A Case Demonstrating Links Between Poor Governance, Conflicts of Interest, and Excess Executive Compensation at a Hospital System

The Salinas Valley Memorial Healthcare System in California first appeared on our radar in 2011 for not only giving an improbably large severance package to its CEO, but doing so two years before he actually retired.   At the time, hospital "officials" gave the usual sorts of justifications we see for huge executive compensation packages.  They suggested the CEO is brilliant, in particular, "gifted and experienced," and that to retain him they needed to pay "private sector-level benefits."  Then it turned out the system was rapidly raising the compensation of other executives while laying off employees who actually took care of patients. 

A Government Audit

Because the system, despite its title, is actually a local government agency, these controversies triggered not only outrage, but also a state audit.  The Los Angeles Times described its results. 

The audit found that the Salinas Valley Memorial Healthcare System regularly did business with firms that the board and top officials had financial stakes in — in some cases in apparent violation of state conflict-of-interest laws.

The report stated that Salinas Valley lacks sufficient safeguards against making decisions that violate conflict-of-interest laws, and that the district therefore can't guarantee 'that it's board members and executives do not experience personal financial gain from its transactions with businesses.'

The audit found 11 instances between 2006 and 2010 in which board members had reported economic ties — including stocks, salaries and other types of payments — to vendors with which the district did business.

Not all the cases represented violations of conflict-of-interest rules, state auditors said, but in two cases they found that officials may have broken the law.

One case involved former Chief Executive Samuel Downing, who had $50,000 in investments with 1st Capital Bank, an institution Salinas Valley and the executive agreed to deposit $1 million into.

In another case, the hospital made $5.6 million in disbursements to Rabobank, where a board member, Harry Wardwell, serves as a regional president and receives a salary of more than $100,000, according to his most recent statement of economic interest.

A San Jose Mercury News article listed some other problems found by the audit:

· Absence of a formal executive compensation policy despite paying its top administrators at the upper end of the industry scale. Downing received a nearly $5 million retirement payout, and other executives received generous pay topping out at $341,000 per year. The reported also cited supplemental pensions, which have been discontinued.

· Violations of state open-meeting laws as the board approved executive pay.

· Failure to ensure all employees who are required to file statements of economic interest had done so.

· Absence of a duly approved, legally binding conflict of interest code, which must be approved by the county Board of Supervisors. The report noted the hospital board instituted a properly approved code in December.

· Lack of proper documentation on the selection process for no-bid contracts, necessary to ensure the hospital gets the best value for its money. The report found only one of eight contracts reviewed during the audit included such documentation.

· Need for better oversight of hospital funding of community events, including the rationale for why and how they benefit Salinas Valley Memorial, to adhere to the ban on making gifts of public money. The report found the board delivered $54,000 to California Rodeo Salinas without any evidence it had considered how it furthered its public purposes.

Conclusions

First, this case should not be viewed as an indictment of hospitals run by local governments.  Rather than indicating that bad behavior is particularly likely at such hospitals, the fact that questionable behavior came to light at such a hospital is more likely due to better regulation of such hospitals leading to more transparency about them compared to other hospitals.  The regulations and laws governing the operations of non-profit hospitals not run by government agencies, or for-profit hospitals vary from US state to state.  To my knowledge, rarely do states strictly regulate conflicts of interest affecting, or require much transparency about governance at hospitals that are not government run.  There is a similar lack of state regulation of for-profit hospitals, and federal regulation of either non-profit or for-profit in these areas.  Thus it is extremely rare to see an audit or report about any non-governmental hospital like the one about Salinas Valley Memorial Healthcare.  Without the greater transparency produced by such investigations, there is little data about whether the practices seen at Salinas Valley are common at other hospitals, be they government run, non-profit and private, or for-profit.   

However, while this is just one case, it does allow an interesting comparison.  We have discussed the usual "talking points" proffered by management and boards to explain outsized compensation packages in health care.  They often include statements about the brilliance of the executives in question, almost never with any supporting evidence, and the need to pay "market" rates.  Although these, and other talking points may seem implausible, they are hard to challenge, because hospital and other health care organizations are usually able to conceal the processes which actually lead to compensation decisions. 

However, in this case there is documentation of problems with governance processes which may have plausibly enabled unjustified levels of compensation.  Failure to maintain processes to disclose and deal with conflicts of interest could increase the likelihood that conflicts would occur.  A board that included individuals who may have been personally profiting from their board membership might be inclined to go along to get along with the CEO.  Meeting in secret despite an open meeting law would prevent discovery of cronyism.

This case therefore suggests that governance that lacks transparency, accountability and integrity may lead to self-interested, conflicted leadership that responds to perverse incentives.  Such leadership is likely to pay more attention to its own interests than the health care mission, short-changing patients' and the public's health.

So once more with feeling.... health care organizations need leaders that uphold the core values of health care, and focus on and are accountable for the mission, not on secondary responsibilities that conflict with these values and their mission, and not on self-enrichment. Leaders ought to be rewarded reasonably, but not lavishly, for doing what ultimately improves patient care, or when applicable, good education and good research. On the other hand, those who authorize, direct and implement bad behavior ought to suffer negative consequences sufficient to deter future bad behavior.

If we do not fix the severe problems affecting the leadership and governance of health care, and do not increase accountability, integrity and transparency of health care leadership and governance, we will be as much to blame as the leaders when the system collapses.