How To Invest

Read a proxy statement in 10 minutes: How to suss out a company’s management

A proxy statement is a document filed with the U.S. Securities and Exchange Commission (SEC) by a publicly listed company. Proxy statements give readers a vast amount of information about a company’s shareholders and management and other salient details that are often missing from an annual report, making proxy statements a vital source of information for every investor. Unfortunately, investors often overlook these statements, even though they offer pertinent information about a company’s prospects.

A proxy statement typically consists of the following:

  • Notice of annual meeting of shareholders
  • Board structure
  • Election of directors
  • Board of directors compensation
  • Executive compensation

We’ll now go through each of these sections and what to look out for.

Notice of annual meeting of shareholders

This section contains information on the agenda of the annual meeting, where and when it will occur. This section should give shareholders an idea of what topics will be covered at the meeting. Typically, there will be a voting motion for director elections and approval of the company’s auditors.

Board structure

This section typically provides general information about the structure and operation of the board of directors, as well as a description of the roles they perform, the number of director executives and non-executive directors, and what character traits and overall qualifications qualify someone to serve on the board of directors. This information will help readers understand who is running the company and how they have been performing.

Companies with a strong governance structure should look for individuals with various skills and appropriate experience to fit the business’s industry and sector. Further, a good corporate governance practice should also include separating roles between the CEO, Chairman, and Lead Director. Companies that employ ‘trophy’ directors, such as ex-politicians, celebrities, royal families, etc., may exhibit questionable corporate governance practices.

Election of directors

This section contains information about nominees for the board election. Readers should focus on the regularity of the Board of Directors elections and the duration of a director’s term in office. It is good practice for a corporate entity to adopt a staggered board where all directors do not stand for re-election — this encourages a constant influx of new faces and ideas.

Readers should assess whether directors are more likely to be interested in the company’s operations, have the needed business background, and have incentives aligned with shareholders when browsing the selection of company nominees. Most companies will include all sorts of additional information regarding the nominee within this section, such as the ethnic and gender make-up of the board and industry expertise. 

Board of director compensation

This section summarises the total compensation paid to all directors during the year. Only outside directors, those not on the management team should be compensated for serving on the board. Typically, board members’ compensation is broken down into two categories: base salary and some form of equity compensation. Base salary is generally paid in cash and ranges from $40,000 to $150,000 per year for most U.S. companies depending on the size of the company and the level of experience of the individual board member. In addition, each director who’s served a full term usually receives an equity award in the form of stock.

Determining proper director compensation is not necessarily a simple task. Nevertheless, board members should be fairly compensated for their time and responsibilities while not too excessively that shareholder interests are neglected. Companies with a strong governance structure will typically require every board member to invest at least one or two years of their annual compensation as stock holding to enhance alignment between board members and stockholders.

Executive compensation

We have now reached the most exciting part of a proxy statement that discusses critical management compensation and its rationale. Of course, most companies will write this section in a persuasive tone to paint the picture that their compensation structure has managed to form an alignment between management and stockholders; however, specific details must be read with an informed eye.

Note that only compensation of the company’s top executive officers is shown in the company’s proxy statement. Generally, executive compensation is divided into a base salary, a short-term cash award, and a long-term equity incentive. It is usually good practice for companies to structure executive compensation so that management is paid a fixed base salary, while a large portion of their executive’s total payout is based on performance incentives that depend on management’s ability to achieve a predetermined short-term and long-term performance target. Here’s an example:

Costco executive compensation.

As illustrated in the table above, Costco’s compensation structure is an excellent example of reasonable compensation. Notice that all five of Costco’s key executives get paid a modest base salary of less than $1.1 million. While majority of their executive’s compensation is paid out as stock awards in the form of a restricted stock unit with a five-year vesting period for achieving long-term company targets.

Costco clawback policy and stock ownership requirement as part of compensation.

The fifth perspective

 Reading a proxy statement may seem daunting, but it is essential if you want to make an informed investment. By reading the proxy statement, you will better understand whether a company’s management is acting in your best interests.

Choon Leo Wang

Choon Leo is a growth-focused investor with an interest in innovative platform businesses that connect users and fix market inefficiencies. He believes that companies with the most competitive business models will compound in value over the long term. He currently holds CFA Level I qualifications.

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