For corporate governance and compliance thinkers, Mylan Labs is the gift that keeps on giving. Earlier this week we looked at the compensation incentives Mylan designed for senior executives—incentives that drove them to raise the price of EpiPens to punishing levels for consumers.
Let’s keep pulling on that thread. It leads to some excellent questions about boardroom governance, and as often happens with U.S. securities law these days, those questions don’t have good answers.
Those pay incentives, worth millions of dollars to CEO Heather Bresch and other senior executives, came from Mylan’s compensation committee. The committee itself used outside consultants (Meridian Compensation Partners and the law firm Cravath, Swaine, and Moore, according to the 2015 proxy statement), but ultimately the committee’s three members were responsible for creating the conditions that reward Bresch for a strategy of steep and steady price hikes.
Wait a minute, I thought. Don’t compensation committees have to disclose how their pay plans might lead to unnecessary risk-taking? Wouldn’t that be reflected in Mylan’s proxy, since Bresch’s moves have led to a reputation risk nightmare?
Yes to the first question, no to the second. Which is precisely the governance dilemma U.S. securities law has foisted onto Corporate America.
Our compensation disclosure rules only address financial risks, relevant to shareholders. They ignore all the other enterprise risks that sloppy executive compensation can cause, and leave a company fumbling in front of all its other stakeholders.
What the Rules Say
The Securities and Exchange Commission adopted rules in 2009 for all companies to disclose more in the Compensation Discussion & Analysis about how executive pay plans might lead to reckless risk-taking. The goal of the disclosure, as the SEC said, is to “help investors identify whether the company has established a system of incentives that can lead to excessive or inappropriate risk taking by employees.”
OK. And how does the SEC define the risks that should be disclosed and discussed?
“To the extent that risks arising from a company’s compensation policies and practices for employees are reasonably likely to have a material adverse effect on the company, discussion of the company’s compensation policies or practices as they relate to risk management and risk-taking incentives that can affect the company’s risk and management of that risk.”
That’s a narrow, financially focused view of risks to the company. Phrases such as “reasonably likely” and “material adverse effect” drive home the point, and remember that the rules were adopted in 2009. We had just suffered the disaster of the financial crisis, where financial firms had rewarded employees to take too many risks that would go bad in the future. This whole debate centered on financial risks.
In other words, our proxy disclosure rules ignore whole other realms of risk that poor executive compensation can cause. That’s exactly what happened at Mylan. It geared its performance-based compensation and strategic goals toward higher revenue from EpiPen sales, and the compensation committee never stopped to consider the reputation risks that idea might bring—nevermind that any parent with a peanut-allergy child could tell them the reputation risks were sky high.
The irony here is rich, since boards always say that preserving brand reputation is one of their top priorities. The reality is that compensation committees aren’t assigned to worry about risks other than those that lead to financial misconduct. Mylan hasn’t even committed any “misconduct” per se. It simply engaged in permissible conduct that most consumers find shameful, and shot its reputation in the head while doing so.
And proxy disclosure rules are totally silent on that dilemma. The risks go unaddressed.
What Mylan Says
Mylan’s compensation committee seems to make only the required disclosures. For anyone keeping score, this is the discussion from this year’s proxy about compensation risks (on Page 51 of the proxy):
…We believe that the nature of our business, and the material risks we face, are such that the compensation plans, policies, and programs we have put in place are not reasonably likely to give rise to risks that would have a material adverse effect on our business. We believe that the mix and design of the elements of executive compensation do not encourage management to assume excessive risks.
You can see the key phrases, “reasonably likely” and “material adverse effect”—words that parrot back what SEC rules require. The wording is essentially identical to what Mylan reported in its 2014, and presumably in other years. This is what a board says when it goes through the motions of compliance.
Here in today’s real world, however, the public wants more governance. It wants boards to be good stewards of a company’s role in society, which goes well beyond financial risks and returns to shareholders. Too bad our governance and proxy disclosure regime don’t keep up.