Sometimes extra-rich pay packages actually do work

By Robert Cyran

In just about three years, Michael Pearson has received about $200 million in stock as chief executive of Valeant Pharmaceuticals. Sound outrageous? Not to shareholders of the drugs group which last week walked away from a bid battle for rival Cephalon. Indeed, the incentives may very well explain that sensible decision.

Consider the way Valeant pays Pearson. At its most basic, Pearson is motivated in the way a private equity firm might be. To begin with, Pearson had to put some of his own money at risk. When he took the job in 2008, he was required to personally buy $3 million of the company’s stock. He bought $5 million.

Then he was rewarded a form of restricted equity that would pay him as much as $4 for every $100 of value created on his watch. But there was a hitch. The stock only vested if shareholders were treated to a 15 percent return annually. That’s like the hurdle ratios common in private equity – though they are usually much lower than 15 percent.

Moreover, if the return for shareholders hit 30 percent per annum, his rewards doubled, and they tripled if returns were more than 45 percent per annum. That meant more shares for outperformance, which mathematically keeps his share of all value created for shareholders at about 4 percent.

The incentives seem to have worked brilliantly. A dollar invested when Pearson came aboard Valeant’s predecessor company in 2008 would be worth about four times as much. Valeant stock is up more than 80 percent this year alone. As a result, Pearson is now sitting on securities worth some $200 million.

This, more than anything else, may explain why Valeant last week walked away from its attempt to acquire Cephalon for $5.7 billion. As originally, and hostilely, pitched, the deal made sense for Valeant, which would have reduced Cephalon’s heavy spending on R&D and prioritized selling the company’s existing drugs.

But when Teva Pharmaceuticals waltzed in with a 12 percent higher bid, Valeant didn’t get distracted. Rather than engage in a capital-destructive bidding war, it walked. Investors liked the discipline – the shares are almost 15 percent higher than where they were before the company made its initial bid. That’s reward enough for Pearson.

Published on May 10, 2011

(Image: REUTERS/Christinne Muschi)

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