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With proxy season approaching, this is a good time to highlight the key items to look for in this important filing. If you've never looked at a proxy before, this document is the official notification to stockholders of matters to be brought to a vote at the annual meeting. But it also contains a trove of other data that you won't always find in the annual report, or 10-K.
For example, the proxy will tell you about the board of directors' background, any relationships the company or its officers may have with customers, executive compensation (including stock options) and how much the independent auditor gets paid for consulting services.
To illustrate, we'll look at
most recent proxy (formally called the DEF14A), which was filed with the
Securities and Exchange Commission
on Jan. 28. A review of Disney's proxy is topical for several reasons. The company's 2003 annual meeting is being held tomorrow in Denver.
Also, according to a recent story in
The New York Times
, Michael Eisner, Disney's longtime chairman of the board and chief executive, recently fended off a boardroom coup by another board member. At the same time, there's room for improvement at the ABC network, Disney's
movies were flops, and the company is haggling with some of its creative partners. Then there's the stock, which has been the second-worst performer of the 30
Dow Jones Industrial Average
components for the last five years.
Little to Celebrate
Let's start with the board, where I want to know what percentage of directors are "independent." In theory, independent directors are more apt to speak freely, whereas company employees who also sit on the board may be afraid to tell the chief executive that his or her pet project is a bad idea. After the board meeting, Disney will have three board members who are company employees: Michael Eisner, Roy Disney (Walt's nephew and head of animation) and Robert Iger, the company's president and chief operating officer. Thus, it appears that 10 of the 13 directors are independent. So far, so good.
Another plus is that all of Disney's board members must stand for re-election every year. This is an improvement over the past, when Disney used to stagger its elections, which potentially insulates the company from angry investors who might want to toss out all the directors.
Next, let's look at the committees that set pay for executives and oversee the audits. They should be composed solely of nonemployee board members to avoid any conflict of interest. In Disney's case, none of the board members who sit on the audit or compensation committees are employees. This, too, is a plus.
One area of concern is that four directors have little direct ownership in the company. John Bryson, a director since 2000, owns 1,500 shares beneficially; Monica Lozano, a director since 2000, owns 1,000 shares; Gary Wilson, a director since 1985, owns 3,000 shares; and Father Leo O'Donovan, a director since 1996, doesn't own any stock. (It's possible that the reason O'Donovan, president emeritus of Georgetown University and a member of the Society of Jesus, doesn't own any stock is for religious reasons. Disney didn't return my call seeking comment on the matter.)
Although each of these directors are able to buy more shares by exercising stock options, and each is also entitled to receive additional stock units of varying amounts after they leave the board, these shares weren't paid outright. In other words, what concerns me is that for one-third of the board, most of the stock was given to them. I much prefer to see directors who buy stock out of their own pocket, because directors who have lots of "skin in the game" are more apt to get involved in the business and challenge senior management.
On page 9 of the proxy under the heading "Certain Relationships and Related Transactions," we find that many directors or their family members are employed by, or do business with, Disney.
Jennifer Gold, a daughter of director Stanley Gold, was paid $95,000 as a marketing manager.
Director Ray Watson's son, David Watson, got $176,000 in salary and bonus.
Director John Bryson's wife was paid $386,000 for a company in which Disney has 50% equity interest.
Director and vice chairman Roy Disney was paid $624,000 as reimbursement for business travel through Air Shamrock. Air Shramrock is owned by Shamrock Holdings, of which Roy is sole owner. Director Stanley Gold is a director of Air Shamrock.
Robert Iger's father-in-law received $70,000 for services provided during fiscal 2002.
In fiscal 2002, director George Mitchell's law firm, of which he was chairman, received $443,000 in fees for legal and regulatory services. (Disney isn't retaining Mitchell's firm for any further services.)
Outgoing director Robert Stern was paid $45,000 in fees and expenses for architectural services during fiscal 2002 and another $60,000 in fees and expenses from Euro Disney.
To see seven of the 13 directors have some sort of business dealing with Disney really turns me off. Among other things, it makes me wonder how independent some of these directors really are. If I owned Disney's stock, I'd want all these related transactions to come to an end immediately.
Another item in the proxy to look for are the proposals that stockholders have brought before the board. On this year's docket, for example, stockholders are being asked to vote on issues concerning labor standards in China, theme park safety, executive compensation review and stock options. How the board asks stockholders to vote can yield valuable clues about whether management deserves your support.
While these are all important issues, the one that interests me the most is a proposal by stockholder Michele McGeoy. McGeoy has asked the board to publish a report that, among other things, considers whether stockholder value would be enhanced if Disney established a policy limiting the concentration of stock options among executive officers, whether the granting of stock options should be tied to Disney outperforming its peer group, whether executive pay should be frozen during a period of layoffs, and whether there should be a maximum ratio between the highest paid executive officer and the lowest employee.
"Disney's executive compensation policies have failed to deliver their promise of enhanced shareholder returns, McGeoy's proposal states. Further, "While executives have become rich, shareholders have suffered mediocre returns over the last six years, and thousands of loyal Disney employees have lost their jobs to layoffs. It is time for the company to try a different approach."
I think this proposal makes a lot of sense. Unfortunately, the board recommends a vote "against" because these objectives can't be made "through unduly rigid approaches to compensation decisions." This is a red flag, in my book.
Now, lets look at how much PricewaterhouseCoopers, Disney's independent auditor, makes in fees and consulting services. If PwC makes a lot more money by providing consulting services than doing audit work, that may be a conflict of interest that could cause it to pull its punches (as Andersen may have done with
) if it sees something wrong.
In 2002, Disney paid PwC $51.2 million in fees, which include $10.5 million for audit work, $23.3 million in financial information design fees, and $27.4 million in other consulting work. I'd much prefer to see some other firm handle the design and other consulting work. Notably, in January 2002, Disney said it would stop using its independent auditor to also do consulting work.
One other change I'd make here is for Disney to rotate its auditors every five years. PricewaterhouseCoopers has been Disney's auditor since 1938.
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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