Are More Stock Options the Answer for Target's Woes?

I’m no expert on stock options or executive compensation. So maybe you should stop reading, and I should stop writing. But here I go anyway…Target Corporation’s latest executive pay plans were revealed yesterday in its proxy filing with the SEC.

The CEO didn’t get an incentive bonus. Makes sense…Target hasn’t been hitting its financial performance targets. Some other top executives received bonuses for strategic initiatives. I have no basis for doubting that these are valuable strategic initiatives, so this makes sense, too.

But I became more confused when the Star Tribune reported the following in today's paper:

Target's board decided to offer more stock options to executives to help keep pay levels up since the company's recently lowered growth targets for the coming year would likely mean financial and performance goals previously used to trigger bonuses won't be reached in coming years.

So…executives are given incentive pay in order to push their performance. And when those performance targets are not met, the natural consequence is to not receive rewards. Hopefully my personnel economics students can tell you that that’s a fundamental principle of incentives. But what Target’s board seems to have done is to add more stock options so that executives don’t miss out on payouts when the performance targets aren’t hit.

My first reaction was that this seems to be a confused understanding of incentives. It’s not really an incentive if there aren’t consequences for failure (alternatively, a lack of rewards for a lack of performance). So is executive compensation really just a game to give executives lots of pay, and the talk about incentives and performance is just a nice public relations spin?

I’m not sure. So I looked up Target’s proxy statement online. In that document, the compensation committee explained that Target has now committed over $8 billion in store and customer-experience investments. These are likely to reduce profitability in the short run, thus making long-term incentive performance targets unlikely to be achieved. So to make up for the presumed lack of long-term incentive plan payouts, additional price-vested stock options were granted.

The principle here seems to make more sense than I initially thought. Those investments are likely important, and it’s important that they be done well. But why not change the performance targets to reflect new realities? And more puzzling (to me, the admitted non-expert on executive pay), why the continued obsession with stock options? Wall St. is notoriously short-term focused. If these store investments are meant to have long-term payoffs, why magnify the linkage between compensation and stock options? And doesn’t this just further reinforce the incentive for executives to buy back shares rather than invest in the business? This latter phenomena is a major issue with our increasingly financialized world. 

Admittedly, designing effective incentive systems are harder in practice than in theory (that's why I teach the theory!). But new approaches beyond stock options seem to be needed.