Biotech clusters are big business. They attract investment, spur innovation and create economic prosperity for the local economy, let alone the bragging rights that come from market superiority. In the United States, Boston in Massachusetts and the Bay Area in California, duke it out annually for the accolade of top life science cluster. Unquestionably though, what is happening in Boston right now is nothing short of remarkable and the gravitational pull of this bioscience ecosystem is attracting companies from across the globe.
When we look at these clusters, we look for the winning formula – the template that will translate ambition into reality, in the way Boston has managed to. How can we emulate that success? Well, the truth is, the success of a bioscience cluster is driven my multiple factors, the more prominent of which are; scientific research, access to capital, investment environment, infrastructure and resources, and human capital.
So while Boston reigns superior and San Francisco tries to regain top spot, we wondered about the other pretenders to the crown. In particular, that of San Diego, a highly ranked cluster (often 3rd) which offers something different from these current ‘super-clusters’.
For this reason, we took a deeper dive into the San Diego biotech cluster and we did so from the knowledge base that we possess, which is human capital and executive leadership. We wanted to look at what public biotechnology companies (44 in total) looked like in terms of their CEO leadership and the board of directors which govern them.
The 4 questions we set out to answer were the following:
1. What are the compensation structures of the Board and CEOs of San Diego’s Public Biotechs?
2. What does the composition of the board of directors look like of these San Diego companies?
3. Are there any governance indicators which might inform us about the companies or the cluster?
4. Do these San Diego biotechs face any particular CEO or board recruitment challenges near term?
We looked at the 2012-2014 proxy statements of 44 publicly listed biotechnology companies and stratified them according to market capitalisation. Below I set out the top-level findings of this analysis.
1. CEO Pay and Board Compensation
We found that as a collective group, CEO salary rose 7.6% over the period (2012-14) but that total compensation rose by exactly ten times this amount over the same time. In our study, the highest salary peaked at around $860k while total compensation approached $15m.
The rates of CEO compensation growth seen throughout the various valuation levels differed considerably, with the least valuable companies experiencing the greatest percentage rise in total compensation. Whereas the most valuable companies showed a very considerable rise in CEO total compensation in 2014.
The median non-executive director fee across all the companies was seen as $35k, although great variability was seen across the board fee structures. As we analysed the Chairman and the fees earned for the Board Committees and their respective Chairs, we found great variability in the data. For example, the upper quartile Board Chairs of the companies belonging to the second lowest group by valuation, were paid the highest of the entire study group. Equally, we found that Audit committee members were earning more than twice that of the nomination committees.
What this means for boards
• Boards need to pay particular attention to CEO compensation and the way in which compensation packages are arrived at. We found that equity made up in excess of 70% of total compensation, much of which was linked to long-term incentives. However, the design of these equity based LTI programs needs careful planning and this poses particular challenges for the smaller/younger companies who perhaps have particular difficulty with long-range performance targets and linking these to CEO pay.
• Compensation committees need to ensure they are appropriately setting fees for their non-executive directors and the respective committees which are discharging the board responsibilities. The evidence points towards marginal difference in some board fees despite the relative values of companies and the inherent complexity faced by the board. Furthermore, as boards face the emerging complexity of compensation and the need for improved capabilities in terms of succession planning and refreshment, both the Compensation Committees and the Nomination Committee fees need to attract the right experience and capabilities.
2. Board Composition
The average size of the boards was 7 board directors and this scaled from the smallest of 4 to the largest of 12. Clearly one of the characteristics of the San Diego biotech market is that many of the companies are comparatively small. This suggests that the board size will reflect the collective responsibilities needing to be discharged by the board members. One clear prediction is that this would grow as the composite companies mature their operations.
For a board of directors, age is another way in which to introduce diverse perspectives and is often considered a surrogate for experience. We conducted analysis of each board and analysed the age distribution to look for a diverse spread of ages, as well as differences between the genders. While the average age of all board members was 60, we saw that there was 3 year’s difference between men and women, with women the younger. The study also found 14% of directors were over the age of 70.
Education remained predictably high among the CEOs and Directors with over 70% having achieved a master’s degree of higher.
Women were consistently under represented on the board of these companies. Just one female CEO and the director population falling short of the 1 in 10 board member figure identified in previous, larger studies.
What this means for boards
• The skills, experience and capabilities of the board are extremely important but there is evidence that many of the companies could significantly improve the composition of their boards. We are cognisant that many argue that older members of the board offer considerable insight in board affairs, however, we also would suggest that biotechnology is a very rapidly evolving field and that full consideration must be given to the overall age composition of the board. While many companies do not set retirement ages for the board directors, some do, and these often range between 70 and 75 years of age. For the study, we took the lower range of 70 years as we see this as a trigger for succession planning. At the very least, boards should be developing full succession plans and ensuring that orderly board transitions are factored.
