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By: Keith Kefgen and Rosemary Mahoney-Browning  - May, 1998

It's that time of year again…the temperature is rising, flowers are blooming, and the mailman is delivering proxy statements to shareholders. If you are an Investor, this is the time to voice your opinion and vote on critical company matters. However, scrutinizing a proxy is not as simple as it sounds. Until recently, many companies omitted and concealed pertinent information from shareholders. This practice is changing as SEC requirements become more stringent and corporate governance is brought to the forefront.

So what exactly is a proxy statement and what is its purpose? A proxy statement is a document required by the Securities and Exchange Commission for a publicly-traded company that notifies shareholders of the company's annual (or any special) meeting, includes information relevant to matters that will be voted upon by shareholders, and further encloses a ballot for voting. In addition, extensive information pertaining to compensation of the CEO and the next four highest paid officers is included. We will focus on the compensation portion of the proxy and share strategies on how and what to look for during your examination process.

When reviewing a proxy, first and foremost, locate the Summary Compensation Table. This table details all of the components of pay over a three-year period for the CEO, the four highest-paid executives (earning greater than 100K in cash compensation), and up to two additional executives that have left the company, but would have been one of the top earners. The compensation components include Salary, Bonus, Other Annual
Compensation, Long-Term Compensation  including Restricted Stock Awards, Securities underlying Options/SARs, Deferred Compensation) and finally All Other Compensation (see Table1).
 
 

Look to see if salaries have been raised, and by how much? How does that compare to industry norms? Review the bonus column to make sure payments seem reasonable based on company performance. Bonuses should vary according to quantitative measures, such as growth in revenue, EBITDA, net earnings and so forth. If bonuses are paid without corresponding performance increases, it's a red flag that pay and performance are not aligned. The "Long-Term Compensation" column will include restricted stock awards, the number of stock options / SARs granted and deferred compensation payments. Examine the size, frequency and grant rationale. Again, read the fine print. Make sure that these grants have performance measurements tied to them and are not flagrant gifts by the company.

Often the real eye-opener lies in the Stock Options Grants Table (See Table 2). This table details the exercise price, the expiration date, vesting period and the potential value of the options based on 5% and 10% annual appreciation rates. We recommend the use of the Black -Scholes valuation model for calculating potential value, rather than the SEC - required 5% and 10% estimates. Black-Scholes is the most common valuation model used by Wall Street brokers and analysts. Make sure exercise prices are not below market value. In fact, we prefer to see premium-priced and index-priced options. These are options that must see meaningful appreciation in stock price to be worth anything. Another red flag with regard to options is repricing. Repricing is a no - no on Wall Street. Analysts hate them and so should you as a shareholder. Don't let management move the performance bar lower every time business hits a down market.
 
 

The Aggregate Option /  SAR Exercise Table notes how many options each executive officer exercised during the fiscal year and the value realized in the transaction (See Table 3). It also shows the yet-to-be-realized value of stock options that the executive is still sitting on. If the company offers Stock Appreciation Rights in tandem with stock options, it will be noted in this section.
 
 

The Report On Executive Compensation summarizes the company's pay philosophy. The report is written by the Compensation Committee and submitted to the board. Make sure that no company insiders are on this committee, it's a clear conflict  of interest.  Study whether the company really embraces a pay-for-performance methodology. Compensation Committee Interlocks is where the company must disclose whether directors on the committee have ties to outside entities that do business with the firm, such  as  banks,  law or accounting firms. Look to verify, whether the committee uses competitive data to set compensation levels. Sources such as our Hospitality Compensation Exchange are readily available and cost -effective.

The Employment Agreeents  section discusses employment contracts between the company and key executives. These discussions are rarely comprehensive, but they can shed some light on how rich the pay packages can get. The next table worth looking at is the Beneficial Ownership Table. The SEC requires company executives, directors and persons who own more than 10% of any class of stock to report their ownership stake.

Finally, SEC guidelines require most public companies to publish a performance graph comparing their share-holder return to a self-selected peer group of similar companies and a national market index, such as the Standard & Poor's 500. The chart will show whether the company is outperforming or underperforming the market. This chart is another good benchmark for comparing the relationship between executive pay and company performance.

You now have the knowledge and ammunition to make a considerable impact on the annual shareholder
meeting. Don't forget - company directors and management work for you, not the other way around.

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