When seeking information about the financial health of a company, the first place investors often look is the 10-K or 10-Q. But the proxy statement can be just as revealing, as it delves into business relationships, the backgrounds and compensation of corporate officers. The typical proxy statement addresses many topics of value to investors. Below is some of the information you can glean from this important document.

Key Takeaways

  • The proxy statement provides details about management, their experience and qualifications.
  • The document also provides important information their compensation, and whether their compensation structure is aligned with shareholder interests.
  • The proxy statement can reveal potential conflicts of interests, such as related-party transactions that may not be beneficial to the company.
  • Another thing to look for are company loans advanced to senior executives. These loans can deprive the company of capital, are often made on generous terms, and sometimes are forgiven, footing shareholders with the bill.

Profile of Management

The proxy provides detailed information about a company's chief executive officer, chairman, and board of directors. 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 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? Are their duties spread too thin? These are important questions 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 shareholders, or for the benefit of insiders. One section will detail executive compensation and how much board of directors members get paid.

Also, look at their option positions. Does the board and management 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 could be worth a bundle if the share price moves materially higher. Put simply, option-based stock compensation gives management an incentive to enhance shareholder value and to find ways to drive the share price higher.

Senior-Level Loans

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 problemand perhaps the most worrisomeis 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 practices.

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 other 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 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.

Litigation Risks

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.