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Does Cronyism Compromise Shareholder Value at SandRidge Energy Inc. (SD)?

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Investing expert Charlie Munger, Warren Buffett’s right hand, warns us that we should always pay attention to the power of incentives. While well-crafted incentives can promote good management that leads to strong returns for investors, poorly crafted incentives can lead to mismanagement that can cause our investments to plummet.

SandRidgeSo I’m concerned that SandRidge Energy Inc. (NYSE:SD) has given its board incentives to serve management’s interests rather than shareholders’ interests. Here’s why.

What do shareholders get in this quid pro quo?
In its 2013 proxy, SandRidge Energy Inc. (NYSE:SD) disclosed that it signed a three-year contract to rent commercial space from an entity that is partially owned by board member Roy T. Oliver. Under the contract, SandRidge Energy Inc. (NYSE:SD) will pay $510,000 in annual rent, minus the cost of any renovations it makes to the property.

The disclosure indicates that the board believes the terms of the contract are fair market rates. While I don’t see a particular reason to be concerned about the price the company is paying for the property (given the limited information that is provided), I am concerned about the possibility that this business relationship may create a “quid pro quo” relationship between SandRidge Energy Inc. (NYSE:SD)’s management and Oliver, who may be grateful for SandRidge Energy Inc. (NYSE:SD)’s patronage.

And Oliver’s gratitude could be risky for investors. Note that Oliver is classified as an independent board member despite this business relationship. He was a member of SandRidge Energy Inc. (NYSE:SD)’s compensation committee in 2012, and is currently a member of the nominating and governance committee. Oliver’s presence on these committees puts him in a strong position to help CEO and Chairman Tom Ward secure attractive compensation packages and recruit board members that would be charitable to management.

Note that the presence of this business relationship doesn’t mean Oliver will make decisions that favor management over investors. However, management’s willingness to engage in these related-party transactions can give board directors incentives to curry favor with management in hopes of getting something in return down the road, even at the expense of shareholders.

Stealing our Thunder
SandRidge also disclosed certain business dealings with NBA team Oklahoma City Thunder, in which Tom Ward owns a 19.23% interest, and board director Everett Dobson owns a 3.85% interest. Interestingly, Dobson is also categorized as an independent board member despite this business relationship, and is the chair of SandRidge’s audit committee.

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