Proxy statements, or -- as the Securities and Exchange Commission (SEC) likes to call them -- Forms DEF 14A, offer insight into some of the most sensitive corporate issues. Issues like executive compensation, option grants, and employee stock option plans are laid out in more detail than some of the highest paid would like, but hey, that's the law. Besides satisfying the voyeuristic urge to look up the salaries and options packages of company bigwigs, proxy statements can be used to gain insight into how top management is rewarded. Motivation is key to steering a company in the right direction, so understanding how these men and women at the helm are motivated can help you decide if the shareholders' (read: your) concerns and management's are truly aligned.
Let's not kid ourselves here. You know it, I know it, and from the conversations I've heard and the testimonials from actual board members in a recent Fortune article, CEOs know it. The money spigot is turned on full blast in the U.S., and executives are the ones with the biggest buckets. It's not uncommon to hear about pay packages that would make even Alex Rodriguez blush.
Therefore, we, as part owners of these companies, want to make sure management is being properly motivated to build long-term, sustainable shareholder value. The wrong incentives and management could set sail for the best fishing spots without regard for the hurricane brewing behind them. Accusing these industry titans of thinking they will head for the prime spot, catch a ton of fish, and jump ship before the storm hits may sound dramatic, but it's not.
Golden parachutes like the $47 million that Jill Barad walked away with after destroying billions in shareholder value at Mattel (NYSE: MAT) or the astonishing $128 million (give or take a few million!) that Michael Ovitz pocketed after spending only a year in the top job at Disney (NYSE: DIS) will always be there to remind us of how misaligned management and shareholder interests can get. Jealousy and envy aren't the only reasons shareholders should grimace over these types of deals. They cost us money -- big money.
The greatest culprit behind excessive payouts is stock options, and despite their absence from the income statement, options aren't free. Options hit the shareholder through dilution or cash drain. When an employee exercises in-the-money options, a company has to buy those shares in the open market at market prices, yet it can only collect the lower exercise price from the employee. This is a cash hit, and with Ovitz-sized option grants it can mean the difference between upgrading plant equipment or not.
So, what can the individual investor do about it? Not much, really. But you can do a little digging of your own to find out how generous the directors of your investments are, and that starts with the proxy statement.
The proxy can help investors gain a sense of what is expected from management. These filings often detail the employment contracts of top executives and always provide bios of the board members. And it's the board's compensation committee that determines these outrageous pay packages, so determining if there are friends or family members chairing the compensation committee could be a good start to determining its objectivity. If this sounds paranoid, don't take my word for it; listen to the seven directors that Fortune interviewed.
The magazine asked these seven directors for candid appraisals of the runaway compensation packages offered to our top managers. Several comments stood out, such as "CEOs don't want independent directors" and "there are few things that CEOs are interested in more than their own compensation," that left me concerned. It's not like their salaries are a secret, though. The total compensation packages of the top-five highest-paid individuals at every public company are right there in the proxy, so investors can make their own judgments about management's worth.
The board of directors is largely responsible for setting top exec pay through its compensation committee, but to counter that, CEOs hire compensation consultants to justify their own salaries. Often, these compensation experts -- who are hired by the very people that they are assessing -- also make recommendations to the board. Think about it: Management is paying a consultant to determine how much it should be paid. If that's not bass akwards, I don't know what is!
The character the board comp committee may be the only thing between you and your ex-favorite CEO buying a private island in the South Pacific. If he or she is worth it and creates enormous shareholder value like the late Roberto Goizueta of Coke (NYSE: KO), let them have their riches. But when contract terms like the option to buy your office furniture for $1 (a provision in Ms. Barad's contract) show up in the proxy, beware. So, be an inquisitive investor and dig through that proxy for anything that smells funny. Question the incentive-based pay and make your own decisions.
When tying management's interests to shareholder value, it's important that compensation is not based solely on financial measures like net income or revenue growth. These numbers can be manipulated, and as Rule Maker co-manager Rich McCaffery put it, "can destroy [long-term shareholder] value if pursued recklessly." He cited the fact that Coke uses unit case volume to measure its managers, and I found that American Express (NYSE: AXP) execs are also measured by non-financial goals like credit card growth, market share in card purchase volume, and expanding the network of AmEx accepting merchants.
The proxy statement is a hidden gem of information about management compensation and therefore management motivation. Foolish investors looking for kernels of information to evaluate management's intentions can start here. At the very least, you will learn one thing: You're not as rich as you think.
Fool on.
The first thing Todd Lebor does when he gets a proxy statement in the mail is to turn to the Summary Compensation Table to see how much the top five make. At the time of publication, Todd owned shares of Disney. His other holdings can be found online, along with the Fool's complete disclosure policy.
