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White Paper – CEO Pay at Valeant: Does Extreme Compensation Create Extreme Risk?

CEO Pay at Valeant: Does Extreme Compensation Create Extreme Risk? this is the actual title of a new white paper – interesting – usually white papers do not mention companies by name unless they are no longer here like Enron – not saying Valeant is like Enron just find it atypical to get so company specific especially in title – anyway white paper below.

Valeant white paper Valeant white paper 3 Valeant white paper 2

Abstract:

The litmus test for an effective compensation program is whether it provides “pay for performance.” While the concept of pay for performance is simple, its implementation is not. In particular, boards must consider not only whether a compensation plan encourages executives to pursue corporate objectives and build shareholder value but also the unintended consequences of pay. We consider these issues through the example of Valeant Pharmaceuticals, whose CEO received a compensation package that offered exponential rewards for exceptional long-term performance.

We ask:

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How can shareholders tell whether the right balance has been struck between “pay for performance” and risk?

• To what extent were the problems that occurred at Valeant directly a result of the incentives placed on its CEO? Would they have occurred if the incentives were less aggressive?

• Did the board fail to identify red flags that should have warned them that the company’s approach was not sustainable? Did a rising share price make them complacent in their oversight?

The Stanford Closer Look series is a collection of short case studies through which we explore topics, issues, and controversies in corporate governance and executive leadership. In each study, we take a targeted look at a specific issue that is relevant to the current debate on governance and explain why it is so important. Larcker and Tayan are co-authors of the books Corporate Governance Matters and A Real Look at Real World Corporate Governance.

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ceo pay at valeant

J. Michael Pearson was recruited as chairman and CEO of Valeant Pharmaceuticals in 2008 by hedge fund ValueAct. ValueAct was the company’s largest institutional investor, holding a 16 percent stake and a seat on the board. ValueAct had acquired its position after a late-stage trial of a promising hepatitis C treatment was shown to be ineffective, precipitating a 20 percent drop in the company’s share price.6 ValueAct believed that in-house research for new drug development was not a cost-effective method for drug discovery—a belief that Pearson, previous head of the

global pharmaceutical practice at McKinsey & Co., shared. The two favored an approach of allowing outside research groups to identify promising treatments and only acquiring those thatoffered favorable risk-reward characteristics. The company also looked for situations of untapped pricing power in existing drugs.

According to a board member, “We [the industry] fail more often than we succeed. Rather than invest in a high-risk bet, we will be smart through acquisition and licensing.”7 According to Pearson,

“There have been lots and lots of reports… talking about how R&D on average is no longer productive. I think most people accept that. So it is begging for a new model and that is hopefully what we have come up with.”8

ValueAct was also influential in designing the compensation package offered to Pearson—one that encouraged a focus on long-term value creation. Pearson received a $1 million salary and package of equity awards (stock and options) valued at $16 million (see Exhibit 1). Included in these were performance stock units that would vest only upon achievement of the following three-year compounded total shareholder return (TSR) targets:

• 3-year TSR < 15 percent per year, zero shares vest.

• 3-year TSR of 15 percent to 29 percent, 407,498 shares vest (base amount).

• 3-year TSR of 30 percent to 44 percent, 814,996 shares vest (double the base amount).

• 3-year TSR > 45 percent, 1,222,494 shares vest (triple the base amount).

Full study below

SSRN-id2771358

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