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14 Ene 2020

15/1/20 - William Lazonick, Open Society Fellow

US pharma companies need price regulation amid focus on stock prices and executive pay

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This article is part of our Rethinking Corporate Governance blog series

Business activity for the discovery, development, and distribution of medicines is critical to our well-being. Unfortunately, US pharmaceutical companies have become global leaders in “financialization” at the expense of innovation.

The executives who run these companies gouge households with high drug prices so that they can boost their companies’ stock prices and, thus, enrich themselves with gains from stock-based pay.

US pharmaceutical companies lobby vigorously against government regulation of drug prices. Their main argument is that the reinvestment of the huge profits from high drug prices allow pharmaceutical companies to be more effective in drug innovation.

In a recent publication, the industry lobby group Pharmaceutical Research and Manufacturers of America (PhRMA) defends the profits of its corporate members by stressing the high cost of drug development:

From drug discovery through FDA [Food and Drug Administration] approval, developing a new medicine takes, on average, 10 to 15 years and costs $2.6 billion. Less than 12% of the candidate medicines that make it into Phase I clinical trials are approved by the FDA.”

On its face this argument has merit. Drug research and development is a very expensive and highly uncertain endeavor. Pharmaceutical companies have to reinvest profits from their existing commercial products to finance the next generation of potentially life-saving drugs.

Yet many of the largest pharmaceutical companies in the United States use all of their profits, and often far more, to distribute cash to shareholders in the form of stock buybacks and dividends. PhRMA’s contention fails because, in reality, pharmaceutical executives use the corporate profits from high drug prices to drive up stock prices. 

The 18 pharmaceutical companies among the 466 S&P 500 companies publicly listed in 2009-2018 had combined profits of $588 billion over the decade. These 18 companies spent $335 billion on buybacks, equal to 57% of their profits, and $287 billion on dividends, another 49% of profits.

These distributions to shareholders were 14% greater than the $544 billion that these companies devoted to research and development (R&D) spending over this period.

And the billions of dollars that were spent on R&D have not necessarily resulted in innovation. Academic Öner Tulum’s in-depth analysis of specific pharmaceutical companies shows that the corporations most financialized in terms of distributions to shareholders have the least productive R&D expenditure per dollar spent.

Among these low-productivity pharmaceutical companies are Merck and Pfizer, which ranked #9 and #10 respectively among all US companies in R&D expenditures in 2018. In recent decades, these companies have grown large by acquiring “blockbuster” drugs that other companies have developed and then milking them for revenues over their remaining patent lives.

Meanwhile, notwithstanding all of their R&D spending, these companies do little in the way of internal drug development. From 2009 through 2018 Merck distributed 151% of its profits and Pfizer 114% to shareholders as buybacks and dividends.

These two companies have prioritized distributions to shareholders since the mid-1980s. Over the decades, both companies have been increasingly aggressive in buying back their own shares on the open market, thus creating opportunities for ‘sharesellers’ through the timing of the sale of shares in these companies.

Among those parties best-positioned to reap gains from these stock trades, in a process that Jang-Sup Shin and I have called “predatory value extraction”, are hedge-fund managers, Wall Street bankers, and the senior executives of the companies that are doing the buybacks.

From 2011 through 2018, Merck CEO Kenneth Frazier averaged $21.5 million per year in total compensation, with 65% of it from realized gains from the exercise of stock options and the vesting of stock awards.

Not to be outdone, over the same eight years Pfizer CEO Ian Read took home an average of $25.0 million per year, of which 64% came from stock-based pay. From 2011 through 2018, average total compensation of pharmaceutical executives who were among the 500 highest-paid executives in the United States ranged from a low of $20.5 million for 27 people in 2011, with 70% stock-based, to a high of $43.8 million for 35 people in 2015, with 88% stock-based.

Meanwhile, through the National Institutes of Health, US taxpayers give drug companies $30 to $40 billion per year in life-science research. These companies also get subsidies and market exclusivity under the Orphan Drug Act of 1983 along with other types of federal, state, and local government support. And, of course, the US government grants companies patent protection, which is supposed to incentivize drug innovation.

From this perspective, PhRMA’s arguments against drug-price regulation are as ephemeral as today’s stock price. Society should expect pharmaceutical companies to deliver safe, effective, and affordable medicines, and, for the privilege of doing business in the United States, Americans should ensure that a system of corporate governance is in place to achieve these objectives. That governance system won’t be one that seeks to “maximize shareholder value”.

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