Valeant's Six New Value Aligned Pay Practices

| About: Valeant Pharmaceuticals (VRX)

By David Lee Berkowitz

Valeant CEO's Pay Package Draws Praise as a Model -

In the above article in Wednesday's WSJ, G Mason Morfit, chairman of Valeant's (NYSE:VRX) board compensation committee and a partner at ValueAct, an activist hedge fund whose 22% stake makes it Valeant's largest shareholder, lays out 6 pay practices that mimic a private equity pay plan in a public company.

While the article does not say what metric - sales, earnings, ROIC or EVA - annual cash incentives are tied to, we can see from the graph below that after the new CEO Pearson arrived in 2/2008 he was motivated to improve economic margintm right away.


Economic Margin or EM on productive capital (calculation details here) explodes in 2009 to over 30 from 5.2 the year before. How did he do it? He sold poor performing businesses, slashed research spending and partnered with another firm to introduce a big drug.

The stock market results so far - +105% since the new CEO started with aligned equity incentives:

VRX Stock Price

What's the magic formula?

1. Make top managers buy lots of stock with their own money.

2. Tie equity grants to total shareholder return - share in wealth created don't dilute it.

3. Be generous on the upside, but tough on the downside.

4. Don't grant equity automatically every year.

5. Don't backslide - no bonuses if executives miss targets. Board will not make up reasons to award bonuses.

6. Scrap entitlement perks like car allowances and club dues - let them buy what they want and need with their own money.

These aligned motivating incentives, but one size does not fit all type of companies. For instance, retaining technology executives would be difficult without competitive value option grants each year.

It's nice to see how implementing a Value Aligned bonus plan can still motivate executives to take tough, but value creating decisions.