Abercrombie & Fitch Co. and the Gap, Inc

Corporate Governance & ESGCheng Qiao

IMGT 8619Nathalie Marin-Gest

March 7, 2012Dennis Petersen

Abercrombie & Fitch Co. and The Gap, Inc.

Abercrombie & Fitch Co. (ANF) and The Gap, Inc. (GPS) are two corporations, which both offer apparel, accessories and personal care products for men, women and children. Each corporation sells its products under multiple brand names and does so through its stores, websites, catalogues and direct-to-consumer operations in the US, as well as worldwide. ANF was originally founded in 1892 in New York City by David Abercrombie and Ezra Fitch. GPS was founded in 1969 by Donald and Doris Fisher in San Francisco. Both corporations have grown into huge apparel providers. Especially Gaphad exceptional growth in the 1990s due to a complete reinvention of the company’s product lines and stores. Currently, ANF has over 9,000 employees and GPS has over 135,000, so there is a size difference between the two companies, but we believe a comparison of the two companies is possible since they operate in the same way in the same market.

If we look at the financial performance of the two companies, we see a clear difference. We have listed some financial data and ratios of ANF and GPS in Exhibit 1. We look at market value related to the stock price and other relevant financial ratios during a three-year period (2008-2010). The stock price of GPS has been increasing, but it is important also to look at the amount of total outstanding shares. If we multiply these two numbers, we get the market capitalization. The market cap increased by $5 billion from 2008 to 2009 but decreased $1 billion in 2010. It makes sense that the stock price has been going up, because the financial ratios tell us that the company has been doing very well. They have managed to avoid being affected by the financial crisis in 2008. In the three-year period they have had increasing sales, income, net profit margin, earnings per share, ROA, and ROE, and that is considered really good.The picture is different when we look at ANF. The market cap of ANF has been increasing throughout the period, but their financial ratios are not as impressive as GPS. They have had a really bad financial year of 2009, and therefore it can seem odd that the market cap has continued to go up. Their assets and equity have been pretty constant, but in 2009 their sales went down, and their net income practically disappeared. The financial crisis can be the explanation. In 2010 they improved, and their sales were back to the level of 2008. However they were still doing worse than in 2008 since their cost had gone up, and the net income had decreased.

ANF – Board of directors

The company has a combined chairman and Chief Executive Officer (CEO) structure. The practice of having the same person as CEO and Chairman of the board is constantly disputed and partiality is always a main concern. Therefore together with the CEO and the board, the company also sets a position of a Lead Independent Director.The board adopts the staggered director institution. This means directors are divided into three classes and elected every third year. This is a common takeover defense that makes it difficult to acquire control immediately after obtaining share majority.Only non-associate directors receive compensation for services as directors. The compensation package includes an annual retainer (including an addition for each standing committee Chair and member) and an annual grant of restricted stock units, which the highest director compensation for fiscal 2010 was $245,836 (refer to Exhibits 2 & 3 for information on the compensation for Directors).The board has five standing committees and the average number of directors in each committee is four. Some of the directors hold multiple positions in different committees (refer to Exhibit 4).

ANF - Ownership

As of the end of 2011, Michael Jeffries owns 1,011,142 shares and is by far the largest major direct holder, which is expected due to his doubly high rank. The next highest major direct holder is Leslee K. Herro, the Executive Vice President of Planning and Allocation, who owns 38,127 shares. As of September 2011, the top institutional holder is FMR, LLC, with 13,149,942 shares, which is actually the top holder of ANF shares overall. Following FMR is Columbia Wanger Asset Management, LP, with 5,814,850 shares. The top mutual fund holder is Fidelity Low-Priced Stock Fund with 6,500,000 shares, with Columbia Acorn FD coming in second with 3,510,000 shares. See Exhibits 5, 6 & 7 for a list of the top shareholders.

