross profit and net earnings for 2009. There were 2 types of impairment
involved that had an impact on the value of natural gas and oil properties, as well as investments.
In 2009, impairment loss on oil and gas properties accounted for more than 66.7% of the total
13
operating costs in that year (Appendix C-3). Chesapeake stated, natural gas prices were dressed
throughout 2009, [] reflecting an impairment of approximately $6.9 billion, net of income tax,
of our natural gas and oil properties. We also had an after-tax non-cash impairment charge to
certain investments and fixed assets of approximately $183 million in 2009, as a result of lower
asset valuation estimates (Chesapeake 10K report 2009, p.28). The impairment also had an
impact on the gross profit and the net income percentage for 2009 (Appendix C-4), given that the
percentage change in gross profit was -116% compared to 12.5% in the year prior. As
production, reserves and resources continued to grow at a constant rate through 2008 and 2009,
we can conclude that the volatility in net earnings was largely due to large impairment losses
(Chesapeake 2009 annual reports).
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Appendix C-2 demonstrates that Chesapeake does not have substantial accrual accounts
relative to other large firms in the industry. The main accruals are Accounts Receivable,
Inventory, Accounts Payable, Accrued Liabilities and Deferred Income Taxes. The accruals-to-
cash flow from operations ratio of 0.09 in 2007, 0.12 in 2008 and -0.21 in 2009 indicate effective
accruals quality in Chesapeakes financial reporting. According to Scott, "Earnings quality
depends primarily on the quality of working capital accruals, since cash flow from operation is
relatively less subject to errors and manager bias, and therefore is of reasonably high quality to
start with" (p. 166). Thus, Chesapeakes low level of accruals ensures that the company has a
substantial amount of cash transactions and in turn, higher earnings quality. Although there is a
relative volatility in the aforementioned ratios, the absolute values are not significant relative to
the industry average.
14
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The intent to disclose proved reserves in financial statements is primarily to provide
investors with more relevant information about the company's future cash flows (Scott, 2011).
CHK's stock value is greatly pegged to its capacity to extract natural gas, and thus is intrinsically
related to its proved reserves. Methods to evaluate proved reserves were elaborated by 5
different consultants firms, where volumetric calculations were based on data and maps provided
by Chesapeake (Chesapeake 2009 Annual report). As such, the valuation of proved reserves
stemmed from to data that could be manipulated by CHK management.
In this case, the issue of moral hazard is prevalent. In particular, management is in a
position to present distorted figures on proved reserves, while shareholders are not aware of the
true value of the assets. Increases in proved reserves show that volumes in 2009 were greater by
18% than the year prior, while Chesapeake was actively selling assets in order to meet liquidity
needs (Appendix C-5). This in itself is contradictory and validates that managers were artificially
increasing proved reserves (Reserve And Economic Evaluation Of Proved Reserves Of Certain
Chesapeake Energy Corporation Eastern Division Oil And Gas Interest, 2001, p.1).
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Hydraulic fracturing, commonly known as fracking, is Chesapeakes method of drilling
for natural gas, where large volumes of water, sand and chemicals are injected into gas-rich rock
formations miles underground in order to extract the resource. The process has introduced a
tension between environmental and economic objectives, in that increased public attention has
unlocked billions of dollars of gas reserves, leading to prosperity in production, jobs, and profits,
as well as concerns about pollution and public health (The Associated Press, 2012).
As the price of natural gas had risen and its use as an alternative to oil had grown, natural
gas companies were attracting more attention. Consequently, energy companies have gone on
13
the offensive to shore up the public image of fracking (Politics & Economics, 2013).
Chesapeake might have engaged into earnings management to reduce reported profits by
booking write-downs, and make the company seem less profitable as to reduce the risk that
governing bodies regulating CHK's activities might be tempted to tax "frackers" or to restrict
their rights to engage in polluting activities (Scott, 2012, p. 425). This would indeed explain such
drastic write-downs of capital assets of $6.9 billion in Q1 of 2009, shortly after reporting a 15-
year record high EPS in Q2 of 2008.
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CHK offers compensation to all employees to motivate their efforts and contributions to
the firm. CHK provides short-term compensation in the form of base salaries and cash bonuses
and long-term compensation in the form of restricted stock awards. These arrangements are
designed to stimulate both short-term and long-term efforts. For the senior management team and
executive officers, amounts are designed and governed by Mr. Whittemore and Maxwell
Governor, Chesapeakes independent compensation consultants. The independent Committees
Board of Directors must be unbiased, and selected in accordance with the NYSE corporate
governance listing standards (ChesapeakeDEF14A, 2008, p. 16). All non-executive employees
semi-annual compensation is separately managed and coordinated by the companys internal
human resources department. The Compensation Committee does not utilize pre-determined
guidelines for allocating between cash bonuses, short-term, and long-term incentives.
Factors that influence the allocation of compensation amounts for both executive and
non-executive employees, depending on individual responsibility level, functional level, soft
skills and overall financial condition of the company. The compensation review is highly
subjective and discretionary, and the Committee does not use objective metrics or set guidelines
when designing the amounts between short-term and long-term compensation. CHK emphasizes
16
that reserve valuation is highly volatile and is not an effective reflection of employee efforts to
the company, in that "...using the price of natural gas on a daily basis to estimate oil and natural
gas reserves for financial reporting purposes [] fails to reflect a fair representation of reserve-
base value" (ChesapeakeDEF14A, 2008). Additionally, the long-term success and profitability of
the company depends on its capacity to explore and discover new sources of oil and natural
gasa high-risk and expensive process. In order to foster and motivate the exploration and
discovering activities, executive compensation is designed to avoid direct linking to drilling
results in the short-run. CHK firmly believes that objective performance criteria cannot
differentiate executives contribution, due to external factors beyond the companys control, such
as lack of predictability and high volatility experience in natural gas and oil prices. Due to the
highly contingent nature of the incentive program, the Compensation Committee does not set
pre-determined target performance metrics on an annual basis (ChesapeakeDEF14A, 2008, p.
36), but rather value the subjectivity it retains in its review of executive compensation.
Chesapeake believes that long-term incentive compensation for executives should be tied
to equity compensation to encourage a longer-term decision horizon and ensure that interests are
aligned with the long-term growth of the company. This incentive plan motivates executive
officers to make decisions that will benefit the firms long-term financial performance, attract
new employees and encourage employee retention, since they have a stake in the business.
Employees with significant influence in long-term strategies of the company receive long-term
equity based compensation in order to align their interests to maintaining long-term growth and
profitability of the firm. For example, McClendon received approximately 80% of his
compensation in the form of equity, since the company values the CEO as the most influential
and instrumental to shaping the vision of the company. He is also highly respected for his role in
the companys evolution to one of Americas leading natural gas producers
17
(ChesapeakeDEF14A, 2008, p. 36). Having significant ownership of approximately 33 out of
546 million shares of CHK's common stock as of July 15
th
, 2008, the proxy statement proudly
stated that McClendons substantial portion of personal wealth is tied directly to stock price
performance. McClendon also had a reputation as a continuous purchaser of shares in the open
market, not selling a single share of the companys stock up until October 10
th
, 2008. This
implies that his compensation provided direct alignment with shareholder interests, ensuring
long-term interest of the company. The 2008 Compensation Summary illustrates that all other
executives received the majority of compensation in the form of stocks (Appendix C-6). Overall,
as executives responsibilities increase, the trend shows that compensation is increasingly
weighted toward the equity incentives, reinforced by CHKs compensation philosophy.
There are similarities and differences between the compensation philosophy of CHK and
its top three competitors within the industry. ECA, APC, and BP are all natural gas exploring and
producing companies and use similar compensation structures, such as mix of base salary, short-
