SPECIAL REPORT: EXECUTIVE PAY : How to Read Between the Proxy Statement Lines

By KATHY M. KRISTOF

May 29, 1994 12 AM PT

With so many executives earning so much money, stockholders increasingly want to know if the managers deserve those big bucks and if the insiders are minding the shareholders’ business--or merely their own.

Fortunately, new proxy disclosure rules make it easier to conduct such assessments--which, in turn, may be pivotal in determining whether your shares are worth owning over the long haul.

What should you be looking for in the proxy statement?

Start with the stock performance table near the end of the proxy, says Nell Minow, principal of Lens Inc., a Washington-based investment company. This table graphically compares how your company’s stock has performed relative to a market index, such as the Standard & Poor’s 500, and--more tellingly--relative to its peers.

Experts say the latter is the key comparison, because market forces--such as strong or weak consumer spending and various investment trends--affect industries in different ways at different times. In other words, the best company in the world could appear lackluster during a down market for that industry, and a terrible company could look like a superstar if you happen to examine it when that company’s industry is popular with investors.

What’s important is that your company consistently perform as well or better than similar companies. If you invest in Transamerica Corp., for instance, you’ll want to know how its performance stacks up with that of other insurance or financial services firms. If you invest in Chevron Corp., consider how it has fared relative to other oil companies.

This information has been difficult for most investors to compile in the past, but thanks to Securities and Exchange Commission rules that took effect last year, companies must now disclose this information both graphically and numerically.

For instance, the “Performance Graph” for San Francisco-based Chevron appears on Page 21 of the company’s 1994 proxy. The graph compares Chevron’s stock value to the value of the S&P; 500, as well as to a peer group index made up of Amoco, Atlantic Richfield, Exxon, Mobil and Texaco--the company’s direct competitors. Over the entire period, Chevron performed somewhat better than the group.

You’d also like to see that compensation is going in roughly the same direction as the stock price, experts say. If the company’s shares are falling year after year, you’d expect to see executive salaries, bonuses and stock awards decline as well.

The “Summary Compensation Table,” which is usually in the middle part of the proxy, spells out how much executives have earned in salary, bonuses and stock awards over each of the last three years.

Another item to watch is stock ownership of directors and executive officers, which is in a chart near the front of the proxy statement. At a glance, you can determine whether officers and directors own large percentages of the company’s stock, or less than 1%. And if you spend a little time with a calculator, you can come up with a more valuable figure: the dollar value of insider holdings.

A positive sign is when officers and directors own several times their annual salaries in stock, says Minow. A warning sign is when the value of shares held by officers and directors amounts to significantly less than one year’s pay.

“These are the people who know the company best,” she says. “If it’s not worth it to them to buy shares, you’ve got to ask whether it’s worth it to you.”

Beware: The graphs can be deceiving. Most companies lump together the number of shares that executives and directors own outright with the shares they have not yet--and may never--buy through exercising their stock options. To determine how much stock the individuals already own, you must read the footnotes.

Consider San Francisco-based PLM, a transportation leasing firm that has seen sales and net income decline over the last five years. The company’s director and officer stock ownership is given on Page 3 of its proxy.

Robert N. Tidball, president and chief executive, is shown as owning 137,000 shares--worth slightly more than $291,000 at PLM’s 1993 closing price of $2.125. (Tidball’s salary and bonus, on Page 10, amounted to $360,000.) However, the footnotes reveal that Tidball owns outright only 7,000 of those shares, or less than $15,000 worth. The rest were stock options--rights to buy the company’s shares at a set price in the future--that he had not yet exercised. Tidball would not comment on his compensation package.

The stock performance graphs and the information on officer and director stock ownership give investors the company’s track record and a reading of what the coach thinks of the team’s chances of continuing to clear the hurdles. That information alone is enough to determine whether the stock is worth its salt, Minow says.

If you’ve got some time and are interested in a more detailed analysis, you can also look at the “Compensation Committee Report,” which explains how executive salaries are determined. This is important because executive pay in excess of $1 million a year as of 1994 will not be tax-deductible for the company unless it is linked to the company’s performance. (Otherwise, such compensation is deductible as a business expense.)

According to a survey conducted by Hewitt Associates, about half the nation’s big companies have already taken steps to comply with the law. Others have said in their proxy statements that they don’t plan to comply or will not be able to because of current contracts with their executives.

Finally, look at the stock options and stock grants given to top executives. Stock options are widely used by companies as a way of tying executive interests to the interests of shareholders.

Here’s how they work: Shares of XYZ Inc. are selling for $20 each. The company’s board wants to inspire CEO Jim Megabucks to work harder at raising XYZ’s market value. XYZ gives Megabucks an option to buy 100,000 shares in XYZ at the current price of $20 a share. He can exercise, or use, this option at any time over the next 10 years.

If XYZ’s shares double in value to $40 before the 10 years are up, Megabucks is in the money. His option for 100,000 shares is suddenly worth $2 million, because he can buy 100,000 shares at $20 each, then turn around and sell them for $4 million--double what they cost him. Investors should consider it a good sign when the exercise price at the date of grant is higher than the market value of the shares at that point, compensation experts say. The theory is that the higher the hurdle, the harder executives will run to clear it.

Other warning signs are when companies issue options at below-market prices, issue “mega-grants” of several hundred thousand or even 1 million shares at a time, or “reprice” options.

Why? Options issued at below-market prices indicate the board is not optimistic about the company’s chances for strong price appreciation, Minow says. And mega grants are bad because executives win regardless of whether the company performs well, experts note. If Jim Megabucks gets an option for 4 million shares, he will make $4 million even if XYZ’s shares appreciate only $1 over the next 10 years, says George B. Paulin, president of Frederic W. Cook & Co., a compensation consulting firm in Los Angeles. That’s not exactly performance worth paying extra for.

Another problematic pattern: Some companies reprice their options when the market drops. In other words, if XYZ’s shares fell to $10, the company might trade in Megabucks’ $20 options for an option to buy 100,000 shares at a $10 exercise price.

Companies that reprice grants say out-of-the-money options are a poor incentive, but shareholder activists contend that executives should not get a retroactive price break on shares when individual stockholders can’t get as good a deal. Such arrangements, they say, create a chasm rather than a link between the interests of outside stockholders and managers. And they may indicate that the company’s board is pessimistic about the firm’s chances of recovery--an ominous sign for shareholders.

“Any company that reprices options, sell fast,” Minow says. “This is a company that’s on its way down.”

Measuring Performance

The Securities and Exchange Commission requires companies to graphically illustrate how their stock has fared in relation to a market index and a group of their peers. Such graphs give shareholders the ability to quickly determine how well their company’s management has performed. This chart from Chevron Corp.’s latest proxy compares the oil company’s stock performance to the Standard & Poor’s 500 and a bundle of stocks representing its direct competitors.

Comparative Five-Year Total Returns

Chevron Corporation, S&P; 500, Peer Group (Performance results through 12/31/93)

1988:

CHV: $100.00

S&P; 500: $100.00

Peer Group: $100.00

1989:

CHV: $155.72

S&P; 500: $131.49

Peer Group: $133.91

1990:

CHV: $174.05