Target Corporation (TGT) recently reported respectable revenues and earnings despite a challenging retail environment and fierce competition. The company has been executing well on its initiatives and finding a way to compete in the online marketplace while leveraging its store base to grow revenues. Indeed, online revenue grew at an impressive 42% from the prior year period, marking an acceleration in the growth rate of online sales compared to the 36% growth posted for all of the prior year. In addition, online ordering with curbside or in-store pick up coupled with store-based fulfillment appears to be an increasingly popular option and effective strategy for competition.
It’s something of a shame, then, that so many of the company’s directors haven’t seen fit to benefit by these successes by investing their own funds into the company. Shareholders who recently received the company’s annual report and proxy statement will also note a less stellar performance on the part of the board. Specifically, the lack of direct share ownership in the company by a majority – a full two thirds – of the company’s non-executive officer directors.
Target is not, as we’ve noted before, alone in having directors with limited personal investment in the company beyond shares or equivalents received solely for serving as directors. However, Target’s board members take this lack of personal investment to an unusual level with eight of the twelve nominees having not invested a penny in the company’s stock. This is, in fact, a deterioration from the poor record of the board in the prior year when seven of the eleven nominees directly held no shares of the company’s common stock. In essence, even the smallest Target shareholder has invested more personal funds into the company’s shares than the majority – a supermajority – of the company’s board of directors.
Source: Target Proxy Statement (2019)
Interestingly, not only is this a worsening of the state of affairs from the prior year, but the company also changed its presentation of director share ownership for the current year to deemphasize the lack of direct investment by directors by moving the column providing this information from the first in the presentation to the last in the presentation, favoring instead restricted stock units which, notably, are not actual shares of the company’s common stock.
Source: Target Proxy Statement (2018)
It would be presumptuous to suggest that our repeated commentary to the board regarding the lack of share direct and personal share ownership on the part of the majority of directors contributed to the decision to change the presentation, but it’s nonetheless intriguing.
It’s also worth noting a couple of bizarre conditions which are the result of this situation. First, even though the directors with no direct ownership in the company’s shares are exposed to variation in value through their restricted stock units, these units are not actual shares. The majority of the company’s directors are therefore not actually shareholders of record and thus not eligible to vote at the company’s annual meeting. Second, as the company’s financial disclosures state, the restricted stock units held by directors are generally settled at the time a given director leaves the board, often in cash, resulting in a situation where a majority of the members of the company’s board of directors will never have actually held a single share of the company’s common stock at any point in their service. In each case, it’s not exactly the profile one would expect a corporation to present to its shareholders.
The lack of direct or indirect ownership of company shares purchased with personal funds, as noted earlier, is not an issue limited to the company. A lack of direct investment by board members can be identified at many other companies. In many cases, the shareholding disclosure in the proxy statement is structured in such a way that direct and indirect individual ownership is not specifically separated from ownership through stock grants and restricted stock units (as is the case with Target’s disclosure), thus obscuring the nature of ownership and requiring investors to go to the fine print notes associated with the tables to understand the true nature of share ownership.
However, the extent of the lack of direct investment at Target by its board members is striking, and it’s not simply an issue of directors new to the board. In fact, the majority of the eight nominees with no personal investment in the company have been board members since 2013 and one – Calvin Darden – has sat on the board for nearly 15 years.
Target does currently have stock ownership guidelines for directors (and executive officers), but in our experience these are only marginally meaningful. The current stock ownership requirement for directors is a fixed value of $500,000, but this level of ownership may be achieved over a period of five years after election to the board and, based on the compensation paid to directors, is conveniently significantly less than the roughly $1.4 million that a director will receive in fees and restricted stock units over the same five year period. The company therefore establishes a requirement – and then effectively fulfills that requirement over time out of company funds. The proposition for directors is relatively risk free with no initial commitment.
We find the structure of this arrangement, though not unusual in the corporate world, nonetheless concerning and especially so in light of the lack of direct stock ownership. A significant body of evidence – as well as common sense – supports the view that individuals (and board members) tend to react differently when making decisions when there is a personal investment (made with personal funds) versus an indirect investment developed through the granting of stock grants or stock options. The difference is similar to the psychological difference between risking personal funds or “house” funds. A lack of direct personal investment has the potential to result in decisions which don’t reflect the best interests of shareholders as the psychological alignment does not reflect the apparent financial alignment with common shareholders.
In addition, it begs the question exactly what message is sent to the public markets on the margin when the members of a company’s board of directors don’t see sufficient reason to invest directly in the shares of the company of which they are a director.
It’s difficult, of course, to assign a particular decision or fault to the lack of direct ownership of stock on the part of the board of directors. We’re also not suggesting that the board of directors has implicitly failed in its duties with respect to shareholders. Individual shareholders may have their own perspective on these issues.
Nonetheless, shareholders may be better served by including a minimum direct investment requirement before an individual may be nominated to the board of directors, such as a fixed threshold of $100,000 in company stock in addition to the $500,000 five year requirement, to ensure that individuals being nominated to the board have an actual, personal, tangible investment in the company however small relative to the scale of the company. A minimum investment threshold before an individual is eligible for nomination is not an unusual requirement. We’ve previously communicated these concerns to the company without receiving a satisfactory response.
We believe there is a compelling investment argument for Target despite the ongoing competitive challenges. We believe the company is making the right moves in several areas, especially with respect to its exclusive brands, to remain relevant and differentiated in the new retail landscape. We’re also not a subscriber to the conventional wisdom that physical retail is dead in the face of online competition. Indeed, we’ve argued that the growth of Amazon (AMZN) over the last several years isn’t unprecedented and, at least so far, actually rather closely tracks (and possibly underperforms) the retail market share capture achieved by Walmart (WMT) more than two decades earlier. Regardless, our view is that the company will remain profitable and, at the right price, represents a decent long-term investment.
However, from a governance perspective, we do believe that Target shareholders should be concerned about the lack of personal investment by those who purport to represent the interests of the company’s shareholders.
Disclosure: I am/we are long TGT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.