When seeking information about the health and well-being of a company, the first place investors often look is the 10-K or the 10-Q. But the proxy statement really should be the first stop. It offers a brief, yet thorough, description of a company's health. More specifically, it delves into business relationships, the backgrounds and compensation of corporate officers, and the future outlook of the firm in plain, easy-to-read text.
The typical proxy statement addresses many topics of value to investors. Below is some of the information you can find in this important document.
Profile of Management
The proxy outlines a company's management employment history. This is valuable because it gives investors insight into officers' abilities and experience. Have the officers worked in the industry before? Did they move up the corporate ladder in the typical fashion, or were they somehow transplanted from another industry? Do they sit on boards at other companies? Do they have any potential conflicts of interest, or are their duties spread too thin? These are all important questions that the proxy can often answer.
Insider Ownership and Executive Compensation
The proxy statement can tell you whether a company is being run for the benefit of the shareholders or insiders. One section will detail executive compensation. Check out how much management is being paid. Also look at their option positions. Do they have a vested interest in seeing the shares rise? Or are they merely collecting a fat paycheck?
Ideally, you want to see a large percentage of management's pay coming from out-of-the-money call options, meaning options that are currently worthless, but that could be worth a bundle if the share price moves materially higher. Put simply, option-based compensation gives management an incentive to enhance shareholder value and to find ways to drive the share price higher.
Sometimes in the course of business, companies will make sweetheart deals with their senior-level executives. These loans are sometimes in the hundreds of thousands or even millions of dollars. This is bad for the average shareholder for several reasons.
First, the company should not be acting as a bank. Its capital, if it were looking out for the common shareholder, should ideally be retained to spur business-related growth, or be paid back to the shareholders in the form of a dividend.
A second issue is that the interest rate being charged on these loans is often below what is being offered in the broader lending market. This is problematic because it means the company is being inadequately compensated for making the loans. A third problem, and perhaps the most worrisome, is that many times companies will forgive these loans entirely, particularly if the employee is fired or retires, leaving shareholders to foot the bill.
Changes in Auditors
Sometimes a company will switch auditing companies. The proxy will outline the rationale behind the change and give the investor some insight into whether it was a legitimate switch or due to a disagreement on accounting.
Overall Health of the Business
Similar to an annual or quarterly filing, in a proxy statement, management will also typically include a general discussion about the overall health of the business. Interesting insights can often be gleaned from information on the backlog, gross margin trends, balance sheet opportunities or concerns.
Detailed Business Plans
The proxy will detail business plans or issues on which the board may vote. This information, while sometimes contained in the 10-K, is often much more concise and easy to read in the proxy statement. This valuable information should be analyzed by the investor to determine whether the company is facing any potential challenges down the road, or if there are any opportunities that management has not outlined on conference calls, or in the management discussion and analysis (MD&A) section of the 10-K or 10-Q.
Related Party Transactions
In the proxy, there will also be a section that reveals "related party transactions." Look for potential conflicts of interest or sweetheart deals that management has set up for themselves.
For example, is the company obtaining a critical raw material for its products from another company owned by the chief executive? If so, perhaps the company may be paying more than it has to. Too many conflicts of interest should certainly pique your interest as a shareholder and make you wary of the company's investment merits.
The company may describe litigation risks in the footnotes of other financial statements. The proxy will often comment on the potential outcomes of certain suits, or the possibility that management may set aside money in the form of a reserve to pay for the potential loss of a suit.
The Bottom Line
The proxy statement is probably the most overlooked form that is filed with the Securities and Exchange Commission (SEC). However, it can inform and enlighten the curious and diligent investor.