Mastering The Proxy Statement, Part III: Q&A

By The Sick Economist

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In parts I and II, we explored the meaning and relevance of the Proxy Statement, and separated the critical parts of the statement from the fluff.

Now, let’s determine exactly how to ask the right questions, and identify which items need scrutiny…

If You Don’t Ask the Right Questions……

In part II, I revealed that I might have been one of the only kids in America that actually learned something from watching GI Joe cartoons. Fortunately, I also had a lot of other positive influences in my youth, and one of them was my grandfather and even my great grandfather. Both were accomplished business people who had eventually found success in the rough and tumble world of 20th century small business. They taught me the following saying, “If you don’t ask the right question, you don’t get the right answer.”

If you read part one of this post, by now, you should know where to look to find some clean, simple, honest answers. But, answers to what? Data on a page doesn’t mean anything unless we know how to ask the relevant questions.

Again, this is the point where too many average investors get intimidated and give up. Formulating smart questions can be a lot tougher than you would imagine especially if you don’t have a lot of experience! But don’t worry. There are only a few core, “starter” questions that you should always be asking, every time. Once you get used to asking these basic core questions, the answers themselves will cause you to formulate organic, unique follow up questions, and the whole exercise will become as routine as brushing your teeth. With practice, you will learn how to tear apart a big, bad proxy statement in twenty minutes flat, and you will easily come to your own conclusions about what constitutes a smart investment.

The very first question I always want to answer is: “Who really owns this company?”

Ownership Means Control

The title means everything. The point of the exercise is not to calculate the often vast wealth of the company’s primary shareholders (although, you will be able to do that with this information.) Rather, the point is to figure out who really controls a massive, publicly traded corporation (if anyone). The most simple way to think about it is the following. Unless you happen to be very, very rich, your modest share purchase will entitle you to an economic stake in a publicly traded corporation. But it probably won’t entitle you to control that corporation. So, before you essentially become an economic partner in this business, wouldn’t you want to know who, exactly, you are partnering with? If you owned 33% of a dry cleaning business, you would want to know more about your other partners, right? Very same principle if you own .00033% of a much larger business.

You also want to understand the control dynamic before you join the venture. The vast majority of retail investors believe that the workings of a publicly traded company is quite straight forward. The CEO makes all management decisions, and the board of directors supervises him. Everybody votes on very key, “big picture” matters, and whoever gets the most votes, wins. Right?

Wrong. What I just described above is how it works, sometimes, but NOT all of the time. Remember when I said that, the three legal rules of a publicly traded corporation were simply, disclosure, disclosure, disclosure? Well, there are actually no legal rules about who controls corporations or how voting works. Those rules are actually set by the corporation itself. The only legal rule is: the corporation must disclose the voting arrangement and the control arrangements to the general public, and then each potential investor can decide for herself whether or not she finds the arrangement to be acceptable.

But what if I told you that the vast majority of investors have no idea what the actual voting arrangement is before they invest? Under the hundreds and hundreds of pages of disclosures, typically the only place where true ownership and control is disclosed is in the proxy statement, on that little table that lists the corporation’s major shareholders.

For example, did you know that Mark Zuckerberg, and Zuckerberg alone, controls the internet behemoth Meta? This is because Meta actually has two different classes of stock. One class of stock is for the general public, and carries no votes. But Zuck has a special class of ownership stock, reserved just for him, whereby he controls all major decisions at the company. The board of directors controls nothing. They could get together quarterly, and talk about the weather, or baseball. It doesn’t matter, former boy genius Mark Zucherberg runs Meta as an absolute dictatorship.

Most people have no idea that Zuck and Kim Jong Un have so much in common. They simply assume that, because Meta has all of the standard titles and features of publicly traded companies (a board of directors, a COO, lots of Vice Presidents) that voting functions like a standard publicly traded company. It doesn’t. And this information is clearly disclosed on page 62 of the 2022 Proxy Statement. This tiny disclosure makes this dictatorial arrangement fully legal. But if you don’t know where to look, and you don’t know what to ask, you wouldn’t know. Millions and millions of investors don’t know. But now, you do.

Some people find a dictatorial ownership and control arrangement to be just fine. After all, shareholders still have an economic interest in the company, they just don’t have a voting interest. After all, even non-voting Meta shareholders have enjoyed a shocking compounded annual growth rate of 21.2% per year over the last ten years, transforming a $1,000 investment into $7,000 in just ten years.

Under that set of circumstances, you might be perfectly happy to know that Zuck will always be the unchallenged captain of the Meta ship. But you should at least know. The more you know about your investment, the bigger advantage you will have over other investors.

The Meta example is an extreme example. The most common arrangement is just one class of shares for everybody, with one share equaling one vote. So, if the CEO owns 7% of the shares, he gets 7% of the votes. In this case, the CEO can be outvoted, and he can even be fired by the board of directors.

There is a huge variety of arrangements out there. For example, Ford corporation is effectively controlled by the Ford family, but that means dozens of different Ford family members have input, as do common shareholders. At the Walt Disney corporation, the Disney family are still shareholders, but they lost control of the company years ago, and now they don’t have much more influence than anyone else.

In the world of biotech, it’s shockingly common for top executives and managers to own little of the corporation and for “silent” investors to be the real “power behind the throne.” For example, the CEO may own as little as 1% of the company, but a hedge fund that backed the whole venture owns 20% of the company. Remember, when it comes to ownership and ultimate control of a publicly traded corporation, “anything goes,” as long as the arrangement is disclosed. And the only place where that disclosure really happens is in the proxy statement.

In the next part of the series, we will address everybody’s favorite topic……pay days! When you own shares in a publicly traded corporation, you are an owner in that business. The business’s C-Suite executives work for you, managing the company that you own. Wouldn’t you want to know exactly how your employees are paid? We will discover right where to look in part IV of this series.