CEO Pay at Valeant: Does Extreme Compensation Create Extreme Risk?

The litmus test for an effective executive compensation program is whether it provides incentive to attract, retain, and motivate qualified executives to pursue corporate objectives that build shareholder wealth. This concept, known as “pay for performance,” reflects the degree to which executive rewards are correlated with financial outcomes that benefit shareholders. While the concept of pay for performance is straightforward, the optimal structure is not. The board of directors must make a series of decisions about pay design that involve real tradeoffs, including whether to tie pay more closely to operating or stock price results, the balance between financial and nonfinancial targets, the balance between cash and equity awards, the size of awards, and whether allowances should be made for executives who miss targets because of economic factors outside of their control. The board must also consider the unintended consequences of pay, including whether it encourages decisions, actions, or behaviors that are not in the interest of shareholders—such as excessive risk-taking or artificial moves to boost the value of awards. The research literature provides substantial evidence that these types of outcomes can occur. As a result, executives holding compensation awards that pay out only in the case of extreme performance likely require especially vigilant oversight by the board.