term cash incentives, and long term equity incentives. As required by the NYSE, all competitor
also use an independent compensation committee that semi-annually reviews compensation-
related structures and designing.
ECA, for example, utilizes the peer-benchmarking method to take into account
marketplace trends (Encana Corporation, p. 27). Compensation benchmarking occurs when a
CEO's pay depends on the compensation of other CEOs within the firms peer group. To create a
more accurate set of peer group definitions, the firms follow federal law requiring an unbiased
list of primary market competitors, similar in size and scope, in their annual filings. Every year,
the Committee sets targets for future performance periods within each compensation program,
using the primary peer group. The key factor that distinguishes ECA from CHK is that
compensation is highly results-oriented, and due to the cyclical nature of the natural gas
18
business, the movement of commodity prices influences ECAs total compensation. This
compensation philosophy encourages market completion to attract and retain the top leadership
talent necessary to execute strategic objectives.
BP also uses similar methods, setting performance measures and targets at the beginning
of each year, based on their annual target plan. For example, the target level bonus is designed to
exceed the base salary by 120% and superior performance extends the threshold up to 150% (BP,
p. 80). Under this method, the company can estimate potential bonuses in the beginning of the
year, effectively setting the upper limit on annual short-term compensation. The key factor that
distinguishes BP from CHK is that BP compensates its executives mostly in the form of an
annual performance bonus rather than in the form of equity (Appendix C-8).
APC also uses the industry peer group method to establish a reference point for assessing
compensation values. The level of each element of direct compensation is generally targeted
between the 50
th
to 75
th
percentiles of the industry peer group. APCs new API bonus plan is
also unique in that, if the target performance hurdle is not achieved, the executive earns no API
bonus at all for the year (Anadarko, p. 104). The performance-based unit awards incentive
program is also unique since cash bonuses and the vesting of the units are solely dependent on
companys total shareholder return for the year, relative to the total shareholder return of a
predetermined group of peer companies. This helps the incentive system to be in line with
increasing shareholder returns, taking into an account the peer groups that reflect the overall
market condition. The key factor that distinguishes APC from CHK is the annual target bonus
plan, which calls for full achievement, where failing to do so results in the elimination of a cash
bonuses for the given year.
19
Quantitative analysis showed that CHK has the highest compensation risk among its top
3 competitors (Appendix C-14). It also showed inconsistent patterns in short-term and long-term
ratio from year to year. Chesapeakes compensation risk ratio is 96.59% in 2008, a 4.56%
increase from 92.03% in the previous year. Its short-term ratio increased by 43.82% from the
previous year, whereas the long-term ratio decreased by 43.82%. The long-term ratio decline in
2008 is due to an unusual $75 million short-term cash bonus awarded to McClendon during the
year. The high compensation risk ratio of 96.59% experienced in 2008 is significant and raises
concern for high risk of moral hazard from shareholders viewpoint.
Overall, in comparison to its competitors, the key distinction is that CHKs compensation
valuation is highly subjective. The compensation package analysis and process involves highly
subjective consideration of each executive, therefore amounts are usually difficult to estimate
and predict. Unlike its top three competitors, CHK does not set annual performance targets or
designate peer groups, and considers industry the peer-benchmarking method unfit in their nature
of the business.
H'7#% I#J#7=
Moral hazard is one manifestation of the owner-agency problem arising from information
asymmetry, where employees and executives manage the business on behalf of shareholders.
Chesapeake and its competitors compensation mix, as stated in the proxy filings, are designed to
mitigate risk of moral hazard and promote appropriate risk-taking. However, moral hazard risk is
very difficult to detect and involves comprehensive understanding of not only the companys
internal operations and finance, but also external publicity, such as presses releases, analyst
outlooks, and other information regarding key executives financial welfare. During the year of
2008, the company granted a $75 million bonus plan, a so-called Well Cost Incentive Award,
to invest in the companys wells. McClendons 2008 compensation package included a one time
20
$75 million bonus, a $975,000 base salary and 32.7 million in stock, even as the companys
stock price tumbled (Appendix C-6). In 2008, the Top CEO Compensation survey named
McClendon as one of the seven highest paid CEOs in 2008, despite poor firm performance. This
eventually led to a compensation scandal faced by CHK, where the firm defended the
controversy by stating that the bonus was designed to keep McClendon from abandoning the
company. That is, the bonus was a means of retaining the CEO in the form of incentive pay, due
to the effects of other entrepreneurial opportunities that exist in the industry and Mr.
McClendons reduced company stock holdings (CNN Money, 2009).
Numerous events took place throughout 2008 in relation to McClendons transaction
activities with outside parties and as a result, the level of information asymmetry between
Chesapeake and its shareholders became more apparent. On April 21
st
, CHK disclosed its
CEOs compensation via proxy statement, reporting McClendons $100 million compensation
package, despite a 60% fall in stock performance and 50% drop in the companys profit for that
year. The company also agreed to purchase McClendons personal art collection for $12.1
million. It was further revealed that McClendon managed a $200 million hedge fund for natural
gas trading and had a personal borrowing of $1.1 billion against his stake, Founder Well
Participation Program (FWPP), in the companys oil and gas wells (Reuters, 2012). The FWPP is
a special program that provides the rights for the CEO to take up to a 2.5% stake in the wells
working interest for those drilled during that year (ChesapeakeDEF14A, 2008, p. 16). The
rationale for this special incentive was that the CEO would use the proceeds to invest in the
companys wells, which would align his economic interest with the companys long-term
business plan. McClendon was the only executive to participate in this program and have
consistently acquired stakes in the companys wells since 2005. With Chesapeakes shares
tumbling along with commodity prices, McClendon received margin calls and was forced to sell
21
33.4 million shares, approximately 90% of his stake in the company, at a price ranging from $15
to $22 over three days, a stake that was worth $1.9 billion at the time (Forbes, 2008).
Chesapeake also restructured its CEO employment agreement, lowering the number of
shares required to hold a stake in the company to approximately 200% of McClendons salary
and bonus, the same time of the year he received margin calls (NY Times, 2009). This temporary
restructuring term allowed him to sell 94% of his shares in the company and use the proceeds to
cover his margin calls, amounting to $569 million (Business Insider, 2013), causing stock
performance to depress even further. By flooding the markets with sell orders, Chesapeake sent
prices even lower, creating a disadvantage to common shareholders holding CHK stock.
When shareholders learned of the CEO obtaining loans backed by his stakes through
FWPP, CHK responded that the nature of transaction was a personal transaction and therefore
not qualified to be reviewed under the companys management and requiring no obligation to
disclose the information (Reuters, 2011). Although the SEC transaction rule required companies
to disclose when executives use corporate stock as collateral for loans, McClendons personal
loan transaction backed by his stake in the company was not covered by the SEC rule since his
stake in the company through FWPP was a personal asset. This is a classic example of
managements strategic movement in circumventing SEC rules to disguise financial information,
even though the underlying nature of the transaction called for shareholders approval. As such,
the loans should have been disclosed by Chesapeake, effectively creating a situation where there
was a conflict of interest. The CEOs outside transactions backed by his stake in the companys
wells intensified the potential for unmanaged and unmonitored conflicts of interest, and FWPP
practices were severely criticized by the public.
22
In order to gain insight into the companys moral hazard problem, compensation risk
ratios of Chesapeakes top 3 competitors were compared to assess the risk-taking level of the
firm (Appendix C-14). In 2008, despite the financial turmoil and poor market conditions, CHK
paid out total compensation amounting to approximately $153.51 million, a 129% increase from
2007s $66.96 million (Appendix C), supporting that the compensation payout is volatile and
difficult to predict. ECA and BPs use of benchmarking ensures reasonable and fair evaluation of
compensation, taking into account the peer group and the market conditions at the time.
However, CHK experienced negative publicity post-announcement of executives compensation
in 2008, due to over-payment relative to the industrys overall market performance. The
