Why a New Employment Agreement for Abercrombie & Fitch CEO Michael Jeffries Won't Fix Anything

As has been widely reported, hedge fund Engaged Capital wrote to Abercrombie & Fitch (NYSE: ANF  ) a few days ago indicating that there was no succession plan for the CEO at the company – true – that current CEO Michael Jeffries' leadership was inadequate for the recovery needed by the company – probably true – and that a leveraged buyout of the company might be the best option – not sure.

The company's response? Typically, Abercrombie's response would have been to completely ignore the hedge fund and carry on regardless. In contrast, it released yesterday a rewritten employment agreement with Michael Jeffries.

Now, while the timing of the two events might be more than coincidental, it is hardly likely that a new employment agreement for Jeffries could have have been produced in just a few days. No, this new employment agreement is a result of the company having spectacularly lost its Say on Pay vote in each of the last two years. In other words, a large majority of Abercrombie's shareholders think the company's executive pay plans are rotten and want them changed, and this is the company's response.

What's changed?

And how will the new pay plan be different from the previous pay arrangements? Well, changing CEO pay at Abercrombie & Fitch at any point now is rather like closing the stable door after the horse has bolted. The damage has already been done.

Back in 2010, the board decided to buy out Jeffries' unlimited personal use of company aircraft for $4 million, plus $200,000 per year of "limited" use. Given the costs associated with Jeffries' typical flying patterns prior to this, this will not save the company any money at all, but it has prevented the disclosure of aircraft costs at horrendous levels, which was an annual occurrence at the company.

In addition, Jeffries had last renegotiated his employment agreement in 2008 and this one purported to "secure his services" in the event of his leaving the company to work elsewhere. That such a move was extremely unlikely given Jeffries' position as "effectively the 'founder' of the modern day Abercrombie & Fitch due to his unique role and contributions during his more than 20-year tenure" seems not to have occurred to the board at the time.

As a consequence of this pressing need to retain Jeffries, the company awarded him 4 million stock appreciation rights (SARs). SARs act like stock options, except that shares do not change hands. Profits arise if the share price rises above the strike price, and those profits are usually delivered in cash.

Given the company's stock price performance recently, some of these SARs might turn out to be worthless, but, regardless, given the number of SARs already held by Mr. Jeffries, the notion that he needed more to persuade him to stay was nonsense.

The performance question

So what's new? The most significant change is that "the vesting of at least 60% of the target value of the executive's annual equity award shall be subject to performance criteria." This is not that much of a change at all, actually.

Prior equity grants were based on performance at grant, and Abercrombie's performance has been so dismal that in the past few years, often Jeffries has not received a grant at all. This change would appear to be one way around that problem, ensuring that he at least gets a grant.

Unfortunately, the statement that performance conditions will have to be met before any of the shares vest with Jeffries does not inspire confidence. Performance conditions at Abercrombie are not known for their difficulty. Take the spring 2010 operating income target. That was set at $0, for which it was possible to earn a bonus of 63% of target. The target was met, Abercrombie did make operating income of at least nothing, and bonuses were paid out. Now you know why my confidence is not inspired.

So what's wrong with Abercrombie's performance? Aren't all teen clothing retailers suffering? In this, as in many other things, I will bow to the superior market knowledge of my 15-year-old daughter. She of the "no one shops at Abercrombie & Fitch now, Dad" comment.

So where does she shop now? Wet Seal (NASDAQ: WTSL  ) and Urban Outfitter (NASDAQ: URBN  ) . The performance of these two companies over the past 12 months has hardly been brilliant, but it has, nevertheless, been a lot better than Abercrombie's. So the complaints of all shareholders, not just Engaged Capital, are worth listening to.

And the issue raised by Engaged that this employment agreement does not put to rest? There is no successor to Jeffries for the position of CEO.

Except for 2012, when performance was particularly disastrous, Jeffries is typically paid around 12 times as much as any other officer at the company, and succession planning problems are typically bleak when this differential is more than three times. Clearly, the board doesn't think it has a successor either. If I were a shareholder, that problem would worry me and tinkering with CEO pay is not going to solve it.

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