Monday, August 13, 2012

A Bonus for Bankruptcy? - KV Pharmaceutical Reveals CEO's Bonus, then Declares Bankruptcy

The latest example of the disconnect between compensation for leaders of health care organizations and their and their organizations' performance comes from a report in the St Louis Business Journal. 

Executive Compensation and KV Pharmaceutical

Its essence was:
KV Pharmaceutical Co. President and CEO Gregory Divis Jr. earned $976,270 in the fiscal year ended March 31, more than double the $385,102 he was paid in fiscal 2011, according to a proxy statement the company filed Thursday with the Securities and Exchange Commission.

His 2012 earnings were comprised of a $638,750 salary, a $130,000 bonus, $204,189 in option awards and $3,331 in other compensation, which includes a $2,909 car allowance, a 401(k) match and group term life insurance.

The total pay for other top executives was as follows:

Treasurer and Chief Financial Officer Thomas McHugh earned $506,615 in fiscal 2012, including a $65,000 bonus. Hit total comp in fiscal 2011 was $320,950.
Vice President, General Counsel and Secretary Patrick Christmas earned $530,604 in fiscal 2012. He joined the company in June 2011.

Admittedly, compensation of just under $1 million a year does not seem that high for the CEO of a pharmaceutical company in this day and age. Furthermore, as noted in Forbes, Mr Divis' compensation is less than that of his predecessor:
who was interim ceo and president, received $1.25 million before Divis succeeded him, and so the ceo is now being compensated at a lower amount.

The Troubled History of the Company

However, first consider that the company was not exactly in the best financial health at the time Mr Divis was getting his pay, as per the St Louis Business Journal:
KV Pharmaceutical Co. officials said July 20 that the company has been notified by the New York Stock Exchange that it is below listing standard criteria due to the company’s average market capitalization being less than $50 million over a 30-day trading period and its stockholder’s equity being less than $50 million.

After years of missteps, mismanagement and mounting losses, KV Pharmaceutical’s ability to survive is in question. The company itself raised doubts as to its ability to continue as a going concern in its quarterly filing Feb. 9 with the Securities and Exchange Commission. [Note that this filing occurred during the same fiscal year in which the CEO received the compensation noted above - Ed.]

In fact, as we discussed here in 2010, a former KV Pharmaceutical CEO and Chairman is one of the very few for-profit health care corporate leaders who actually received personal punishment due to a US government prosecution. Former CEO and Chairman Marc Harmelin was banned from doing business with the US government for 20 years after a fraud prosecution that lead to "a KV subsidiary's conviction on criminal charges earlier this year for shipping oversize morphine tablets" per the St Louis Post-Dispatch.

The Failed Strategy to Get a License for a Previously Generic Drug, and Increase its Price by Ten Thousand Percent (10,000%)

Then consider the direction company leadership took after that setback.  As described in an August, 2012, St Louis Post-Dispatch article, the company's main strategy was based on a license to sell Makena, an injectable form of hydroxyprogesterone. Hydroxyprogesterone had first been approved in the 1950s. In 2003, a National Institute of Health funded study showed that injecting it reduced the risk of premature birth [Meis PJ, Klebanoff M, Thom E et al. Prevention of recurrent preterm delivery by 17 alpha-hydroxyprogesterone caproate. N Engl J Med 2003; 348: 2379. Link here.]. Somehow, with funding from KV Pharmaceutical, "the FDA granted the approval to Hologic, which presented the application and argued for the drug based on medical research sponsored by the National Institutes of Health." After that, while "KV neither invented nor patented Makena, but agreed to pay Hologic nearly $200 million for 'orphan drug' status – and seven years of market exclusivity – for the rights to sell the branded drug." I cannot figure out why either company should have been granted an exclusive right to sell this drug under these circumstances. Nonetheless, once KV Pharmaceutical obtained the rights,
Makena sparked a national controversy over its sky-high price – a 100-fold increase over the average cost – about $15for an already widely available non-branded version of the drug produced by compounding pharmacies.

Leading national medical organizations and advocacy groups, including the March of Dimes and two U.S. senators, publicly blasted the pricing.

On March 30, 2011, the FDA announced that it would not enforce KV’s market exclusivity because of concerns that the drug would be unaffordable to many women. Hours later, the federal Centers for Medicare and Medicaid Services indicated that states could purchase the compounded version, called 17P, from specialty pharmacies.

The resistance prompted KV executives to dramatically lower Makena’s cost, but the move failed to forestall the backlash. As a result, KV’s ambitious sales projections for its latest drug failed to materialize.


That sealed the company's fate, and the same article reported,
KV Pharmaceutical Co., once among the St. Louis region’s strongest public companies, now faces yet another survival struggle after filing for bankruptcy.

Summary: A Bonus for Bankruptcy

So a company that suffered a criminal conviction for selling morphine tables whose dose was twice what was on their label, whose former CEO was banned from the pharmaceutical industry, which based its survival on a scheme to game the regulations to allow it to sell a previous $15 drug for $1500, then paid its CEO nearly $1 million, including over $330,000 in cash bonus and stock options just before it filed for bankruptcy.  Note that the CEO "earned" that compensation over a time period during which the company revealed doubts that it could survive as a "going concern."

This is a simple, relatively small, but especially graphic example of how leaders of health care organizations are not simply overpaid, but seem to personally profit from their organizations' mismanagement, poor financial results, and last but not least, exploitation of patients. Describing these incentives as perverse seems euphemistic.

Economists seem to like to justify outsized executive compensation by citing shareholder value they create, realistically defined as short-term stock price (look here).  One could argue that companies that sell health care products or provide health care directly should measure performance in terms of effects on patients' and the public's health.  Putting this aside, however, in this case, the executives seemed to be receiving bonuses not based on shareholder value, or stock price, but for continuing a course that resulted in the complete destruction of shareholder value.  (Stock shares lose essentially all their value when a company goes bankrupt.) 

In this case, and in others we have discussed, executive compensation seems to be based on the ability of executives to control their own pay, which seems more like what economists like to call "rent-seeking," as defined by Wikipedia, gaining from "manipulating the social or political environment in which economic activities occur, rather than by creating new wealth." 

Clearly, as long as health care leaders can personally profit however bad their performance is, or even due to their poor performance, we can expect nothing other than worsening performance.  Health care will become continually more dysfunctional until true reform makes health care leaders accountable for their actions, and all their effects, on stockholders, but also on patients' and the public's health.

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