More Advice on How to Read a Proxy

Editor's note: This is the second part of a two-part column. Click here to read part one, which appeared Tuesday on RealMoney.

We've already covered some of the basics of how to read a proxy, using media and entertainment giant Disney (DIS - commentary - Cramer's Take) as an example. Now we want to learn whether Disney is liberally bestowing options on its employees. If a company doles out an excessive number of options, then those options, when exercised, will dilute the existing share count.

Options Dilution Rate

Of course, management can buy shares in the open market to avoid dilution, but this use of cash means less money to invest in growth-producing initiatives like more efficient factories and research and development, or to pay down debt or boost the dividend. For me, a dilution rate of more than 4% to 5% a year is troubling, although circumstances vary from one company to the next.

To estimate Disney's dilution rate, we'll use Robert Iger's numbers because Michael Eisner wasn't granted any options in fiscal 2002. Iger was granted, or received, options on 1.75 million shares. Since this represents 3.38% of all options granted to employees, I estimate that Disney awarded options on 52 million shares.

This number doesn't tell us anything unless we know how many basic (not diluted) shares are outstanding. According to its latest 10-K filing, Disney had 2.04 billion shares outstanding. Dividing the options on 52 million shares by the 2.04 billion share count, the indicated dilution rate for fiscal 2002 was 2.5%. Disney doesn't have a dilution problem.

One other note. If Iger got 3% of the options awarded last year, that means all other employees below him received 97% of the options awarded. I like to see companies like Disney that distribute options throughout the ranks, rather than concentrate them in the hands of a few top dogs.

Corporate Governance

As mentioned in Part 1 of this two-part series, Michael Eisner is both chairman of the board and chief executive of Disney. To me, this is terrible corporate governance, as the board's job, among other things, is to hire and keep an eye on the CEO's progress. When the CEO and the board chairman are the same person, the board may be reluctant to talk turkey in meetings. (A recent article in The New York Times mentions that twice a year board members meet with director George Mitchell, the former U.S. senator from Maine, presiding. Eisner isn't at these meetings.)

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Hewitt Heiserman has been a financial analyst for 15 years and has worked for Fidelity Investments, Simplex Time Recorder, American Holdco and Breakaway Solutions. He is now writing a book on the Earnings Power Box, an analytical model he created to gauge the quality of a firm's profits. (The Earnings Power Box is a trademark of Hewitt Heiserman.) At the time of publication, Heiserman had no positions in any of the securities mentioned in this column, although positions may change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Heiserman appreciates your feedback and invites you to send it to [e-mail].