Strategic Management

ZCZB 6523

Case 1: Accounting at Biovail

Prepared for: PROF. DR MOHD TUSIRIN BIN HJ MOHD NOR

by: HENG SHER YIN ZP00382 MUHAMMAD ALI IMRAAN B HJ SALLEH ZP00368 MOHD KHAIRI B MOHD ANUAR ZP00439 SHAZA MARINA AZMI ZP00456 NORLIZA ABU TALIB - ZP00449

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Corporate Governance and Ethics Corporate governance is a relationship among stakeholders that is used to determine a firms direction and control its performance. How firms monitor and control top-level managers decisions and actions affects the implementation of strategies. Effective governance that aligns managers decisions with stakeholders interests can help produce a competitive advantage. There are three internal governance mechanisms in the modern corporation which include (1) ownership concentration, (2) the board of directors, and (3) executive compensation. The market for corporate control is the single external governance mechanism influencing managers decisions and the outcomes resulting from them. Ownership concentration is based on the number of large shareholders and the percentage of shares they own. With significant ownership percentages, institutional investors are able to influence top-level managers strategic decisions and actions. At times, force managers and boards of directors to make decisions that maximize a firms value. The board of directors is a group of elected individuals whose primary responsibility is to act in the owners interests by formally monitoring and controlling the corporations top-level manager. A firms board of directors is composed of insiders, related outsiders, and outsiders. Insiders are the firms CEO and other top-level managers. Related outsiders are individuals that are not involved with the firms day-to-day operations, but who have a relationship with the company. Outsiders are individuals who are independent of the firms in term of day-to-day operations and other relationships. Executive compensation is a governance mechanism that seeks to align the interests of managers and owners through salaries, bonuses, and long-term incentive compensation, such as awards and options. A firms board of directors is responsible for determining the effectiveness of the firms executive compensation system. An effective system elicits managerial decisions that are in shareholders best interest. The market for corporate control is an external governance mechanism that becomes active when a firms internal control fails. The market for corporate control has been effective in causing corporations to combat inefficient diversification and to implement a more effective and strategic decisions. Effective governance mechanism ensures that the interests of all stakeholders are served. Strategies that will help the firm achieve competitiveness and earn above-average returns can

be formulated and implemented only when proper corporate governance is exercised. Effective governance also produces ethical behavior in the formulation and implementation of strategies.

II. Strategic Profile and Case Analysis Purpose Biovail Corporation, a pharmaceutical company, engages in the formulation, clinical testing, registration, manufacture, and commercialization of pharmaceutical products utilizing various drug-delivery technologies in the United States and Canada. In addition, Biovail Corporation offers research, development, and clinical contract research services to third parties. The company was founded in 1983 and is headquartered in Mississauga, Canada. Biovails primary focus centers on three therapeutic areas: cardiovascular disease, central nervous system disorders, and pain management. The companys other areas of interest include Type II diabetes, antiviral medicine, and other select niche therapeutic categories. Key to company activities is the development, manufacture, and sale of products incorporating controlled release technologies that possess significant therapeutic advantages over existing formulations. On March 24, 2008, both Ontario Securities Commission and the U.S. Securities and Exchange Commission release a Statement of Allegation targeting Biovail Corporation and four former and current executive and the companys financial reports for 2001, 2003, and Q1 and Q2 of 2003. The SEC statement accused the company and its management team of chronic fraudulent conduct, including financial reporting fraud and other intentional public misinterpretation. The alleged financial reporting fraud involves (1) the improper use of a special entity, (2) revenue manipulation, (3) an intentional misstatement of foreign exchange losses. Biovail also intentionally misstated in the press releases and public statements both the effect of the accident on Biovails third quarter earnings as well as grossly overstating the value of the product involved in the truck incident, which in fact had no effect on third-quarter earnings. Biovails chairman and CEO, Eugene Melnyk, also violated share ownership disclosure provisions by failing to identify his beneficial ownership held by several trusts in which he continues to exercise both investment and trading authority. Assumptions can be made that the actions of Biovail executives might be construed as just poor management judgment, but on the other hand, perhaps as noted by OSC and SEC, this was a case of fraudulent conduct. As of July 2010, to further expand in neurology, the company merged with the former Valeant Pharmaceuticals and took on the Valeant name. Biovail is now formally known as Valeant Pharmaceutical International Inc. III. Situation Analysis (External and Internal Environment Analysis)