• Adding women is clearly an important task for almost all the boards we studied. The absence of women in director roles as well as CEOs, is a very negative indictment on these companies. The topic of gender diversity at the top of companies continues to receive considerable attention and here we see a distinct under-participation of women at the board director level. Increasing diversity, including that of gender, has been shown to considerably improve the financial performance of the company and deliver better returns. Companies are now under considerable pressure to voluntarily change their boards or face greater scrutiny from regulators and investors. The Chair of the SEC said in July that she has requested the Commission to take another look at the policy rules relating to gender diversity on boards with the intention to tighten their application.
3. Corporate Governance
Tenure seems inextricably linked to age, with advancing tenures ages of course climb, and on the boards we examined this was clearly true. The average tenure of the CEOs within the study was 8 years and the tenure of the board directors was 7 years. The number of directors having served their boards for in excess of 9 years was nearing a third of all the directors serving.
The independence of the boards was also examined in the study, one measure of which was to look at the companies who separated the CEO and Chairman roles. In our sample of 44 companies, we saw a figure close to I in 5 were holding combined office of Chair/CEO.
Of the total number of board directors we identified, in excess of 4 in 5 were non-executive directors and thereby ‘independent’.
What this means for boards
• There is no legal commitment for the board of directors to enforce upper-limits on non-executive board director tenures in the US, whereas in European countries there are limits set out in the compliance code, such as 9 years in the UK. ISS, which is a shareholder proxy group that acts for vast numbers of shareholders, sets 9 years as the threshold for independence for their Quickscore 2.0, which calibrates good governance. With our study group showing nearly one third of the total director populations nearing this threshold, nomination committees should be beginning to plan for the succession of those directors. In response to the report, some board directors have conveyed to us that 9 years is when a director is beginning to add the most value and that it is not a marker for diminishing independence as a result of being closely attached to the company. We accept there will be very valid arguments for extending tenures of some board directors, but boards should be more actively engaging in refreshing their boards.
• The national trend among US public companies is to divide the role of Chair and CEO and this is a governance practice which investors are increasing pushing for and favouring. The division of the roles, it is commonly espoused, provides greater independence and improves governance. In other words, the Fox is not in charge of the Hen house. An independent Chairperson can manage the board and challenge the CEO more effectively, whereas the CEO/Chair combined perhaps leaves the CEO freer to set strategy without the necessary checks and balances. This is not to suggest that many Chair/CEOs haven’t been very successful, they have, and the strategic alignment this creates is often a factor to which they attribute their success. However, those holding combined office are in the complete minority today and should be closely assessing if they need to amend this structure. The Lead Independent Director is one approach boards have taken to counter this issue, seen only 5 times among our group, but increasingly investors are preferring a split in CEO and Chairman responsibility.
4. Board Recruitment Challenges
As a general commentary on the recruitment of board directors in the US among biotechs, we’d say that the competition remains incredibly high. The healthy market of relatively well-funded private biotechs has attracted many board directors with public company board experience to align themselves to the ‘hot new thing’. This has created strong internal market competition for board talent, further exacerbated by the number of companies having listed publicly since 2010/11. This has meant large numbers of VC nominated directors leaving the board and replaced with more independent directors.
The figures set out in our report point towards some prominent recruitment challenges when combined with this backdrop. The board refreshment, diversity, age and tenure issues are among the explicit issues facing nomination committees. That coupled with a natural attrition of CEOs and directors, we see quite considerable in-tray items for any of the nomination committee members.
What this means for boards
• CEO succession is an incredibly challenging thing for boards to get right. The selection of the right candidate is difficult enough but moreover it is the planning, preparation and management of the process that leads to this important change that creates problems for so many boards. The decision to vacate the role of CEO would hopefully be an orderly one but this is not always so. Boards, and in particular nomination committees should maintain constant awareness of their desired replacements should the CEO leave. This is a dynamic market and nomination committees seldom have adequate time to cultivate this intelligence themselves, so they should decide on how they maintain this market knowledge while retaining the requisite confidentiality.
• The board of directors, led by the recruiting remit of the nomination committee and supported by the Chair, should be looking at the near-term and long-term board requirements. These requirements mean that they have to align the capabilities of the board with the strategic aims of the business, ensuring the board has the right sort of experience blend to provide suitable oversight. This means that they need to conduct regular evaluations of the current board for continued relevance and performance, as well as manage any change in the board’s composition to achieve this. The board constituents should offer suitable diversification of experience, background, gender and age. This complex assessment of composition must be conducted with reasonable frequency and the board must also ensure it is paying attention to climbing tenures, such as the one third of directors exceeding 9 years we’ve reported. These combined challenges make active recruitment of board directors something which boards must do with greater levels of structure and process. It is a competitive market for good non-executive directors and boards must be on their game to win out.
San Diego is an extremely exciting cluster with great levels of innovation. Like all good biotech clusters it needs a regular flow of highly talented leaders to elevate the companies to the next levels. Recognising where you can improve is one step towards becoming better and through data like that produced in our study, San Diego biotechs can do this.
To obtain the Board and CEO Compensation and Governance Report (San Diego Biotech Cluster) which has now been made publicly available for download at a highly discounted rate, follow this link. https://www.liftstream.com/board-and-ceo-whitepaper.html