subjective nature of Chesapeakes compensation raises concern for the risk of moral hazard due
to the Committees ability to manipulate or easily influence the payouts.
Overall, the moral hazard assessment of CHK suggests that the firm is highly subject to
conflicts of interest between managers and shareholders. The fact that McClendons personal
hedge fund traded oil and gas contracts indicated the potential for the CEO to take advantage of
his role at Chesapeake to leak market-moving information. The companys lack of transparency
in the CEOs fiduciary duties and subjective compensation practice is concerning for the publics
interest in the firm. Ultimately, moral hazard is a major issue faced by CHK, leading to
enormous loss of credibility and reliability from shareholders perspective.
1#38+#% H#7C&+ K*)&*+86&.
On March 25
th
, 2008, CHK revealed its progress in the Haynesville project, which had
been kept secret beforehand. At this point, the project was being openly discussed in the
industry, thus acreage values were likely to escalate, requiring Chesapeake to accelerate leasing
and drilling activities accordingly (Chesapeake, 2008, p. 2). This triggered a race to the leases
per se, where getting the working capital to exploit the resources was essential to success in the
23
industry. CHK had planned to fund 2008 and 2009 capital expenditures through cash flow from
operations, borrowings from their revolving credit facility and asset monetization, but
"...considering the increasing number of opportunities available, [CHK] expects to fund some or
all additional capital expenditures through public capital market transactions" (Chesapeake,
2008, p. 25). Since CHK was now going to fund growth through share issuance, the firm had
motivation to increase share value in order to raise enough capital and get ahead in the industry.
On that note, CEO McClendon was signaling strongly to the market an undervaluation of
the stock by buying 1.6 million shares in the month prior to the public offering (Appendix C-11).
CHK's stock price outgrew competitors by nearly 30% and the market by nearly 40% between
June 4
th
and July 2
nd
of 2008 (Appendix C-12). The consensus on CHK's adjusted EPS grew
from 0.822$/share on March 22
nd
to 0.972$/share on July 18
th
. Such EPS outlook growth
reflected the good news from the company's announcements of growth opportunities with new
shale plays, as well as the CEO's share acquisitions, but could also be the result of earnings
management.
From Q1 2002 to Q1 2008, with the exception of 1 quarter in 2004, analyst estimates
were consistently below actual reported figures (Appendix C-13). Throughout this period,
Chesapeake earnings had average abnormal returns of 13.5% above estimated EPS values.
Analyst consensus, composed of 25 to 30 analysts during that period, was almost always beneath
reported figures, leading to the conclusion that there was earnings management done to help
consistently report above expected results. This put high pressure on CHK management to beat,
or at least meet expectations for Q2 of 2008. As the CEO held 33 million shares of CHK, some
recently acquired, he had a strong incentive to ensure earnings expectations were met, knowing
that "the market penalizes firms that fall short of expectations by more than it rewards firms that
exceed them" (Scott, Financial accounting theory, 2012, p. 434).
24
The Q2 earnings release on May 1
st
, 2008, showed adjusted EPS of $0.89, while estimate
consensus just below at $0.88, thus abnormal returns of only 1%. As earnings were only slightly
above consensus, it is plausible that Chesapeake engaged in earnings management in order to
ensure that actual were above expected returns.
B&3'7+8*E '( +-& "7#*.#)+8'*. 8* +-& G8*#*)8#% <+#+&2&*+.
Chesapeake accounts for its natural gas and oil assets using a full cost method of
accounting, which allows all operating expenses relating to new oil and gas reserves to be
capitalized, regardless of outcome, and written off over the course of a full operating cycle (Fox,
2009). In accordance with SEC regulation, Chesapeake is required to perform a ceiling test at
the end of each quarter by calculating a cost center ceiling and comparing it to the net
capitalized costs of its gas and oil properties. If the capitalized costs exceed the ceiling, CHK is
to record a noncash impairment charge. In this case, fewer depreciation, depletion and
amortization expenses are recorded in future reporting periods, since impairment charges reduce
capitalized costs, which then has the effect of boosting net income. Generally defined, the ceiling
is the present value of future net cash flows from reserves, discounted at 10%, with year-end
commodity prices held constant over the life of the reserves (Mobley, 2009).
As a result of the performance of Chesapeakes ceiling test in Q1 of 2009, the company
was required to recognize $6 billion in after-tax impairment charges. Although a non-cash
expense, the impairment still reflected a decline in the profitability of Chesapeakes proven
reserves. More importantly, the charges had a significant impact on Chesapeakes bottom line
via the income statement. This can be seen to investors as bad news and may suggest a hindrance
to future firm growth prospects (Scott, p. 167). However, it is important to note that this did not
impact the various covenants of Chesapeakes $3.5 billion revolving bank credit facility. Such
23
noncash charges were excluded from the calculation of Chesapeakes debt-to-capitalization ratio
pursuant to a March 2009 amendment to the credit agreement (Mobley, 2009). In the case of
such flexible debt contracting, there is less incentive for Chesapeake management to engage in
earnings management, since covenant violation can be avoided through negotiations rather than
playing with financial ratios. Nonetheless, management tried to conceal the effects of the
impairment by not disclosing it, knowing that the inclusion of a significant write-down would
have a negative impact on share price and debt ratios. Due to the information asymmetry
between management and investors, CHK stock was trading at an inflated price and the company
was able to meet its debt-to-cap and debt-to-EBITDA credit facility covenants.
As funding gaps grew, Chesapeake became more prone to complex and convoluted deals,
including joint ventures and volumetric production payments (VPP). Chesapeake made a number
of long-term commitments to Wall Street banks that required the firm to deliver specific amounts
of oil and natural gas each month, through to 2022, in exchange for upfront cash. These deals,
known as volumetric production payments, are essentially debts, with payment made in fuel
rather than cash. Chesapeake told investors how much the unusual deals have brought in for the
company$6.4 billion since 2007but did not provide details about the costs to fulfill the
contracts, such as pumping and delivering the oil and gas.
CHK accounts for the proceeds of the VPPs in reduction of their full cost pool. These
transactions are treated as loans for tax purposes, thus a great way to monetize assets effectively.
In this case, due to poor reporting of the liabilities that were associated with these transactions,
the VPPs were in fact a means of off-balance sheet financing. Analysts and investors have
criticized CHK for the controversy involved in reporting the VPP transactions, "...because they
26
effectively move future obligations to opaque off-balance sheet structures. Once a well is moved
off the books, it can be difficult for investors to track production" (Reuters 2012).
B&%&6#*)& #*= B&%8#$8%8+4 1'*)&7*.
As a public company, Chesapeake is required by the SEC to fully disclose financial
information and faithfully represent its current economic condition. According to Scott, relevant
information provides financial statement users with an indication of the firms future economic
prospects, while reliable information implies a correspondence between the accounting valuation
of an item and the real item that information represents (p. 36). However, Chesapeake failed to
disclose substantial impairment on natural gas and oil properties, as well as the fact that the
majority of its hedge contracts were bound with a firm experiencing severe financial distress.
These omissions served to overstate the balance sheet and distort shareholders predictions of
future firm performance. As a result of the foregoing material misstatements, the information
provided regarding CHKs asset valuation and credit counterparty risk was irrelevant and
unreliable to investors. Ultimately, financial statement users could not accurately evaluate the
risks associated with the purchase of CHKs overpriced stock.
,-#.& L
1'*(&7&*)& 1#%%M ,'.+?1%#.. ,&78'=
The first conference call following the revelation of Chesapeakes impairment charges
and subsequent 73% share price decline in 2009 was held with 11 analysts, shortly after the class
period on May 5
th
, to discuss the first fiscal quarter of the year (Audio call 3). CEO McClendon
only briefly mentioned the ceiling test impairment in his introduction, instead emphasizing the
recent media coverage regarding his revised employment agreement, as well as the operational
observation of natural gas pricing and production. CFO Marcus Rowland later shed positive light
on the full cost ceiling test, stating that the PV10% at March 31 [] computes to a value for
27
accounting purposes of only $0.75 per thousand cubic feet equivalent (p. 9). He also mentioned
that CHK would be more profitable going forward, as impairment charges reduce capitalized
costs and thus, as mentioned, the firm will record fewer depreciation, depletion and amortization
expenses in future reporting periods.