ANF - Compensation

The overall objective of the executive compensation is to align executives’ goals with shareholders’ goals. Therefore they try to link the compensation to long-term returns. However they also have a short-term focus. The purpose of the short-term focus is to attract and retain talented executives. ANF’s executive compensation consists of four elements: Base salary, Annual Incentive Compensation Plan, Long-term Incentive Program, and benefits. One of the benefits is a retirement program or pension that secures payments to the executives the rest of their lives. ANF has an employment contract with their CEO. This means additional obligations to him, but he is valued very highly in the corporation. As a measure of severance the CEO would get $114 million in case of a change of control and a termination without a cause.

GPS – Board of directors

Mr. Glenn Murphy serves the combined role of chairman and CEO. In the same way as ANF one of the independent directors acts as the Lead Independent Director. The board met seven times during fiscal 2010 and the independent directors are typically scheduled to meet without the presence of management during each regularly board meeting. All directors are elected at the annual meeting to serve for one year. Then they need to be reelected to continue.In the compensation package, in addition to annual retainer and stock units, the company also provides meeting expense reimbursement and other benefits, such as deferred compensation plan and gift match program(see Exhibits 2 & 3). Among all the directors, the highest compensation is $266,289.The company has three standing committees and the average number of committee members is three. The committee members are all independent directors because of the company policy that employee directors are not eligible to serve on committees or as committee chairs(refer to Exhibit 4 for information on Board Committees for GPS).

GPS - Ownership

The Fisher family has held its roots in Gap from the beginning and continues to do so to this day. John Fisher is the top major direct holder with 16,421,658 shares. His mother, Doris Fisher, comes in second with 10,564,349 shares, and the other Fisher son, Robert, comes closely behind with 10,489,431 shares. The fourth largest major direct holder of GPS shares is Arthur Peck, the President of Gap North America Operations, with 181,576 shares. The top institutional holder for Gap is RBS Partners, LP, with 31,172,156 shares, which is actually the top holder of GPS shares overall. Following RBS is Hotchkis & Wiley Capital Management, LLC, with 21,272,700 shares. The top two mutual fund holders are T. Rowe Price Mid-Cap Value Fund with 5,529,000 shares and Thornburg Value Fund with 5,238,700 shares. GPS’ Class B common stock can be converted into shares of common stock on a share-for-share basis and the holders of this stock can have six votes per share on most matters and are entitled to a lower cash dividend. Refer to Exhibits 5, 6 & 7 for a list of the top shareholdersof GPS.

GPS - Compensation

GPS’ object of compensation is the same as it is for ANF. GPS’ executive compensation consists of three elements: (1) Base salary, which is based on peer-group data and the base salary of other executives; (2) Annual bonus, which is based on performance, mainly earnings performance, but also subjective objectives for all executives except the CEO;(3) The long-term compensation is stock based, typically in the form of stock options. A new incentive plan (LGP) focuses on multi-year performance. It means you have to achieve certain performance goals over 3 years. This incentive should motivate the executives to achieve corporate goals and secure long-term growth, especially because GPS does not offer any supplemental executive retirement plan, and severance is relatively conservative. The CEO would get $27 million in case of a change of control and a termination without a cause. Additional interesting factors about GPS’ compensation policy are that all compensations are reviewed annually, there are no employment contracts with any executives, they have a claw-back policy in case of intentional misconduct by executives, no tax gross-up payments, no re-priced stock options, and there is a stock ownership requirement.

Comparison

Regarding the board of directors, these two companies have many of the same features. They have the same board structure with a combined chairman and CEO structure, together with a Lead Independent Director. They both have the policy that employee directors do not have compensation serving as a director. They both only have one finance expert in the board, which seems not enough effective dealing with audit and finance issues. However, one important difference is that ANF adopts the staggered director institution that is regarded as an anti-takeover strategy while all the directors of the board of GPS are elected at the annual shareholders meeting. For ANF, Mr. Jeffries, the Chairman and CEO, also serves as a member in one of the board committees (The Executive Committee), while in Gap, employee directors are not eligible to serve on committees or as committee chairs. For GPS, it has many more benefit policies than ANF.About the oversight, both companies have three independent but interconnected links: internal auditors, the board/audit committee and the outside public accounting firm.

