Valeant Pharmaceuticals International Inc. is in the midst of a hard sell on how it's changed its corporate culture now that former CEO Michael Pearson and many of his fellow board members have left the company. Valeant's proxy statement to shareholders, which arrived in mailboxes in recent days, is part of the effort, what with its listing of "shareholder-friendly compensation practices" and a passage about all the dialogue it's had with investors in the last year or so.
The message may have been undermined, however, by the recent headlines that the company's new chief executive officer, Joseph Papa, received $62.7-million (U.S.) in compensation in his first year with the company.
The number is correct, as far as it goes when companies follow the rules in reporting executive pay. But taking a step back and reading the fine print reveals two truths: One is that Mr. Papa likely will have far, far less than $62-million in the bank thanks to Valeant's woeful performance. And the second is that had things gone in the other direction, Valeant's pay plan would have put Mr. Papa on the path to the billionaire status that Mr. Pearson once enjoyed.
A key part of the Valeant compensation program, then and now, is a "performance-share" plan where Mr. Pearson, and Mr. Papa, received large grants of shares that could grow even larger if Valeant's stock performance cleared certain hurdles. For Mr. Pearson, this worked exceptionally well as the company's shares rose by more than 2,300 per cent over a decade. His shares, combined with stock options and other awards, were worth roughly $3-billion in the summer of 2015 as the company's shares approached their all-time highs.
Valeant has chosen a similar structure for Mr. Papa. The company gave him an award of 933,416 performance shares, which it valued at just under $30-million in the table of compensation it published in the proxy – nearly half of that eye-popping $63-million number.
The $30-million figure actually understates the potential of the award, however. As the footnotes make clear, Mr. Papa can receive up to double the number of shares if Valeant stock soars. On the day of the award, Valeant traded at $32.65 on the New York Stock Exchange. If, at the end of the four-year vesting period, Valeant traded for more than $150, the company would begin to add extra shares to the final payout. By doing a little math, we can see that at its top hurdle – $270 per share – the performance-share award would be worth $504-million. Add in a separate restricted-stock award, as well as a block of stock options, and Mr. Papa's 2016 stock compensation would be worth $773-million in 2020 at a $270 Valeant, a return to its all-time high.
Alas, that result looks increasingly remote, as Valeant as now fallen to little more than $10 a share. And shareholders angered by this week's headlines should note this: If Valeant stays stuck at current levels, Mr. Papa will got no performance-share awards, see his options expire worthless and own a grand total of $4-million worth of stock from that 2016 award.
Mr. Papa has another disadvantage when compared with Mr. Pearson, who saw Valeant do nothing but rise, rather than fall, in his tenure: The hurdles in Mr. Papa's plan are much more difficult.
Mr. Pearson's initial performance-share grant in 2008 required only a total three-year shareholder return (TSR) of 15 per cent; if TSR hit 30 per cent, the award doubled; if it hit 45 per cent, the award tripled. A subsequent stock award to Mr. Pearson allowed for a quadrupling of the share award for a 60-per-cent return over four years.
When you impute TSR numbers from the hurdles in Mr. Papa's plan, however, you see how much better Valeant shares must perform for him to reap the top rewards. The stock needed to return more than 80 per cent from the day it was awarded for any portion of the award to vest. To get the full award, Valeant needed to rise roughly 360 per cent. The maximum award would come only after a 727-per-cent return.
But despite the potentially massive payday, unless Valeant's shares take a big turn for the better, Mr. Papa will have to resign himself to far more modest earnings. His salary for 2016 was $980,769, in addition to a bonus of $9.125-million, of which $8-million was a signing bonus.
Of course, it's easy to look at compensation in hindsight, and say it's no longer relevant what Mr. Papa makes at a $270 Valeant. The important point, though, is that the company created a plan, which Mr. Papa agreed to, that made possible a four-year payout of at least $773-million.
It might also be said that Valeant shareholders would be delighted to see the company's stock produce such mind-boggling returns, and for Mr. Papa to reap such a lavish benefit. It would be the ultimate in pay-for-performance, perhaps. Kind of like what was said about Valeant's performance, and its pay plan, when Mr. Pearson was at the helm in 2015.
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