There was little interest from analysts during the Q&A to inquire about the ceiling test,
nor the resulting impairment charges. During the call, analysts had concerns relating to the
change in Chesapeakes cost trends and falling natural gas prices, knockout swaps, production
levels of certain wells, joint venture progress and prospects, leasing and acquisition
arrangements, as well as fluctuations in quarter-to-quarter capitalized interest expense. Notably,
analysts consistently returned to the topic of Chesapeakes hedge positions, restructuring, and
forecasting. More specifically, analysts were concerned about future expectations for gas
demand and the effect it had on pricing, given that the economy [was] probably in a process of
bottoming (p. 15). However, McClendon had little more to say in terms of macro predictions
than the information provided to analysts by the market.
Most unexpected about the Q1 earnings conference call was that analysts comments and
concerns did not center around the issues introduced by the litigation, particularly the substantial
impairment charge revealed by the ceiling test. Given that the call was the first to be held after
the class period, it is surprising that analysts were not more interested in the specifics of the test
itself. However, according to Investopedia in 2009, investors in the energy sector should get
used to hearing the term noncash ceiling test impairment charge, as a result of the sharp decline
in commodity prices (Fox, 2009). If the impairment charge is not necessarily a firm-specific
event, but rather a signal of future economic consequences on industry players, it is
understandable that analysts did not spend much time on the issue.
28
1-#*E& 8* N:2$&7 '( >*#%4.+.
During the pre-class period, the variance in the number of Chesapeakes number of
analysts was insignificant. On January 15
th
, 2008, 26 analysts were covering CHK, growing to
29 during the financial crisis in October and finally ending with 28 in Q1 of 2009 (Appendix D-
1). The lawsuit did not affect analysts desire to continue to follow the company. Given analysts
recommendation to buy, sell or hold shares at the time, we can see there remained confidence in
Chesapeakes performance. In particular, the majority continued to buy while only a small
amount were selling and approximately 1/3 were holding.
Appendix D-2 shows that during the class period, an average of 1 analyst suggested to
sell CHK shares, indicating that analysts had high confidence in the long-term profitability of the
company, even as the price fell (Bloomberg data).
1#38+#% H#7C&+ B&.3'*.&
Throughout the class period, the target price set by analysts consensus was consistently
above CHKs actual share price. Furthermore, in July 2008, the beginning of the class period,
analysts target price was continuing to increase while share price was severely decreasing. It
was only in September that analysts started to decrease their target price, though still
significantly above actual price. Therefore, analysts estimated that the stock was undervalued.
However, efficient securities market theory suggests that all publicly available information is
reflected in stock prices, thus the market identified Chesapeakes financial difficulties before the
analysts (Appendix D-2). It is possible that analysts continued to give a high estimate for CHK
due to the fact that several analysts were holding CHK stock. That is, a price increase would
ultimately benefit the shareholders (i.e. the analysts). There were 16 of the 26 analysts following
Chesapeake who held a portion of the companys shares, which totaled 35M shares, with
Goldman Sachs leading the group at 16.5M shares as of July 15th 2008. Goldman Sachs, 5th
29
biggest shareholder in the first part of 2008, lost confidence in Chesapeakes management and
began divesting in Q2 of 2008, liquidating almost all shares by the end of 2009, and reducing the
spread between their target price and actual price from 35.24$ to 2.23$ above actual price.
B&.3'*.& '( K*.+8+:+8'*#% K*6&.+'7.
In the first quarter of 2008, Chesapeakes CEO was the second largest shareholder of the
company with 30.7 million shares, just below Southeastern Asset Managements 36.5 million.
Other prominent shareholders were CHK co-founder Tom L. Ward, Wellington Management
and Goldman Sachs Group. Throughout the 2008 reporting period, the holdings of these 5 major
shareholders were subject to significant changes (Appendix D-3). Initially, McClendon was
forced to sell the majority of his shares in order to meet margin calls, ending the year with a mere
1.9 million shares. On the other hand, Southeastern began with 65.3 million shares in the pre-
class period, consistently increasing its stake through to the post-class period, ending with 74.2
million shares by mid-2009. The shareholders were divesting while the share price was
increasing and buying while the share price fell. Similarly, Wellington Management divested
while the share price rose, increasing their stake following CHKs stock price decline in the third
quarter of 2008. By the end of the class period, Wellington held approximately 10 million shares
(Bloomberg data).
O&$+ B#+8*E >E&*)8&.
CHK debt rating agencies are aligned with the trend of the financial crisis, as the
likelihood of default was low until September 2008. The companys debt rating according to
Moody was Ba2 and BB according to S&P, which is the next rating down from the highest non-
investment grade rating, regarded as speculative. It is assigned to less creditworthy securities and
investors face a higher risk of default. Furthermore, during 2008 and 2009, Chesapeakes
30
liquidity reached a long-time low. The company was struggling to sell assets and find investors
in their shale position in order to help meet drilling activity costs.
,-#.& P
It is now abundantly clear that Chesapeake's firm value was closely linked to natural gas
prices during the litigation. Although the firm repeatedly tried to demonstrate that operating cash
flows were protected against the volatility of these prices by engaging in significant hedging
activity, vulnerability was still an issue. Chesapeake was subject to declining natural gas prices
for two reasons: credit contract counterparties were insolvent and hedging was ineffective. The
company failed to report key elements in the financial statements regarding the hedging
contracts, which ultimately gave investors a distorted representation of Chesapeakes future
profitability.
Chesapeake sought to build an empire and gain advantage in the industry by
accelerating lease signing and drilling activitiesa strategy that required significant financing.
Chesapeake was already highly leveraged prior to raising the necessary capital via share
issuance. Evidently, maximizing reported profit to maintain a high share price until the issuance
of these shares was paramount. As such, in order to maintain high earnings and high asset values,
the company delayed impairment on several assets that were overvalued in the financial
statements at the time. It can be argued that CHK management timed the share issuance 2 weeks
before the Q2 announcement, reporting abnormal earnings that were uncharacteristically low
relative to the previous 6 years. In other words, Chesapeake was aware that the market would
react unfavourably in Q2, reducing demand and as a result, the stock price. Throughout the
following year, the company reported an impairment loss of $11.2 billion, wherein a $6.9 billion
portion was attributable to the market decline in natural gas prices. Thus, a $4.3 billion write-
31
down was related to the overvaluation of proved reserves. Since proved reserves are an estimated
component where most of the data required for computation is sourced internally from CHK
management, the result on the market is information asymmetry, further increasing shareholders
risk.
Finally, Chesapeakes compensation structure and the poor structure of the CEOs
employment contract lead to a serious issue of moral hazard. McClendon was involved in several
controversial deals that caused shareholders to lose confidence in his leadership. In fact, US
authorities are looking into the allegations regarding the Founders Well Program being financed
by personal loans granted by CHK creditors, as well as McClendons involvement in a Heritage
Fund trading in natural gas futures. Giving the CEO explicit license to play
the markets represented an extraordinary incentive that enhanced one of corporate America's
most generous compensation plans and reinforced the unique treatment afforded to McClendon
by Chesapeake (Prezioso, 2012). At a minimum, McClendon was distracted from his fiduciary
duties at CHK and further, his position as CEO gave him a strategic position to benefit in his
personal affairs (Schneyer, 2012).
An effective way to enhance the transparency of the firms financial reporting is to adopt
new guidelines for more accurate estimation of produced reserves. Given that this estimation is
subject to manipulation by Chesapeake management, regulations should be put in place to avoid
the possibility of artificial increases. As a result, investors can be confident that reserve valuation
is more reliable.
In order to mitigate the issue of McClendons compensation, the mix of short- and long-
term rewards should be restructured. More specifically, including a greater portion of long-term
incentive will put less focus on bonus rewards, better aligning his objectives with those of the
32
shareholders. In doing so, a conflict of interest in terms of personal vs. corporate profit is
eliminated, as the CEOs interests will be better aligned with those of the firm. Further,
Chesapeake should integrate a peer-benchmarking method that makes the compensation program
competitive within the industry.