The ownership of both companies is comprised of direct, institutional and mutual fund holders, yet some differences set them apart. GPS’ founding family still holds strong roots in the company and is reflected well in direct ownership listings, which ultimately allows for strong foundations to remain. Abercrombie & Fitch’s founders on the other hand, have been out of the picture for decades. Regarding the institutional holders, Black Rock Institutional Trust Company holds over two million shares in both ANF & GPS, although it holds over 9 million shares in GPS. In terms of mutual fund holders, Vanguard Total Stock Market Index Fund owns over a million shares in both ANF & GPS, although it holds over4 million shares in GPS. Having mutual holders of shares in both companies demonstrates that these investors are interested in the industry in general, versus particular companies.

Regarding compensation the two companies have the same objects and almost the same structure, but there are differences. Compensation is more related to financial performance at GPS.As an example the CEO of GPS voluntarilylowered his base salary in 2009 because a tough year was expected. However it turned out to become a good year and he was awarded a special bonus that made up for the lower base salary. The long-term return factor of the compensation is much more evident in GPS. They offer no supplemental executive retirement program. Therefore the executives need their stocks and stocks option to be their long-term investment, and that aligns their goals with the shareholders’ goals. Another difference is that GPS has no employment contracts with any executives. Therefore they are no obligated to offer any continuous increasing salaries, bonuses or long-term incentives, and furthermore it makes it easier to replace the management if that is necessary. Regarding severance the golden parachute is 4.2 timesbigger at ANF than GPS.

Conclusion

We believe that GPS has superior governance. Based on the factors in the comparison above we see that GPS has an advantage in especially board and compensation. Furthermore their governance is related much better to their financial performance. Our result is in order with an independent assessment from ISS (see Exhibit 8). ISS also believes that GPS is superior, because ANF has some issues within compensation and shareholder rights. Issues with shareholder rights could be the takeover defense of a staggered board and a very strong CEO, who has a lot of rights because of his contract and a very strong position in the board.

Sources:

NASDAQ

SEC Company Filings

Wall Street Journal – Finance/Quotes

Yahoo! Finance

Exhibit 1:Financial Data and Ratios of ANF and GPS

Source: Yahoo Finance and company fillings with the SEC

Exhibit 2:Regular Director Compensation Package for ANF & GPS

Type of Compensation / ANF / GPS
Annual Retainer / 55,000 / 70,000
Additional Annual Retainer for Committee Chairs
Special: for Audit Committee
for Compensation and Development Committee / 25,000
40,000 / 10,000
20,000
20,000
Additional Annual Retainer for Committee members
Special: for Audit Committee / 12,500
25,000 / 0
Additional Annual Retainer for Lead Independent Director / 30,000 / 20,000
Fee per Board meeting / 2,000
Fee per regularly scheduled Committee meeting / 1,500
Annual stock / 120,000-300,000 / 125,000
Expense reimbursement and other benefits / N/A / Employee merchandise discount policy;
Deferred Compensation Plan;
Gift Match Program;
Board Service Program

