Corporate Governance and Finance: Aquila Case Study Analysis

This case study examines Aquila's strategic shift from utility services to power trading, analyzing the pros and cons of its 'asset lite' and 'electricity branding' strategies. It explores the performance outcomes of regulated utilities diversifying into new business models, highlighting the impact of market volatility and regulatory pressures. The assignment delves into factors influencing executive compensation plans, considering the financial health of the company, stock prices, and executive performance. It also compares the ideal compensation structures for both regulated utilities and energy trading companies. The study underscores the challenges of diversification, the importance of aligning compensation with company performance, and the need to adapt to evolving market dynamics within the energy sector.

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1. Pros and cons of the “asset lite” merchant trading strategy and the “electricity
branding” strategy used by Aquila
Pros of asset lite strategy and electricity branding strategy
 The strategy of asset lite offered significant value to the company. Aquila would profit
from the natural gas and power they were to offer to third-party plants without
necessarily having to invest in construction and maintenance of infrastructure.
 The strategies were effective as the company experienced massive revenue growth that
made it enter into the history of energy industry. For instance, in 2000, the energy
marketing revenue had risen by 340% (Larcker & Tayan, 2008).
 Aquila was able to cover larger area by accessing foreign market. The Policy Act that
was enacted in 1992 gave Aquila an opportunity to provide power to the deregulated
markets.
Cons of asset lite strategy and electricity branding strategy
 The volatility of the energy trading operations whereby contract pricing kept on
fluctuating depending on the supply and demand. For the company to maneuver through
this it has to have sophisticated financial model, otherwise, it will experience severe loss
of capital. This was seen in the year 2000 and 2001, where Aquila underwent massive
losses due to reversal of the wholesale electricity demand (Larcker & Tayan, 2008).
 Electricity branding strategy is a risk strategy (Lehr, 013) since the company had to take
charge of the economic network that the electric power flowed through to the buyers.

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 Aquila had to cope with adverse economic trading operations in the exotic areas it had
expanded its markets. It included determining the broadband capacity futures and facing
adverse weather hedges (Larcker & Tayan, 2008).
2. Performance outcomes when regulated utilities diversify into business outside their
traditional business model
Due to pressures that are building around the electric utilities business such as use of new
technologies and increased demand from consumers and other suppliers, many companies have
diversified their operations outside their traditional models. The main performance outcome from
this is the formation of partnerships and mergers with other innovative firms so that they can
remain competitive and outdo other companies through integration of their services (Lehr, 2013).
Nevertheless, diversification into foreign markets is usually filled with a lot of uncertainties that
the company should be ready to face. For instance, the regulatory processes concerning the
performance standards need to be obeyed. For utilities, therefore, to achieve much in terms of
revenue and turnover, they need to ensure the economics of the deal are not eroded.
Additionally, diversification outside their business models is encompassed by several
challenges due to faster evolution occurring in power and utilities sector. As such, due to
formation of new value pools, the companies start generating new pricing models for their
services. Due to intensified retail competition, increased power production costs, and subsidized
renewables margins, many utilities find that in the long-run their revenue decrease. For instance,
the sector performance for the GT40 European utilities market value dropped once they
diversified from their traditional business model (Westphal, 2014). Similarly, Aquila also
experienced loss of revenue and reduction in annual dividend after diversification till Robert
Green suggested that they should concentrate on their core utility business.

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3. Factors that influence the design of executive compensation plans for a regulated utility
and an energy trading company and the ideal compensation plan
Financial status of the company, stock price, cash flow, and performance/ input of the
executives influences the design of an executive compensation plan. The board of management
should ensure that the compensation aligns with the financial status of the company. If the
company’s revenue, cash flow, and stock price is relatively high, then the executive
compensation can increase as well (Sirkin & Cagney, 2018). Additionally, the compensation
should be directly proportional to the performance of the executives. It’s not right for an
executive who has performed poorly to be given the same compensation with one who has
performed well. Also, the compensation plan used by a company’s competitors should be
considered so that the executives won’t be lured to the rival company.
The ideal compensation plan for a regulated utility and an energy trading company is the
mix of pay plan. This is because the company will have to maintain a competitive advantage
over its rivals through implementation of a consistent sales compensation structures (Sullivan &
Good, 2011). The mix plan establishes a risk/reward proposition that motivates employees to
work harder. Together with the payout curve, the leverage is determined. Other plans such as
equity-based plans and level of pay as well can be used in utility companies. However, the plans
should be different for each type of company because each company has different demographics.

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References
Larcker, D. F., & Tayan, B. (2008). Executive Compensation: Moving from Utility Services to
Power Trading at Aquila. Rock Center for Corporate Governance at Stanford University
Teaching Case No. CG-14.
Lehr, R. L. (2013). New utility business models: utility and regulatory models for the modern
era. The Electricity Journal, 26(8), 35-53.
Sirkin, M. S., & Cagney, L. K. (2018). Executive compensation. Law Journal Press.
Sullivan, J. E., & Good, J. (2011). Recovery of Executive Compensation Expenses in Utility
Rate Cases. The Electricity Journal, 24(3), 59-71.
Westphal, K. (2014). Institutional change in European natural gas markets and implications for
energy security: Lessons from the German case. Energy policy, 74, 35-43.