33
>33&*=8Q >M ,-#.& /
>33&*=8Q >?/

Company Name: Chesapeake Energy Corporation
Ticker: CHK
Short Description of the company (location, what they do, age, size):
Chesapeake Energy Corporation is the second-largest producer of natural gas and the most active
driller of new wells in America. Headquartered in Oklahoma City, the company's operations are
focused on discovering and developing unconventional natural gas and oil fields onshore in the
U.S. The company also owns substantial marketing and oilfield service businesses through its
subsidiaries.
Date of Filing: Feb. 25, 2009
Class Period related to lawsuit: July 15, 2008 - Jan. 27, 2009
Value change over class period:
July 15, 2008 (adj.close): $55.79
Jan 27, 2009 (adj.close): $14.77
Value change over class period: -0.735 or approx 74% decline in share value.

Are there any major one-day changes in value?
September 30th 2008: -5.34
What is the accounting issue?
On February 25, 2009, an investor of Chesapeake Energy Corporation filed a proposed securities
class action lawsuit against Chesapeake Energy Corporation, on behalf of purchasers of
Chesapeake Energy Corporation stock issued pursuant to the registration statement and
prospectus filed with SEC in regard to July 2008 secondary public stock offering. On July
15,2008, the public offering of 28.75 million shares were made at $57.25/share, resulting 1.65
billion in gross proceeds. The complaint alleged that Registration Statement in regard to Offering
was materially false and misleading because of its failure to disclose numerous facts required
to be stated.
Who is the external audit firm, and is it being sued?
PricewaterhouseCoopers No.
34
Has there been a settlement? If so, when was the settlement? Who settled and for how
much money?
Case status is still ongoing.
What is the most surprising fact that you learned about this company and the litigation
case?
The company entered into significant proportion of hedge contracts with Lehman. Lehman
Brother had a weak financial condition and faced high risk of insolvency at the time. Chesapeake
entered into a significant proportion of hedge action with a troubled firm, an additional risk that
should have been specified in disclosure. How much was hedged with Lehman and how many
hedges are eliminated due to knock out provisions are important to understand the potential of
the risk and effectiveness of the hedge contract. CHK was also incompetent in allowing the land
brokers to bid up on prices, leaving the firm with unnecessarily high LOE costs (overpaying for
leases).

