In this age of skyrocketing compensation for chief executives and dwindling prospects for drugmakers, there is increasing investor angst that boardrooms are either out of touch, unimaginative or simply indifferent to the protestations that pay packages do not match shareholder interests. The issue has engulfed Johnson & Johnson’s Bill Weldon and, in years past, Dan Vasella at Novartis, for instance.

So what to do? Well, pharma boards could start by shifting away from an emphasis on financial measurements - such as EPS, or earnings per share, and EBITDA, or earnings before interest, taxes, depreciation and amortization - to calculate and compare performance, and start focusing on pipeline innovation, according to The Hay Group, a consulting firm that measured ceo pay and incentives. In other words, the incentive part of ceo compensation - beyond salary, that is - should be based on long-term incentives and not short-term ratios. “The whole point of an incentive plan is to create incentives,” says Matt Gurin, vp of life sciences at Hay. “But the only thing big pharma cares about are financial ratios. And these are actually lagging indicators. It’s very disappointing.”

Before reaching this conclusion, the firm examined proxy reports filed recently by 50 US companies - big pharma, mid-sized drugmakers and biotechs - and found that 80 percent of the metrics used by the largest drugmakers to determine incentives were financial measurements, but only 12 percent were tied to progress involving drug development and commercialization. “We always worry when a company gets too focused on a ratio,” Gurin explains. “And one way is to boost the EPS is to buy back shares. It’s a classic maneuver, but says nothing about long-term value. Instead, it was all about lagging indicators of making money and to see if the company is still considered valuable…But a true leading indicator of value creation is the pipeline.”

To turn things around, he suggests that boards examine the role of salary and incentives. For instance, at one large drugmaker, the EPS and EBITDA was used to determine both short and long-term incentives. “This mean they’re paying the ceo twice for the same thing, which doesn’t make sense. The job is to drive financial outcomes and the long-term health of the company, and that’s what the salary is for. Why pay again in terms of incentives?” he posits.

What would be more helpful, he continues, is getting answers to such questions as whether the ceo and senior exec team is positioning the company correctly with certain acquisitions and deals for drug development. “When is the last time a drugmaker reported two years later on the progress of a big merger, other than synergies? As a Pfizer shareholder, for example, that’s something I’d like to see.” Another suggestion: incorporate pipeline progress into incentive plans, by creating criteria that can be used for reliable modeling. “We’re not seeing senior executives really worry about real value creation in the pipeline,” Gurin says. “So the question is why aren’t the boards doing the same modeling to align executive behavior with what analysts are saying drives value?”

For smaller companies, such as biotechs with just one product, the goals and measurements surrounding development and commercialization may be much easier to ascertain. But for big pharma, “this is much trickier. We’re saying the big companies are hiding behind the excuse that this is much tricker, so they’re going to measure by financials. But that system isn’t working.”

Of course, he acknowledges that the specter of the Sarbanes-Oxley Act and FDA oversight have limited risk taking in the boardroom. But, Gurin argues, this aversion to risk also inhibits long-term progress and, hence, undermines the usefulness of relying on financial ratios to set long-term incentives. And in an era when drugmakers must scramble more than ever to develop new medicines and new approaches for doing so, an emphasis must be placed on pipeline progress. “You’re going to get what you pay for and if you pay for consistent, predictable earnings,” he says, “well, that tends not to highly correlate with innovation.”