How price hikes gave CEO’s pay a big jolt
Mylan rewarded exec for actions that might not really prove her mettle
The news that Mylan CEO Heather Bresch got a nearly sevenfold pay increase while hiking the price of her drug company’s popular EpiPen 400 percent over the past eight years is shocking enough. What you may not realize is how closely tied those facts are.
Many people are outraged over what seems like another case of drug-company profiteering. Here’s the thing: Companies often reward executives with big pay increases for things that have nothing to do with strategy and execution. In the Mylan case, Bresch actually got paid for something that made business sense — even if it raises serious questions about drug-price regulation.
Starting in the ’90s, there’s been a vogue for linking executive pay to the stock price. The principle is that when shareholders do well, so do CEOs. When crude oil prices soared to a high of $136 a barrel in 2008, oil companies saw their shares rise, too. As a result, Exxon CEO Rex Tillerson took home a compensation package worth $27.2 million that year.
Did Tillerson really deserve the pay, or did he
just have the good sense to be a CEO of an oil company at a time of sky-high prices? That’s one problem with stock-based pay. In addition, researchers have found that executives whose pay is linked to share prices may conceal bad news and pursue investments detrimental to longterm shareholder interest.
For Mylan, the answer was a trendy measure of financial health called return on invested capital, which measures how well a company generates profits compared with the money it borrowed or raised from investors to fund the business.
By that measure, EpiPen — a product Bresch championed — looks like a winner. Mylan picked up the drug, a cheap dose of epinephrine hormone packaged in an easy-to-use injector, from Merck in a $6.7 billion deal in 2007. Even after the stock’s recent hammering, Mylan is now worth $23 billion — more than double what it was in 2007. EpiPen’s profit margins rose to 55 percent in 2014, Bloomberg Businessweek reported, and it’s a $1 billion-a-year product line for Mylan, which saw $9.45 billion in revenues last year.
“When a company is so dependent on one product for profits, it shifts incentives to focus on that product,” said Hillary Sale, a law professor at Washington University in St. Louis who specializes in corporate governance.
Bresch might be a competent leader, but her pay completely distorts the spirit of linking pay to factors that really reflect a drug CEO’s mettle — innovation and new products. Mylan didn’t create EpiPen; the money it plows into EpiPen goes toward marketing and distribution, not research and development.
More than two-thirds of Bresch’s compensation consists not of cash, but incentives like options and restricted stock grants, according to documents filed with the Securities and Exchange Commission.
About half those incentives are linked to Mylan’s return on invested capital for the year. In fiscal 2014, the company’s specialty segment sales jumped 20.9 percent, or $205.5 million, to $1.19 billion.
“The increase was principally the result of higher sales of the EpiPen as a result of favorable pricing and increased volume,” according to the company’s 10K filing.
“Favorable pricing” refers to the culmination of gradual but significant hikes the company has enacted since it acquired EpiPen. Today, Mylan charges a list price of $600 for two injectors, compared to just $100 from a few years ago.
As a result of the sales increase, Mylan’s return on invested capital for 2014 was 10.97 percent, much higher than the 8.37 percent it averaged over the previous three years.
Correspondingly, Bresch saw her compensation nearly triple to $25.8 million, thanks to a surge in stock incentives. Mylan awarded Bresch $14.4 million in stock options and $4.8 million in stock grants, compared to $995,000 and $3.96 million respectively in 2013.
EpiPen’s price hikes generated so much profit that it distorted the company’s return on invested capital — and thus Bresch’s total compensation.
“Return on invested capital can be very useful in determining CEO pay, but only if the company takes into account the underlying product and industry,” Sale said.
If anything, Mylan‘s compensation structure shows why using return on invested capital to determine pay does not work for every type of business. Were more of Bresch’s pay linked to Mylan’s shares, for example, she would have been hurt by the recent sell-off prompted by widespread criticism of its EpiPen pricing. (The company recently said it would start selling a generic version of EpiPen at $150 per injector.)
Consumers would probably not buy a car if the dealer jacked up the price 600 percent. But in the pharmaceutical industry, consumers rarely see the actual price — and when they do, they may feel they have no choice but to pay whatever the drugmaker wants for life-saving drugs like EpiPen.
“It's their product, they can charge what they want,” said Dr. Jeffrey Lobosky, an associate clinical professor at UCSF and author of “It's Enough To Make You Sick: The Failure of American Health Care and A Prescription for the Cure.”
“That’s the free enterprise system we operate under. There’s nothing illegal about it. But for the CEO to raise prices like they did and make money off it, that’s unconscionable.”
Unconscionable for society, maybe. But Mylan and its board got what they paid for.