List any firm- or industry-specific web links that you used.
www.chk.com
www.ca.finance.yahoo.com

33
>33&*=8Q >?0

Company Name: Miller Energy Resources, Inc
Ticker: MILL
Short Description of the company (location, what they do, age, size):
Miller Energy Resources Inc operates as an exploration and production company that utilizes
seismic data and other technologies for geophysical exploration and development of oil and gas
wells. Its headquarters are in Huntsville, Tennessee, and focuses its operations in Alaska,
Tennessee.
Date of Filing: August 12th 2011
Class Period related to lawsuit: March 15th to August 1st 2011.
Value change over class period: Drop of 0.50 USD

Miller's stock price dropped from $7.04 per share on July 27, 2011, to a close of $3.37 per share
on August 2, 2011, a total drop of $3.67 or 52%
Miller bought assets that it overvalued at 300 M USD. The valuation error of the asset was made
public two years after the acquisition by competitors, saying it was actually worth 25 to 30
million, offset by 40 M USD in liabilities. Miller is accused of several mischief:
1) over stating an asset value,
2) Inappropriately recording revenue on a gross basis for overriding royalty interest rather than
recording revenue on a net basis
3) Failing to record sufficient compensation expense on certain equity awards
4) Improperly calculating the liability for derivative instruments
5) As a result of the above, their financial statements were misstated and not in accordance with
36
G.A.A.P.
6) Lacked internal and financial controls and thus the financial statements were materially false
and misleading at all relevant times
Who is the external audit firm, and is it being sued? Sherb & Co prior to 2010, hereafter
KPMG LLP. There are no litigation involving the auditors as of yet.
much money? No information regarding settlement is available.
case?
They have consistently neglected to produce proper financial statements for a good full year and
a half.
Seeking alpha
Yahoo finance
S.E.C.
Miller energy Resources

37
>33&*=8Q >?@

Company Name: BP, Public Limited Company
Ticker: BP
Short Description of the company (location, what they do, age, size):BP is a multinational,
vertically integrated oil and gas company headquartered in the UK. In 2011, it was the third-
largest energy company worldwide. It operates in all areas of the energy industry: exploration,
production, refining, distribution and marketing, petrochemicals, power generation and trading.
It also has renewable energy activities in biofuels and wind power. It is infamous for the April
2010 Deep Horizon explosion and oil spill.
Date of Filing: May 21, 2010
Class Period related to lawsuit: Mar. 4, 2009 - Apr. 20, 2010
Value change over class period: 72% increase
Are there any major one-day changes in value? On April 20, 2010 (last day of class period),
BPs stock price rapidly declined and did not begin to recover until late in June of the same year:
What is the accounting issue? Earnings management. BP convinced investors that it would be
able to generate tremendous growth with minimal risk. BP was misleading the investing public.
The truth was that the firm was cutting corners and reducing its spending on safety measures in
an effort to maximize profits in the Gulf of Mexico.
Who is the external audit firm, and is it being sued? Ernst & Young - No.
much money? The economic and environmental loss portion of a proposed US$7.8 billion
partial settlement of claims has been approved. BP faces additional billions of dollars in civil
pollution fines and costs to restore natural resources damaged by the spill. It has provisioned
38
about $38.1 billion for spill costs and has paid more than $8 billion in compensation to
individuals, businesses and government entities so far. It has also agreed to plead guilty to 14
counts, including 11 for felony seamans manslaughter, and pay $4 billion to the U.S. Justice
Department to resolve these criminal charges. Lastly, BP has agreed to pay $525 million to settle
the U.S. Securities and Exchange Commissions claim that the company misled investors about
the rate of oil flowing into the gulf.
case? The extent of damage that BPs earnings management had on civilian lives is shocking,
particularly the deaths of 11 victims. The fact that the firm went so far as manslaughter (though
unintentional) to generate profit goes to show how narrow-minded executives become when the
opportunity for growth arises.
Yahoo Finance
Financial Post
Bloomberg News

39
>33&*=8Q >?L

Company Name: Petroleum Development Corporation
Ticker: PDCE
Short description of the company ( location, what they do, age, size): PDC Energy ("PDC" or
the "Company") (NASDAQ: PDCE) is a 40-year old independent natural gas and oil company.
PDC is focused on organic growth and an increasing liquids portfolio through horizontal drilling
while maintaining a solid balance sheet and ample liquidity. The Company is committed to
optimizing margins through efficient drilling operations, sound well management, and
environmental stewardship. PDC operates in Colorado within the liquid-rich Wattenberg Field,
Piceance Basin and Northeastern Colorado (NECO), and the Appalachian Basin including the
emerging liquid-rich Utica Shale play in Ohio and the Marcellus Shale in West Virginia. PDC's
strategy is simple: increase shareholder value through the growth of reserves and production,
while operating properties in an efficient manner to maximize the cash flow and earnings
potential of its assets.
Filing Date: 12/07/2011
Class period related to lawsuit: November 16
th
, 2011- December 7
th
, 2011
Value change over the class period: 2% increase

On November 25, there was a declined in value: 29.01
Accounting issues: Over a period of several years, the Company formed numerous limited
partnerships to raise funds to finance the acquisition and development of oil and gas properties,
and attracted thousands of investors who paid hundreds of millions of dollars for their limited
partnership interests.
The Company prepared and issued proxy statements to the limited partners. Those proxy
40
statements, the plaintiffs claim, contained materially false and misleading statements and omitted
to state material facts relating to the value of the assets of the Partnerships and the units held by
the limited partners. The proxy materials portrayed the value of the partnerships' units to be,
under most measures, less than what would be paid to limited partners upon consummation of
the mergers.
Who is the external audit firm, and is it being sued? PricewaterhouseCoopers LLP No.
much money? No settlement.
case?
When you look at the company website, it says that corporate governance is primordial for them
but still, the company gets sued for material misstating assets value which is one of the most
common frauds a company can make.
List any firm-or industry-specific web links that you used:
http://www.pdce.com/
http://securities.stanford.edu/1048/PETD00_01/
www.finance.yahoo.com

