The new Valeant CEO’s pay package is putting the company in serious danger

Flickr/CasparGirlWatch out, this is slippery.

If you blinked, you may have missed it — a lot of politicians did.

It’s the part of incoming Valeant Pharmaceuticals CEO Joe Papa’s pay package that makes it a dangerous deal.

Bloomberg reported Wednesday that Papa agreed to a $67 million pay package.

But that’s not the most important part here.

If Valeant’s shares reach a price of $270, Papa will get stock equaling $500 million.

That’s right. If Papa manages to get the embattled company’s stock up by eight times its current level, he’ll take home a staggering amount of money.

This news broke at the end of Wednesday’s Senate hearing for Valeant, the former Wall Street darling under fire for buying up drugs and then jacking up their prices by (sometimes) triple-digit percentages.

Claire McCaskill (D-MO) had things to say about the package Thursday morning too.

“In terms of Mr. Papa’s compensation package, it strikes me as tone-deaf to incentivize the exact kind of raise-the-stock-price-at-all-costs mentality that drove Valeant’s immoral and disastrous business strategy to this point,” she said in a statement.

“I certainly hope I’m wrong and that he has success in moving this company in a new direction, but the onus will be on him and Valeant to prove that, as they long ago lost the benefit of the doubt with the American public.”

This is really a story about how a company incentivizes its CEO to care about stock price more than anything else — more than customers, employees, or products — and this is also a story about how that incentivization goes totally over Washington’s head.

See no evil

See, McCaskill’s colleague, Sen. Susan Collins (R-Maine), also had a reaction to this news on Wednesday. She heard about the news just as she was closing the hearing. Collins’ mic was still on, and it picked up her dismay just before cameras cut out on the hearing.

“Did you see this last thing, the pay, $67 million? This is outrageous,” she said.

Afterward, though, when reporters asked her about the issue, she said that billionaire hedge fund manager and Valeant board member Bill Ackman, who had been testifying, talked her off the ledge.

Here’s what she said [emphasis ours]:

Well, I just asked Mr. Ackman about that and he says that that is not accurate. My staff gave me a heart attack at the end of the hearing by handing me an email saying that the new CEO was being paid $67.4 million. That is not what was explained to us by Mr. Ackman. He explained a very complicated process where there is a base salary and then over a four-year period, if the stock goes up, there are bonuses that would be given. But the stock has to go up considerably in order for those bonuses to be paid. There was nothing that added up to $67.4 million in one year. I would encourage you to ask him because he negotiated the deal. This was the first question I asked him when I learned of this.

It’s a good question, Sen. Collins, but it’s not at all the right one. The real prize here is the $500 million Papa would get for bringing Valeant’s stock price back up. So the question isn’t how much he’s getting, but how he’s getting it.

And given the setup in place, who do you think that $270-a-share threshold will incentivize Papa to put first, his customers or the shareholders?

Hear no evil

During the hearing, outgoing Valeant CEO Michael Pearson said that he regretted making statements that made it seem like he only cared about shareholder interests.

“I have come to realize that because many of my public statements have occurred in the context of talking with shareholders — and those remarks naturally focused on shareholders’ interests — my cumulative public comments have left the misimpression that shareholder interests were my only focus as CEO of Valeant,” he said.

Screengrab via YouTubeJoe Papa, Valeant’s incoming CEO.

But it was never just Pearson’s public statements that gave the impression that he cared about shareholders first. It was his actions — the company’s aggressive business model, which he pioneered. It was Valeant’s low budget for research and development and the high margins that came from buying drugs and then jacking up their prices. It was the growth model was made it attractive shareholders and dangerous for patients.

Now that this model isn’t available anymore, Valeant has said it will have to rely on selling a large volume of drugs in order to make the profits it used to enjoy. That hasn’t happened yet, and analysts don’t think it will happen this year at all. In fact, the company has dampened expectations for 2016.

Plus, if the company stands by its commitment to lower prices (analysts say that it has not) it could be a long time before it does. At the hearing, board member and billionaire hedge fund manager Bill Ackman said he would bring down prices 30%. That isn’t much for some drugs that have seen their prices increase by triple digits, but it’s likely enough to keep Valeant’s glory days out of reach.

Speak no evil

So what is incoming CEO Joe Papa, whose compensation is tied to the company’s stock price, to do? Is he to try his best to make something out of a lower-growth, lower-margin business model and be happy with that?

Or should he go back to being aggressive about bringing up the stock price by any means necessary?

Papa is being brought over to Valeant from Perrigo, an over-the-counter-drug maker. While he was there, Papa engaged in some of the same behavior as Valeant. For two examples: Perrigo reincorporated its headquarters in Ireland to avoid US taxes (like Valeant left for Canada), and Perrigowas aggressive about making acquisitions (like Valeant) even as it was fending off a hostile bid from Mylan.

ReutersSen. Claire McCaskill (D-Missouri) reads a General Motors internal document at the Senate Commerce and Transportation Consumer Protection, Product Safety, and Insurance subcommittee in Washington, April 2, 2014.

Again, this is part of a model Valeant pioneered when it was profitable. Even with an entirely new board, even with all the lip service (and so far it’s just that, lip service) that top brass have given to lowering prices, it will be hard for a new CEO not to go back to the basics that drove the stock price up to the triple digits.

McCaskill, for her part, does not seem convinced.

“Only time will tell if this amounts to meaningful, substantive change—or if it’s simply rearranging deck chairs on the Titanic in a desperate attempt to fool the business community into believing the company is headed in a different direction,” she said in her statement.

The market shares her skepticism. After all the promises Valeant leadership made during the hearing, the stock hasn’t moved at all. There’s tons of uncertainty here except for the fact that there’s $500 million on the line for Papa if he can boost the company’s stock price. That’s all we know for sure.