Proxy Statements: What They Are and Why You Should Read Them

In general, it's good to see that a board member's interest in the company goes beyond compensation. It's one thing to collect $300,000 in annual compensation for serving on a corporate board. It's another thing all together to collect $300,000 in fees but have $50 million riding on the company's stock. Outside investors typically make for better board members, since they're most interested in improving the performance of the business and its stock price, not collecting another year's worth of director fees.

3.Executive compensation

If you read nothing else, read this part of a proxy statement. It is human nature to make decisions that maximize your compensation, and corporate managers are no exception. The best companies will plainly disclose the inputs that go into executive pay.

One of my favorite anecdotes about compensation comes from Hertz , the rental car company. Hertz was a subsidiary of Ford Motor , before a private-equity buyout of the company in 2005. Before the buyout, compensation was closely tied to Hertz's market share in the rental car market.

With financial incentives to seek market share at all costs, Hertz opened a bevy of unprofitable offices. Its managers also allowed costs to balloon in its European operations. Surprised? You shouldn't be. If your compensation is tied to your firm's share of the market, you don't have any reason to think about cutting costs or shuttering money-losing stores. More stores and more sales is always good from your point of view.

Not surprisingly, one of the first steps to improving Hertz's performance was replacing its managers' compensation structure. Cash flow and profitability became the main determinants of its managers' bonuses. Under new ownership, Hertz closed unprofitable stores, market share took a backseat to profits, and operations were streamlined to cut costs. Hertz would become tremendously profitable, generating a 30% compounded return over 7 years for its new owners.

With the right incentives in place, corporate managers will break their backs to deliver outstanding returns for investors. The wrong incentives, however, encourage the destruction of shareholder wealth for the benefit of the management team. To borrow a popular phrase among economists, "incentives matter."

Make the proxy statements a key part of your process

We all have a different investment process, but I'm certain that every investor could improve their performance by reading the proxy filings for every company they invest in.

The proxy filings lay the groundwork for understanding how a company's management team thinks, what metrics are important for the business, and whether or not the company is managed by insiders who have a vested interest in the success of its shareholders. These are vital pieces of information that no investor should go without.

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The article Proxy Statements: What They Are and Why You Should Read Them originally appeared on

Jordan Wathen has no position in any stocks mentioned. The Motley Fool recommends Boston Beer and Ford. The Motley Fool owns shares of Boston Beer, Ford, and Hertz Global Holdings. Try any of our Foolish newsletter services free for 30 days . We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy .

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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