41

>33&*=8Q >?P

Company name: Anadarko Petroleum Corporation
Ticker: APC
Short description of the company ( location, what they do, age, size): Anadarko is among the
largest independent oil and natural gas exploration and production companies in the world, with
2.56 billion barrels of oil equivalent (BBOE) of proved reserves at year-end 2012.
The company's portfolio of assets encompasses premier positions in U.S. onshore shales and
resource plays in the Rocky Mountains region, the southern United States and the Appalachian
Basin. The company also is a premier deep-water producer in the Gulf of Mexico, and has
production in Alaska, Algeria, and Ghana with additional exploration opportunities in West
Africa, Mozambique, Kenya, South Africa, Colombia, Guyana, New Zealand and China.
Filling date: 06/23/2010
Class period related to lawsuit: 06/12/2009 to 06/09/2010
Value Change over class period: 31.1% decrease

On June 1
st
, 2010, shares of Anadarko fell almost $10.00 per share -- or approximately 20% --
42
falling from a close of $42.10 per share, from a prior day's close of $52.33 per share, on huge
volume of over 44.8 million shares traded. Shortly thereafter, on June 9, 2010, shares of
Anadarko fell another 20%.
Failure to disclose following information: Leaking millions of gallons of oil into the Gulf of
Mexico; Macondo well site had no effective Exploration and Oil Spill Response Plan;
Implementation of drilling procedures that placed cost-cutting measures above safety; Lacked
adequate systems of internal,operational, or financial controls; Company failed to estimate
adequate insurance reserves to meet the foreseeable risks associated with its deepwater drilling
liabilities; Material deficiencies for companys 1 billion dollars in cleanup costs, despite the
extent and severity of the event; Lacked reasonable basis to claim that Anadarko could achieve
its projected guidance.
Who is the external audit firm, and is it being sued? KPMG No.
much money? Case status is still ongoing.
case?
The joint operating agreement among the partners gave Anadarko broad rights to monitor
and approve activities on the Macondo oil well. Anadarko was given immediate and continuous
access to detailed information concerning all operations on the oil rig, including daily drilling
reports, copies of well test results, and continuous access to "real time" drilling data detailing
current and prospective activities at the well. The operating agreement also required Anadarko's
express approval for key operations on the well. Another surprising fact is that $42.7 million
worth of CEO James Hackett's stock of Anadarko was sold on March 31, 2010, after the
Macondo project had suffered significant delays and just three weeks before the Macondo well
disaster.
List any firm-or industry-specific web links that you used:
www.anadarko.com
Consolidated class action complaint as file in the New-York District
Anadarkos 2010 annual report
Factiva

43
>33&*=8Q AM ,-#.& 0
>33&*=8Q A?/

Taken from finance.yahoo.com
>33&*=8Q A?0

44

>33&*=8Q A?@
LS mean leadlng Lo C2 earnlngs release

>33&*=8Q A?L

43
>33&*=8Q A?P


46
>33&*=8Q 1M ,-#.& @
>33&*=8Q 1?/

>33&*=8Q 1?0

>33&*=8Q 1?@

Annual uaLa 2009 2008 2007
change
07-08
change
08-09
Cross proflL $ (8,943,000,000.00 ) $ 1,437,000,000.00 $2,630,000,000.00 -43 -713
neL
Larnlngs $( 3,833,000,000.00) $ 604,000,000.00 $1,433,000,000.00 -38 -1069
LS 8aslc $(9.37) $ 0.94 $ 2.70 -63 -1118
ulluLlve $( 9.37) $ 0.93 $ 2.63 -64 -1118
Annual uaLa 2009 2008 2007
change
07-08
change
08-09
uec (lnc) ln accounLs recelvable (1 000 000,00) $ (230 000 000,00) $ (229 000 000,00) $ 9,17 -99,60
uec (lnc) ln lnvenLory 33 000 000,00 $ 29 000 000,00 $ (29 000 000,00) $ -200,00 13,79
lnc (uec) ln accounLs payable (634 000 000,00) $ 349 000 000,00 $ 402 000 000,00 $ -13,18 -287,39
lnc (uec) ln accrued llablllLles 40 000 000,00 $ 168 000 000,00 $ 298 000 000,00 $ -43,62 -76,19
lnc ( uec) ln deffered lncome Laxes (338 000 000,00) $ 338 000 000,00 $ 39 000 000,00 $ 817,93 -200,00
1oLal accruals (940 000 000,00) $ 634 000 000,00 $ 481 000 000,00 $ 33,97 -243,73
ClC 4 336 000 000,00 $ 3 337 000 000,00 $
4 974 000 000,00
$ 7,70 -18,69
1oLal acrruals/ClC -0,213794307 0,122083236 0,096702833 26,23 -276,76
lmpalrmenL of LoLal operaLlng cosLs 2009 2008 2007
lmpalrmenL of naLural gas
and oll properLles andoLher asseLs 66.70 27.80 0
lmpalrmenLlnvesLmenL 47.20 38.60 0
47
>33&*=8Q 1?L

>33&*=8Q 1?P

>33&*=8Q 1?R

2009 2008 2007
Cross proflL -116 12.30 33.90
neL lncome -76 4.30 13.80
48
>33&*=8Q 1?S

>33&*=8Q 1?T

49
>33&*=8Q 1?U

>33&*=8Q 1?/V

30
>33&*=8Q 1?//

>33&*=8Q 1?/0

31
>33&*=8Q 1?/@

>33&*=8Q 1?/L

0
0.2
0.4
0.6
0.8
1
1.2
Q
2

0
9

Q
4

0
8

Q
2

0
8

Q
4

0
7

Q
2

0
7

Q
4

0
6

Q
2

0
6

Q
4

0
5

Q
2

0
5

Q
4

0
4

Q
2

0
4

Q
4

0
3

Q
2

0
3

Q
4

0
2

Q
2

0
2

Reported EPS
Estimate EPS
32
>33&*=8Q OM ,-#.& L
>33&*=8Q O?/

>33&*=8Q O?0

24.5
25
25.5
26
26.5
27
27.5
28
28.5
29
29.5
Number of analysts following CHK
33
>33&*=8Q O?@

