The Highest Paid CEOs in Pharma

By Sean

Source: Pfizer via Facebook.

The pharmaceuticals industry is often one of the most sought-after investments for income investors, primarily because of the lofty dividend yields that can often be found among the couple of dozen companies that make up the industry.

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Of the 13 Big Pharma giants with a market valuation of $50 billion or more at the end of last week, all but two paid at least a 2.2% yield. For added context, the S&P 500 collectively has a yield closer to 2%, meaning the pharma sector tends to trounce the broader market index in terms of yield.

Although Big Pharma product portfolios are often very deep and well-established, as are their pipelines, they're also facing an unprecedented number of patent expirations, which have challenged the growth prospects for quite a few of these pharma giants. This has given Big Pharma management teams even more reason to focus on shareholder incentives, such as dividends and share buybacks, to keep investors happy.

The highest paid CEOs in pharma However, Big Pharma's recent struggles with losses of exclusivity also make investors question whether the pay of CEOs in the pharma industry has gotten out of control.

Last year, according to aggregated data from The New York Times which used filings from the Securities and Exchange Commission to compute CEO compensation, four of the highest-paid CEOs in pharma saw their pay increase. Are these pay package increases merited? Let's find out.

Based on the data, these are the five highest-paid CEOs in pharma:

Source: The New York Times.

With the exception of AbbVie's chief Richard Gonzalez, all four CEOs saw their pay increase in 2014, with Bristol-Myers' chief Lamberto Andreotti, Merck's head Kenneth Frazier, and Johnson & Johnson's leader Alex Gorsky seeing substantial compensation increases.

J&J CEO Alex Gorsky. Source: Johnson & Johnson.

One major difference from smaller drug developersPerhaps the biggest standout of the compensation data above relative to the pay structure of biotech CEOs and other smaller drug developers is just how reliant pay is on stock options. Biotech companies tend to reward their CEOs heavily with stock options, whereas Big Pharma CEOs are often rewarded with common stock, tying their interests immediately and directly with that of their shareholders. If pharma CEOs want a raise, they need to do nothing more than push their company's share price higher through outstanding operational results, and deliver a robust dividend.

Bristol CEO Lamberto Andreotti. Source: Bristol-Myers Squibb.

Andreotti at Bristol-Myers Squibb, for instance, was the highest-paid CEO in pharma, but he didn't receive a cent in stock options in 2014 (or 2013 for that matter). Slightly more than $18 million of Andreotti's pay was awarded as Bristol-Myers' common stock, while he also walked away toting a handsome $5.6 million bonus.

Of course, Andreotti isn't alone. Merck's Frazier received $13 million of his $21.4 million in common stock, nearly $9.5 million of Gorsky's $20.4 million at Johnson & Johnson came from shares of his company's stock, and close to half of Gonzalez's pay at AbbVie was derived from common stock awards. Pfizer's Ian Read might be the oddball of the group, with "only" 35% of his pay coming from common stock awards.

Is this pay deserved? On one hand, it's hard to argue against the 2014 results for four of these companies. The S&P 500 rose by 11.4% last year, while Bristol-Myers, Merck, J&J, and AbbVie saw their share price increase by 14%, 17%, 17%, and 27%, respectively. Pfizer was the laggard of the group, with a share price appreciation of only 5%.

Additionally, tying the performance and interests of a CEO with that of his or her shareholders is generally a smart move. It gives CEOs added incentive to ensure their companies remains on track, and it gives a CEO added fire to improve dividend payouts on a year-over-year basis.

Pfizer CEO Ian Read. Source: Pfizer.

But, rising and/or lofty pay in the wake of a sea of patent expirations may not make sense for a few of these companies. For instance, Ian Read's pay increase of only 2% in 2014 may not seem like much, and investors have certainly been willing to overlook his generous compensation package thanks to a 125% increase in Pfizer's share price over the last five years. However, what's not easy to overlook is the midpoint of Pfizer's revenue guidance in 2015 of $45 billion. This is close to $23 billion less in sales than Pfizer generated in 2010, and is a direct result of the negative effects of patent exclusivity losses. With minimal growth prospects on the horizon, I personally have a difficult time justifying Read's compensation package.

The same could be said for Ken Frazier at Merck, whose pay rose by a meteoric 72% in 2014, including a substantial increase in his stock awards and a doubling in his bonus. However, the underlying fundamentals tell an entirely different story. Merck's sales shrank by 4% in 2014, its third straight year of declines, while its free cash flow was nearly halved on a year-over-year basis to just $5.5 billion. The only reason Merck saw an enormous jump in its profitability last year was due to the divestiture of its consumer care business for $11.2 billion -- a one-time gain. I'd hardly qualify this group of data as justification for a 72% pay hike.

Conversely, Alex Gorsky appears to be worth every penny, as J&J's profitability keeps motoring higher thanks to the introduction of more than a dozen new pharmaceutical products since 2009. The cornerstone to success for Johnson & Johnson is healthy growth from its pharmaceuticals business, which provides much better margins than its consumer health or medical device operations.

J&J may not be able to keep pace with high-flying growth stocks in a bull market, but its 53-year streak of dividend increases and better than 30-year streak of EPS growth makes it and Gorsky winners in my book.

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Sean Williamshas no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen nameTMFUltraLong, track every pick he makes under the screen nameTrackUltraLong, and check him out on Twitter, where he goes by the handle@TMFUltraLong.The Motley Fool owns shares of and recommends Johnson & Johnson and Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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