a) General Environment Analysis Demographic segment The Pharmaceuticals positions themselves to better serve the growing baby boomer market. As for Biovail, they focus on market for neurological drugs for ailments that affect an aging population, like Alzheimer's and Parkinson's. Economic segment Majority of pharmaceutical sales originate in the US, EU and Japanese markets. Nine geographic markets account for over 80% of global pharmaceutical sales these are, US, Japan, France, Germany, UK, Italy, Canada, Brazil and Spain. The audited value of the global pharmaceutical market is estimated to reach a huge 500 billion dollars by 2004. Political/Legal segment Pharmaceutical industry has witnessed increased political attention due to the increased recognition of the economic importance of healthcare as a component of social welfare. This in turn has generated political interest because of the increasing social and financial burden of healthcare. Sociocultural segment Gaining and maintaining good health has become an important personal and social requirement. Pharmaceutical firms play a role in providing wellbeing to the society. More so the prevalence of diseases such as HIV, H1N1, cancer and etc. has led to increasing industry efforts to create and maintain good government-industry-society communications by inventing better drug or to find solution to these detrimental diseases. Technological segment The advances in science force the industry to adapt faster to the evolving environment. More money is spent in R&D in order to encourage innovation. The pharmaceutical industry was research and development (R&D) intensive. In 2007, the pharmaceutical industry was responsible for &1.96 billion, or 19 percent of total Canadian R&D spending. Early adopters of new technology to be able to invent new drug, and to be able to ultimately market the new drug often achieve higher market shares and earn higher returns. Global segment The North American Free Trade Agreement has provided the multinational companies with tariff-free access to the large North American market, enhancing the industrys competitiveness. Physical Environment segment Many of the pharmaceutical players are going green in its clinical research and biotechnology. Biovail/Valeant is currently developing an epilepsy medication from plant extraction, which has recently been approved by FDA. Drug is intended to be used if other epilepsy drugs failed.

b) Industry Environment Analysis Porters Five Forces Model Based on Porters five forces model as shown in figure, there is high barrier entry in the pharmaceutical industry due to its high cost in R&D and patent limitations of drugs. However, the competition among pharmaceutical companies is high and they gain competitive advantage by owning a patent drug. Bargaining power of supplier and buyer is low unless after patent expired and generic drug is in the market. Lastly, threat of substitution is low with patent drug but higher with drugs with expired patent. c) Competitor analysis In July 2010, Biovail merged with the former Valeant Pharmaceuticals to further expand in neurology and know known as Valeant Pharmaceutical International Inc. In the therapeutic field of Central Nervous System, Biovail faced competitors such as: H. Lundbeck main business is the health of nervous system. They develop medicine primarily treatment of depression, anxiety disorders, Alzheimer's and Parkinson's disease. Lundbeck spends about 20% of its revenue on research and development; Teva Pharmaceutical Industries is the world-leading generic pharmaceuticals business. Teva's US generic products include antidepressant Prozac and osteoporosis drug Fosamax. UCB manufacturers prescription drugs to treat diabetic pain, Crohn's disease, and epilepsy. UCB's top products include Cimzia for Crohn's disease and Keppra and Vimpat to treat epilepsy. IV. Identification of Environmental Opportunities and Threats and Firms Strengths and Weaknesses (SWOT Analysis) Strengths The merging of Biovail and Valeant will create a company with cash flow of some $900 million and a focus on products for central nervous system disorders and dermatology. With Valeant products, which include drugs for skin cancer and epilepsy, this has led to a complimentary product line for Biovail and places Biovail at a competitive advantage. Weaknesses Biovail is still unable to penetrate some Asian markets as they face great competition from the other pharmaceutical company such as Pfizer, Novartis, Roche, MSD, and Merck, which has a greater share market in the pharmaceutical industry. Opportunities The healthcare industry is growing and is expected to grow further, partly driven by relatively fast advances in healthcare technology and increase is health conscious culture in the society. This has create an array of new/existing products to be penetrated to the un-touch market in Asia, particularly China and India. Biovail also had large investment incentives.

