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Executive Compensation and Pay Packages

July 25, 2017

Dollar Bill Jigsaw Puzzle

Executive compensation is an important aspect of corporate governance and has long been the subject of much analysis and debate. Poor executive pay practice can sometimes be a red flag for ineffective governance, and is often a precursor of large corporate collapses. Shareholders are calling for increased disclosure and accountability in this area as a way to increase overall transparency and improve governance policies.

General Background on Executive Compensation

There are many factors to consider when examining executive compensation and how it is calculated or determined. Some of these factors include:

Internal vs. External Equity Pay Factors
Traditionally, CEO payment was calculated according to “internal equity” — how their pay compares with the pay of other employees in the same company. Later, CEO compensation began to be based according to “external equity” — how their pay compares to that of CEOs from other companies. This shift largely contributed to increased pay grades for CEOs beginning in the late 1970s and early 1980s. 

Compensation Committees
Compensation or “comp” committees are typically composed of some members of the company’s board, as well as executives from other firms. The committee is generally responsible to the company for determining and approving executive compensation packages. 

They may also perform other functions, such as acting as a liaison between the CEO and the board on all compensation issues and recommending changes to compensation packages. Comp committees are also instrumental in determining external equity pay factors by establishing “peer groups” — companies that are comparable in size and functional complexity. In this way, the executive pay package for the CEO can be compared to similar companies. There is some criticism as to the accuracy of this practice, as some peer groups often consist of industries involving drastically different CEO skill sets. 

Other criticisms of compensation committees include:

  • A lack of written mandates defining the role and aims of the committee
  • Disorganized and unplanned committee meetings
  • Lack of procedure and defined criteria for selecting members of the committee
  • Lack of engagement with outside consultants to obtain a better sense of market data

This is the process by which comp committees compare the company’s compensation levels with those of other companies. Benchmarking involves the gathering, summarizing, and analyzing of market data. While this can help establish percentile markers for base CEO pay, it can also cause ever-increasing baselines within a peer group.  

Pay for Performance 
The pay for performance concept provides bonuses and incentives for CEOs and executives that are based on performance. It is not unusual for performance bonuses to make up a larger portion of a CEO’s compensation than their base pay. In some cases, a CEO can earn more than twice their base pay in bonuses consisting of monetary amounts as well as stock options. This is also another area that lacks clarity, specifically with regard to measuring performance. 

Each of these factors can be an area where compensation can potentially be inflated or misrepresented. However, they also represent areas where improvements and adjustments can be made in order to increase disclosure and make the process more transparent. 

Executive Pay Packages in the Healthcare Industry

Mylan Executive Pay Concerns
In May 2016, Mylan disclosed a $97.6 million pay package for chairman Robert J. Coury. The package consisted of new money, payouts of previous awards, and benefits, all triggered by his transition to serve as a non-executive chairman. Coury and other executives would have received bonuses under the proposals if stock prices hit certain benchmarks. The company would have used hefty price hikes and other strategies to reach goals. Coury also would have benefited from a $44 million equity grant. 

The compensation initially caused concern among investors, some of whom said that the board had made “egregious” decisions regarding pay. 

Various institutional investment funds and comptrollers signed a letter to shareholders, encouraging them to turn down executive packages and hold executives accountable for a record of “compensation, risk, and compliance failures.” The letter also revealed that shareholders suffered a 29.4% loss in 2016. 

Since 2010, Mylan’s executive pay plans have drawn at least 30% opposition annually. This type of sustained opposition is not common, as boards typically adjust compensation plans when there is sufficient investor dissent. 

McKesson CEO Compensation Challenges
Similarly, shareholders and governance experts are calling attention to the executive compensation packages at McKesson, particularly for CEO John Hammergren. Hammergren is one of the highest-paid execs in the U.S., and has recently received a $1.1 million boost to his bonus. Surprisingly, this boost comes just months after McKesson’s involvement in a $150 million settlement with the Drug Enforcement Agency in connection with suspicious orders of opioids. 

The International Brotherhood of Teamsters, a large shareholder in the company, sent a letter to fellow shareholders imploring them to vote against Hammergren’s compensation package at the upcoming annual shareholder meeting. The letter also called for greater accountability and board level oversight on a broad level, particularly in light of the company’s alleged role in the ongoing opioid crisis.  

Executive pay issues can be a signal that there are deficiencies with the company’s overall corporate governance policies, as well as their transparency and accountability to shareholders. These types of conditions can be breeding grounds for various types of corporate fraud and wrongdoing. As seen in the case of large healthcare corporations, these issues can translate into risks not only to shareholders, but to the general consumer public as well. 

Corporate governance is a complex subject that encompasses important matters like executive compensation, director elections, succession planning, and other topics. If you have any questions or concerns regarding governance policies, contact us today at Kessler Topaz. Our team has deep experience using the courts and other actions like bylaw amendments to achieve significant governance reform.