Source: Yahoo Finance and company fillings with the SEC

Exhibit 3:Director Compensation for Fiscal 2010 for ANF & GPS

Company, Directors / Fees Earned orPaid inCash ($) / Stock Award ($) / Option Award ($) / Changein Pension Value ($) / AllOther Compensation ($) / Total ($)
ANF / James B. Bachmann / 107,500 / 117,608 / — / — / — / 225,108
Lauren J. Brisky / 105,000 / 117,608 / — / — / — / 222,608
Archie M. Griffin / 90,960 / 117,608 / — / — / — / 208,568
John W. Kessler / 92,500 / 117,608 / — / — / — / 210,108
Elizabeth M. Lee / 57,672 / 153,181 / — / — / — / 210,853
Edward F. Limato / 20,000 / 117,608 / — / — / — / 137,608
Robert A. Rosholt / 60,227 / — / — / — / — / 60,227
Craig R. Stapleton / 128,228 / 117,608 / — / — / — / 245,836
GPS / Adrian D. P. Bellamy / 105,000 / 124,992 / 0 / 21,547 / 14,750 / 266,289
Domenico De Sole / 77,500 / 124,992 / 0 / 0 / 15,000 / 217,492
Robert J. Fisher / 70,000 / 77,042 / 0 / 0 / 15,000 / 209,992
William S. Fisher / 70,000 / 124,992 / 0 / 0 / 15,000 / 162,042
Bob L. Martin / 115,000 / 124,992 / 0 / 0 / 10,000 / 249,992
Jorge P. Montoya / 88,500 / 124,992 / 0 / 0 / 6,500 / 219,992
MayoA.ShattuckIII / 106,500 / 124,992 / 0 / 0 / 15,000 / 246,492
Katherine Tsang / 39,000 / 124,997 / 0 / 0 / 0 / 163,997
Kneeland C. Youngblood / 82,000 / 124,992 / 0 / 0 / 0 / 206,992
James M. Schneider / 58,500 / 124,992 / 0 / 0 / 0 / 183,492

Source: Yahoo Finance and company fillings with the SEC

Exhibit 4:Board Committees for ANF & GPS

Company / Committee / Committee Members / Fiscal 2010 Meetings
ANF / Audit / 4 / 9
Compensation / 4 / 10
Nominating and Board Governance / 4 / 5
Corporate Social Responsibility / 4 / 3
Executive / 3 / 3 plus one action by written consent
GPS / Audit and Finance / 3 / 9
Compensation and management development / 3 / 6
Governance and Nominating / 4 / 3

Source: Yahoo Finance and company fillings with the SEC

Exhibit 5: Top Major Direct Holders for ANF & GPS

ANF
HOLDER / SHARES / REPORTED
Michael S. Jeffries / 1,011,142 / Dec 23, 2011
Leslee K. Herro / 38,127 / May 19, 2011
Edward F. Limato / 24,886 / Jul 6, 2010
Lauren J. Brisky / 20,492 / Jun 9, 2011
Diane Chang / 16,114 / May 26, 2011
GPS
HOLDER / SHARES / REPORTED
Doris F. Fisher / 10,564,349 / Jan 21, 2011
John J. Fisher / 16,421,658 / Mar 8, 2010
Robert J. Fisher / 10,489,431 / Sept 30, 2011
Arthur L. Peck / 181,576 / Aug 20, 2011
John T. Wyatt / 97,976 / Feb 3, 2012

Source: Yahoo Finance and company fillings with the SEC

Exhibit 6: Top Institutional Holders for ANF & GPS

ANF
HOLDER / SHARES / OUT (%) / VALUE ($) / REPORTED
Columbia Wanger
Asset Management, LP / 5,814,850 / 6.76 / 357,962,166 / Sep 30, 2011
The Vanguard Group, Inc / 4,631,242 / 5.39 / 285,099,257 / Sep 30, 2011
Winslow Capital Managmnt / 4,035,327 / 4.69 / 248,414,730 / Sep 30, 2011
Welington Management
Company, LLP / 3,661,787 / 4.26 / 225,419,607 / Sep 30, 2011
State Street Corporation / 3,123,215 / 3.64 / 192,819,155 / Sep 30, 2011
Rainier Investment Mngmt / 2,822,070 / 3.28 / 173,726,629 / Sep 30, 2011
Pennant Capital
Management, LLC / 2,767,800 / 3.22 / 170,385,768 / Sep 30, 2011
Bank of NY Mellon Corp. / 2,250,402 / 2.62 / 109,909,633 / Dec 31, 2011
BlackRock Institutional
Trust Company, NA / 2,162, 479 / 2.52 / 133,122,207 / Sep 30, 2011
FMR LLC / 13,149,942 / 15.30 / 809,510,429 / Sep 30, 2011
GPS
HOLDER / SHARES / OUT (%) / VALUE ($) / REPORTED
RBS Partners, LP / 31,172,156 / 6.38 / 578,243,493 / Dec 31, 2011
Hotchkis & Wiley Capital Management, LLC / 21,272,700 / 4.36 / 384,608,585 / Dec 31, 2011
The Vanguard Group, Inc / 14,373,768 / 2.94 / 266,633,396 / Dec 31, 2011
State Street Corporation / 13,820,303 / 2.83 / 256,366,620 / Dec 31, 2011
Thornburg Investment
Management, Inc / 10,616,648 / 2.17 / 196,938,820 / Dec 31, 2011
LSV Asset Management / 9,961,540 / 2.04 / 184,786,567 / Dec 31, 2011
BlackRock Institutional Trust Company, N.A. / 9,033,048 / 1.85 / 167,563,040 / Dec 31, 2011
RS Investment Management Co, LLC / 7,199,764 / 1.47 / 133,555,622 / Dec 31, 2011
T. Rowe Price Associates, Inc / 7,079,242 / 1.45 / 131,319,939 / Dec 31, 2011
JP Morgan Chase & Company / 5,991,838 / 1.23 / 111,148,594 / Dec 31, 2011

