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
I. Corporate Governance and Ethics

Corporate governance is a relationship among stakeholders that is used to determine a firm’s

direction and control its performance. How firm’s monitor and control top-level manager’s
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 firm’s value.

The board of directors is a group of elected individuals whose primary responsibility is to act
in the owner’s interests by formally monitoring and controlling the corporation’s top-level
manager. A firm’s board of directors is composed of insiders, related outsiders, and
outsiders. Insiders are the firm’s CEO and other top-level managers. Related outsiders are
individuals that are not involved with the firm’s 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 firm’s board of directors is responsible for determining the
effectiveness of the firm’s 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 firm’s 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.

Biovail’s primary focus centers on three therapeutic areas: cardiovascular disease, central
nervous system disorders, and pain management. The company’s 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 company’s 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 Biovail’s 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.
Biovail’s 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 industry’s
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 – Porter’s Five Forces Model
Based on Porter’s 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 Firm’s 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

VI. 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 company’s 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

i. 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 corporation’s 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 corporation’s
board of directors can be an effective deterrent to these behaviors. In fact, effective
boards participate actively to set boundaries for their firm’s 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.

iii. 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.
 iv. 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.