34
A8$%8'E7#3-4
,-#.& 0
About Chesapeake. Chesapeake Energy. February 17, 2013.
<http://www.chk.com/About/Pages/Default.aspx>
Boren , D. (2009, 04 05). H.r. 1835: Legislation for natural gas transportation .
<http://seekingalpha.com/article/129526-h-r-1835-legislation-for-natural-gas-
transportation>
Chesapeake Energy Corporation. NYSE Euronex. March 1
st
, 2013
<http://www.nyse.com/about/listed/chk.html>
Chesapeake Energy Corporation. Stahfor Law School. February 5t
h
, 2013
<http://securities.stanford.edu/1042/CHK09_01/>
Chesapeake Energy Corporation (CHK). Yahoo Finance
<http://finance.yahoo.com/q?s=CHK&ql=1>
Dow Jones Newswires. (2009, 05 28). Natural gas futures climb on eia storage data.
< http://www.firstenercastfinancial.com/news/?cont=31272>
Etp, chesapeake to build new pipeline. (2009, 01 27).
< http://www.bizjournals.com/dallas/stories/2009/01/26/daily21.html>
Jacobs, S. (s.d.). Oil plunges $10 as US bailout plan voted down. Rcupr sur USAToday:
<http://usatoday30.usatoday.com/money/markets/2008-09-29-3815204975_x.htm>
L. Mobley, Jeffrey( 06/06/2008) : Chesapeake Energy Corporation Provides Update on
Haynesville Shale Activities <http://www.chk.com/news/articles/pages/1163252.aspx>
Meerten , J. V. (2012, 02 12). Chesapeake energy is a company in transition.
<http://seekingalpha.com/article/381521-chesapeake-energy-is-a-company-in-transition>
33
Price , T. (2009, 02 26). Chesapeake Energy Corporation Announces Plan to Reorganize its
Eastern Division Operation in Charleston, West Virginia.
< http://www.chk.com/news/articles/pages/1260504.aspx>
Scott, William. R. Financial Accounting Theory, Sixth (Canadian) Ed. Prentice-Hall Canada.
SEC 10-Q filings. (s.d.). Cheasapeake 2008 10-Q Filing Period Ending March 31, 2008.
<http://www.sec.gov/Archives/edgar/data/895126/000119312508111564/d10q.htm>
Teller, K. (s.d.). Natural gas Year-In-review 2008. US Energy Information Administration:
<http://www.eia.gov/pub/oil_gas/natural_gas/feature_articles/2009/ngyir2008/ngyir2008.
html>
Audio call 1: Q1 2008 earnings call, May 2, 2008. PDF from Bloomberg.
Audio call 2: Financial updates, September 23, 2008. PDF from Bloomberg.
,-#.& @
Anadarko. Annual Reports, 2009.
BP. Director's Remuneration Report, 2009.
Chesapeake. (2008). Form 10-Q for Quarter ending March 31, 2008.
Chesapeake. (2008). Haynesville Shale Project Update. Bloomberg.
ChesapeakeDEF14A. (2008). DEF14A. SEC.
Chesapeake. Annual Reports, 2009. <http://www.chk.com/investors/pages/reports.aspx>.
Chesapeake. 10K Reports, 2009. <http://www.chk.com/investors/pages/reports.aspx>.
Earningsprice.com. (2013). <http://www.earningsprice.com/i.php?s=CHK>.
Encana Corporation. 2008 Annual Meeting of Shareholders.
36
Fox, E. (2009, 01 20). Ceiling falls on exploration and production sector
<http://www.investopedia.com/stock-analysis/2009/ceiling-falls-on-exploration-and-
production-sector-apa-apc-wti0120.aspx>
Gammel, J., Wilson, L., & Shilpa, K. (2008). Doing more with less. Macquarie Research.
Grow, B. (2012, 04 27). Exclusive: Chesapeake board member lent money to CEO McClendon.
< http://www.reuters.com/article/2012/04/27/us-chesapeake-board-loan-
idUSBRE83Q17O20120427>.
L. Mobley, Jeffrey (05/04/2009): Chesapeake Energy Corporation Reports Financial and
Operational Results for the 2009 First Quarter.
<http://www.chk.com/news/articles/pages/1283905.aspx>.
Politics & Economics, Fracking: Economic Boom or Environmental Danger. 2013.
<http://politicsandpolicy.org/article/fracking-economic-boom-or-environmental-danger>
Reserve And Economic Evaluation Of Proved Reserves Of Certain Chesapeake Energy
Corporation Eastern Division Oil And Gas Interest.
<http://www.sec.gov/Archives/edgar/data/895126/000119312512089591/d270087dex992
.htm>.
Scott, William. R. Financial Accounting Theory, Sixth (Canadian) Ed. Prentice-Hall Canada.
Simons, R. S. (1999, 05-06). How Risky is Your Company? Harvard Business Review, p.85-94.
SEC 10-Q filings. (n.d.). Cheasapeake 2008 10-Q filing period ending March 31, 2008.
<http://www.sec.gov/Archives/edgar/data/895126/000119312508111564/d10q.html>
The Associated Press. Fracking Critics Using Bad Science, Experts Say. July 22
nd
, 2012.
37
(Business Insider, 2013)
<http://www.chk.com/News/Articles/Pages/news_20120723.aspx>
Wile, Rob. Chesapeake CEO Used Stake in Companys Wells As Collateral For Massive
Personal Loan. Business Insider. April 18, 2012. (Bloomberg Businessweek, 2009)
<http://articles.businessinsider.com/2012-04-18/news/31359223_1_mcclendon-
chesapeake-natural-gas>
Palmeri, Christopher. Chesapeake Energy Battles CEO Compensation Furor. Bloomberg
Businessweek. April 29,2009. (ABC News, 2009).
<http://www.businessweek.com/bwdaily/dnflash/content/apr2009/db20090428_012209.h
tm>
Gomstyne, Alice. Top Five Highest Paid Worst Performing CEOs. ABC News. Sept 22,2009.
(Forbes, 2008). <http://abcnews.go.com/Business/top-highest-paid-worst-performing-
ceos/story?id=8642794#.UWyI0jnmTlI>
Farrell, Andrew. Serafin, Tatiana. Margin Calls Ignite Billionaire Fire Sale. Forbes. Oct
23, 2008. (NY times, 2008) <http://www.forbes.com/2008/10/23/billionaires-margin-
calls-biz-billies-cx_af_1023billiemargin.html>
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Times. October 13, 2008. (NY times 2009)
<http://www.nytimes.com/2008/10/14/business/14margin.html?_r=0>
38
Morgenson, Gretchen. Shareholders Who Act Like Owners. The New York Times. March 28,
2009. (Reuters, 2012). <http://www.nytimes.com/2009/03/29/business/29gret.html>
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Driver, Anna. Chesapeake CEO McClendon Cashes in on Wells Deals Reuters. April 15,
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idUSTRE77E4BT20110815>
,-#.& L
Audio call 3, 2009 Q1 Earnings, May 5, 2009.
Fox, Eric. Ceiling Falls On Exploration And Production Sector, January 20
th
, 2009.
<http://www.investopedia.com/stock-analysis/2009/ceiling-falls-on-exploration-and-
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,-#.& P
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<http://www.reuters.com/article/2012/05/08/us-chesapeake-mcclendon-contract-
idUSBRE8470EU20120508>

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