Source: Yahoo Finance and company fillings with the SEC

Exhibit 7: Top Mutual Fund Holders for ANF & GPS

ANF
HOLDER / SHARES / OUT (%) / VALUE ($) / REPORTED
Fidelity Low-Priced
Stock Fund / 6,500,000 / 7.56 / 483,600,000 / Oct 31, 2011
Columbia Acorn FD / 3,510,000 / 4.08 / 216,075,600 / Sep 30, 2011
Variable Insurance Products FD II-Contrafund Portfolio / 1,590,684 / 1.85 / 76,209,670 / Nov 30, 2011
Fidelity Growth
Company Fund / 1,585,000 / 1.84 / 75,937,350 / Nov 30, 2011
Mainstay Large Cap
Growth Fund / 1,390,700 / 1.62 / 66,628,437 / Nov 30, 2011
Fidelity Balanced Fund / 1,291,571 / 1.50 / 61,879,166 / Nov 30, 2011
Fidelity Series All
Sector Equity Fund / 1,145,968 / 1.33 / 54,903,326 / Nov 30, 2011
Vanguard Mid-Cap
Index Fund / 1,067,234 / 1.24 / 65,698,925 / Sep 30, 2011
Vanguard Total Stock
Market Index Fund / 1,016,878 / 1.18 / 62,599,009 / Sep 30, 2011
Columbia Acorn Select FD / 950,000 / 1.11 / 58,482,000 / Sep 30, 2011
GPS
HOLDER / SHARES / OUT (%) / VALUE ($) / REPORTED
T. Rowe Price Mid-Cap Value Fd / 5,529,000 / 1.13 / 102,562,950 / Dec 31, 2011
Thornburg Value Fund / 5,349,500 / 1.10 / 86,875,880 / Sep 30, 2011
American Beacon Large Cap
Value Fund / 5,238,700 / 1.07 / 97,177,885 / Dec 31, 2011
Vanguard Total Stock Market
Index Fund / 4,723,070 / 0.97 / 76,702,656 / Sep 30, 2011
Vanguard 500 Index Fund / 3,095,567 / 0.63 / 50,272,008 / Sep 30, 2011
JP Morgan Mid-Cap Value Fund / 2,860,760 / 0.59 / 53,067,098 / Dec 31, 2011
SPDR S&P 500 ETF Trust / 2,859,643 / 0.59 / 53,046,377 / Dec 31, 2011
Vanguard Institutional Index
Fund-Institutional Index Fd / 2,840,943 / 0.58 / 46,136,914 / Sep 30, 2011
Vanguard/ Winsor II / 2,638,600 / 0.54 / 49,869,540 / Oct 31, 2011
RS Investment Trust-Value Fund / 2,387,996 / 0.49 / 44,297,325 / Dec 31, 2011

Source: Yahoo Finance and company fillings with the SEC

Exhibit 8:ISS - Governance Risk Indicator (GRI®)– January 1, 2012

Source: Yahoo Finance

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