Chairman Departure Is a Victory For Barrick Shareholders

On Friday, Barrick Gold (TSX: ABX, NYSE: ABX) Chairman and founder Peter Munk disclosed his plans to retire. And while the Canadian business community pays tribute to this titan of industry, Mr. Munk shouldn’t expect a gift basket from shareholders.

Peter Munk’s legacy
Last week Barrick announced that it expected to update investors before year-end on its initiatives to renew the board and review its compensation practices. But the most important revelation was news that the company’s founder Peter Munk will step down from his position as Chairman. No timeline was given. But many expect the departure to take place at company’s annual meeting next year.

The announcement was a chance for the business community to salute the mining mogul after a remarkable 60 year career. As Rachelle Younglai and Brent Jang wrote in the Global and Mail this weekend,

“Peter Munk, a refugee from Hungary who built Canadian businesses in real estate, oil and electronics, is getting ready to bid farewell to the company he transformed into the world’s largest gold producer. The fedora-sporting tycoon, who turned 86 on Friday, is about to leave Barrick Gold Corp. The industry behemoth he started with a small stake in a Northern Ontario mine is now struggling to regain investor confidence following two years of declines in prices for the precious metal.”

Peter Koven at the Financial Post followed with:

“Meanwhile, the big problems at Barrick have been addressed. The troubled Pascua-Lama project has been suspended meaning it will stop sucking billions of dollars out of the miner’s treasury until the many problems surrounding it have been resolved. And the over-levered balance sheet is being repaired by the equity offering. The company has also improved the performance of many of its operations, most notably the Lumwana mine in Zambia. These factors all allow Mr. Munk to retire with his head held high.”

Shareholders may beg to differ.

Under Mr. Munk’s leadership, the last decade at Barrick has been marked by a series of strategic missteps. The company bungled its way out of a commodity price hedging program that cost investors billions. In a costly empire building campaign, Barrick purchased mine after mine at unjustifiably high prices. And it forays outside of precious metals and into copper resulted in a $4 billion writedown.

Most astoundingly, the company has an accumulated deficit – cumulative profits less dividends over the entire life of the company – of $4.71 billion. Even when you add dividends back to that figure, Barrick has generated barely any GAAP profits over its history as a publicly traded company.

The tragic misallocation of capital has left the company saddled with nearly $16 billion in debt and almost nothing to show for it. Now shareholders are being asked to pick up the tab. In October, Barrick announced a $3 billion equity offering – one of the largest in Canadian history – in order to repair its stretched balance sheet.

All of which may had be tolerable had the executives shared in the pain with shareholders. However, in the midst of these strategic missteps, Barrick’s board saw it appropriate to award Mr. Munk a raise increasing his base salary by 67% to $2.5 million last year.

Lessons learned from this fiasco
There are three important takeaways from this investment tragedy.

First, make sure the people you entrust your capital to have skin in the game. Peter Munk held only a tiny fraction of his wealth in Barrick stock owning only 0.2% of the company’s outstanding shares. It’s highly unlikely that he and the board would’ve presided over this massive destruction of wealth if their money was on the line.

Second, you must understand how management is compensated. As Berkshire Hathaway vice-chairman Charlie Munger put it, ‘I think I’ve been in the top 5% of my age cohort all my life in understanding the power of incentive, and all my life I’ve underestimated it.’

Executive compensation at Barrick was directly tied to growing the size of the company. It shouldn’t be surprising therefore that Barrick became the largest gold miner in the world regardless of the cost to investors. Had management compensation been tied to say return on capital employed or production growth per share, I doubt shareholders would be so upset today.

Finally, Munk’s departure is evidence that engaged shareholders can have a say in how a company is run. We don’t have to sit idly by while our capital is squandered. And while more work needs to be done to improve corporate governance at Barrick, it should serve as an inspiration to shareholders at other companies and a warning to complacent boards everywhere.

Foolish bottom line
While Peter Munk’s retirement will be mourned on Bay Street, his boardroom presence won’t be missed by rank-and-file investors. And while lots of work is left to be done at Barrick, his departure is a victory for shareholders.