Threats This will include the vast advancement in the field of complementary medicine or traditional medicines for various ailments. The expiry of drug patent and generic drugs in the market also place the firm at a competitive disadvantage. V. Performance analysis of BIOVAIL Financial performance (fiscal year 2009) Sales: $820.4M One year growth: 8.4% Net income: $176.5M Income growth: (11.7%) Customer Employees: 1,311 (reduced by 11.7%) Focus in neurology and dermatology therapy areas, particularly market share in USA, Canada, Mexico, Brazil, Australia and Central Europe. Competitors : H.Lundbeck, Teva Pharmaceutical, UCB Internal business process Improvement of existing drugs using its oral drug-delivery technologies. Extended-release version of antidepressant. Developing new central nervous system (CNS) therapies. Learning & Growth Valeant learned from previous problems occurred in Biovail where lack of Corporate Governance mechanism put in place. Clear separation of entity between shareholders and managers

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Current Situation Analysis Corporate Governance at Biovail Ownership and Managerial Control Ownership and managerial of Biovail is of the same person, who is Eugene Melnyk. Melnyk was the Chairman of the board of director during his tenure as a CEO and he remained as chairman until his resignation from the board in June 2007. He stepped down as CEO in 2004. Known as a person who does not let the slightest criticism from analyst and regulators pass. This is seen as a one-man-show and managerial opportunist, which leads to poor governance and bad strategic decision. The Impact To BIOVAIL In BIOVAIL, the strategic decision is solely based on the CEO cum Chairman of the board of director, Eugene Melnyk, hence the transparency of the companys performance can be manipulated. Recent emphasis on corporate governance stems mainly from the failure of corporate governance mechanism to adequately monitor and control top level managers decision. This situation results in changes in governance mechanism in corporations

throughout the world especially, with respect to efforts intended to improve the performance of board of directors. The truck accident incident in Oct 2003 and a restatement of 2003 financial statements due to errors in foreign currency translations also reflected weaknesses in internal controls that had a negative effect on investor confidence. VII. Strategic alternatives implementation Separation of Ownership and managerial control In this case, corporate ownership and control resided with the same person. The separation of ownership and managerial control is a basic legal premise suggesting that the primary objective of firm activities is to increase the corporations profit and thereby the financial gains of the owners (shareholders). Boards have the power to direct the affairs of the organization punish and reward managers and protect shareholders rights and interest. Task and appropriately structured and effective board of directors, protect owners from managerial opportunism such as that found at BIOVAIL. Managerial opportunism is the seeking self interest with guile. In addition, board of directors is to renew emphasis on audit and compensation committees. Importantly, the reporting of the operating earnings of BIOVAIL adheres with generally accepted accounting principles (GAAP). ii. Enhancing the effectiveness of the board of directors. BIOVAIL case shows that all corporate owners are vulnerable to unethical behavior and very poor judgments in making decisions. The decisions and actions of a corporations board of directors can be an effective deterrent to these behaviors. In fact, effective boards participate actively to set boundaries for their firms business ethics and values. To maintain a relatively small size of board can increase cohesiveness. And as Biovail grows, apart from financial management, it is essential to improve the skills of the board in terms of risk management, operational oversight and communication among the firm, as well as pharmaceutical experience and large public company board experience. The existence of market for corporate control (Compensation, Nominating and Corporate Governance Committee) Melnyk are assumed to be responsible to be formulating and implementing the strategy that led to poor performance and are usually replaced. Thus, when the market for corporate control operates effectively, it ensures those managers who are ineffective or who act opportunistically are disciplined. As Melnyk is retires from the board of directors, appointments of new leadership were decided and announced by the Compensation, Nominating and Corporate Governance Committee of the Board of Directors. This Committee was design to ensure independence and strategic appointments for BIOVAIL leadership.

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Strengthening the assessment and of transparency and disclosure Biovail need to improve and to be transparent in financial disclosure. There are weaknesses, however, in disclosure relating to corporate governance. Many of these are voluntary disclosures about board practice that the company has historically chosen not to make public. This can be done by forming a new audit committee to address the outstanding issues that limited the effectiveness in the past.

VIII. Conclusion Effective governance mechanisms ensure that the interest of all stakeholders is served. Only when the proper corporate governance is exercised, can strategies be formulated and implemented that will help the firm achieve strategic competitiveness and earn above average returns. Effective governance and set of standing rules also produces ethical behavior in the formulation and implementation of strategies.