Why the trouble at Valeant starts with its board of directors

The CEO and CFO have been ousted for the company’s woes, but Valeant’s board of directors had—and still has—serious flaws

 
Valeant Pharmaceuticals’ Montreal head office

(Ryan Remiorz/CP)

Valeant Pharmaceuticals is beset with problems—a collapsing share price, mounting debt, unreliable financial statements—and it’s now jettisoning its CEO and pinning blame for shoddy accounting on a former CFO. But the role of the company’s board of directors has thus far escaped criticism, and a closer look reveals the board’s structure was less than ideal, and may have contributed to Valeant’s current woes. Despite changes to the board, Valeant still has work to do, critics say.

Two flaws were having both outgoing CEO Michael Pearson and former CFO Howard Schiller on the board in the first place. It’s not unheard of to have executive leaders also sit as directors, but it’s not considered to be a best practice. “They certainly weren’t reaching for the stars in terms of achieving real independence,” says Chris MacDonald, who teaches business ethics at the Ted Rogers School of Management.

Boards need to be completely independent to function properly, and an executive’s presence can exert “undue influence,” says Richard Leblanc, a professor at York University. “When there’s a very strong dominant CEO and CFO, we see directors not speaking up. And when I ask them why they don’t speak up they say, ‘I’m intimidated.’ These are directors you wouldn’t expect to be intimidated,” he says.

Schiller’s presence on the board while also serving as CFO was particularly odd, according to Leblanc. “It’s highly anomalous to have a CFO sit on the board of a publicly traded company,” he says. “Every time the audit chair committee reports to the board about audited financial statements, transactions and financial risks, the CFO is sitting there as part of the board. There’s an inherent conflict.”

The problems surrounding the composition of Valeant’s board don’t stop there. Four of their twelve board members hail from hedge funds: two from ValueAct Capital and two from Pershing Square Capital. Leblanc says hedge fund executives tend to be more focused on short-term results. Recruiting so many board members from the same industry (even if they’re from different firms) doesn’t mean they’re necessarily independent of each other, as they tend to vote as a block.

Inviting Pershing Square CEO Bill Ackman to the board—who has a 9% stake in Valeant—doesn’t exactly inspire confidence that Valeant will be able to right its course. “Directors should not be beholden to a shareholder,” Leblanc says. “They should be loyal to all shareholders.”

The board has so far skirted responsibility for cultural issues at Valeant. When Valeant announced Pearson’s departure on Monday, the company accused Schiller (and a former corporate controller) of “improper conduct” in relation to $58 million in misstated revenue. (Schiller was asked to step down from the board, but refused. He issued his own statement in which he said he “did not engage in any improper conduct.”) The company noted a problem with the “tone at the top” of the organization.

“The performance-based environment at the company, where challenging targets were set and achieving those targets was a key performance expectation, may have been contributing factors resulting in the company’s improper revenue recognition,” read Monday’s release.

The board of directors is influential in setting the tone and culture of an organization, of course, not to mention compensation packages for executives. Pearson, who also served as Valeant’s chairman, has said that the company’s responsibility is to maximize shareholder value. (“The underpinning strategy is creating value for shareholders,” he told Canadian Business last year. “That’s who owns us.”) In the absence of a strong, independent board, however, that philosophy can cause an organization to unravel.

A company shouldn’t be solely focused on its share price, says governance expert Hugh Arnold, a professor of organizational behaviour at the Rotman School of Management. The board should have reined in Pearson, he argues. “The objective of directors is to act in the best interest of the corporation,” Arnold says. “There is no legal document anywhere that the duty of the corporation is to maximize shareholder wealth. That’s an interpretation by management, and some boards have bought into the notion that the stakeholder group they need to concern themselves with is shareholders.”

An aggressive, performance-driven culture has landed other companies in trouble. Last July at Toshiba, a wave of senior executives resigned after it was revealed that managers “systematically” inflated profits over several years. A regulator’s report revealed a corporate culture in which managers placed intense pressure on underlings to produce profits, who felt they couldn’t challenge their bosses.

The extent of the accounting issues at Valeant is still unclear, and no wrongdoing has been determined. But with a weak board and an intense focus on boosting the share price over long-term viability, it’s not surprising that trouble ensued. “When that’s all you do,” Arnold says, “you end up with a situation that Valeant finds itself in.”


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