How to understand and manage LTIPs from Comp & Ben perspective - Comp&Ben Talks #6

We are back with a new episode of Comp&Ben Talks! The three of us, Magda - Comp & Ben practitioner, Aneta Samkoff - Comp & Ben researcher, and I, Bartek - who has experience in implementing Comp & Ben, discussing Long Term Incentive Plans

In this episode, we would like to touch: ➡️ Why LTI is important? ➡️ Challenges related to LTIPs ➡️ How to achieve success in LTIPS?

If you wish to educate yourself on these topics, see other people's experiences and perspectives, this podcast is for you. Here you can find mentioned e-book about LTIPs in the beginning of the video.

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Transcription

Bartek Podolski: Hi, this is Bartek Podolski.

Aneta Samkoff: Here Aneta Samkoff is speaking…

Magdalena Tur: …and Magda Tur.

Bartek Podolski: Welcome to the Comp & Ben talks episode six. Today we are going to talk about long-term incentive plans (LTIPs). Why did we decide to talk about this topic today? Recently such incentives have become more and more popular in the compensation world. At the same time, LTIPs are pretty complex and complicated. Just recently we published an e-book that could be your guide or good source of knowledge about these pretty sophisticated issues. You can find it on our website so I strongly encourage you to download it, read it carefully, and let us know what you think about it.

I am happy that today Magda and Aneta are here with us because they both are experts in the Comp & Ben world. Together we can tackle the LTIPs topic from many different angles and different perspectives. Many of you already know Magda who is a Comp & Ben practitioner with many years of experience in the HR area. You may not know Aneta who is a Comp & Ben researcher. You also have me here. I have an experience in LTIPs software implementations and project management in the IT field. Summing up, we have the Comp & Ben practitioner, the researcher, and the IT guy.

Let’s start our podcast now. In the beginning let me ask a simple question: what is LTIP? Magda, would you like to tell us more about the long-term incentive plan?

Magdalena Tur: Hello everyone! The answer to your question is: LTIP is a bonus plan. However, we have to think about the elements that make this part of the remuneration package more specific. It is about the time frame. Long-term incentives refer to the period of time that lasts at least two years, sometimes three or five years are taken into consideration. If there is only one year or less, we would talk about the short-term incentive plan - it is the opposite instrument. Another distinguishing feature is KPI which is being set for this type of plan. In LTIP’s case, KPIs cover the entire organization, which means that there are no indicators for one manager or one department. KPIs are set in a very general way. They are strictly connected with the company’s strategy. Last but not least, financial instruments used for payouts are pretty specific for LTIPs. It is not only about cash - it is only one possibility of paying out, but also about shares and options (we will talk about it later in this podcast).

Aneta Samkoff: I would like to add a few words here. In general, you can think about LTIPs as incentives and bonuses that are being earned in the present and paid out in the future.

Bartek Podolski: At the beginning, I would like to touch on the performance criteria - KPIs - that were mentioned by Magda. You already explained that KPIs are not being set for a division but the whole company. Most of the time it may be attached to the share prices or the whole company's performance. Typically it is connected with the total investment return. It is something with a very strong connection with LTIPs, right?

Magdalena Tur: Yes, usually those financial KPIs are set on the strategic level. Sometimes I encounter KPIs related to CSR, meaning the social responsibility of the business.

Bartek Podolski: But how do you measure the value of social impact? Do you take the number of organizations that you support or is there another indicator?

Magdalena Tur: No, in this case, you take completed social projects into consideration.

Aneta Samkoff: May I ask you to give us any examples here. It sounds very interesting to me.

Magdalena Tur: It is about the cooperation with NGO organizations or a number of implementations of educational projects or about the amount of money given for social activities.

Bartek Podolski: It is something like a gate KPI - it is measured by the level of the project completion.

Magdalena Tur: Yes, it is assessed in the zero-one formula.

Bartek Podolski: As far as I know, LTIPs come in various types and forms. Sometimes they might be pretty complex. In our e-book, we presented a nice diagram prepared by Aneta which explains everything.

If you want to learn more about different LTIPs, you can download the whole ebook. It is available HERE.

As it is presented in the diagram, we have a couple of LTIPs types. We divided them into four major categories: profit sharing, cash-based, stock-based, and phantom stocks. The interesting thing is that the phantom stocks are a combination of cash-based and stock-based LTIPs. Typically they track the performance of shares but they are not turning to shares. In reality, the company does not have to buy them, but only delivers cash after calculating their value.

Aneta Samkoff: However, it actually is a little bit more complicated because you may have the full value vehicles or the ones that track only the appreciation.

Bartek Podolski: I just wanted to mention that there are many types of phantom stocks: there are for example restricted equity awards, there are options, performance units, appreciation-only vehicles. To sum up, there are many different forms and there is a huge variety of payout: some of them are even treated as dividends which makes them more complicated from the technical point of view. When you have dividend-based stock which is a phantom share, all the calculations are pretty complex. First, you have to calculate the dividends and then you need to add stocks and then turn them into phantom stocks. All calculations must be repeated every year. From the implementation perspective, it is quite a complicated process.

Aneta Samkoff: We also have to remember that there are different voting rights, different tax contributions… Indeed, it can get really complicated.

Bartek Podolski: My experience from the implementation point of view says that the most popular LTIPs are phantom stocks. Companies do not necessarily have to buy them. Sometimes they only truck their prices. If companies decide to buy them, the transaction is being made on the settlement date. It means that they do not have to buy them upfront but at the end of the maturity period. Later it is possible to deliver them either in stocks or in cash. What is more, there are some countries where you cannot deliver stocks, right?

Aneta Samkoff: This is a fair point. What is more, it all depends on the vision and strategy of the company. For example, if you do not want to dilute the ownership of the LTIPs, you would rather offer cash-based or phantom stocks incentives. It might be a good solution for small businesses and family-owned companies. If we are talking about startups and enterprises, stock ownerships are given more often. Magda, what is your experience on this topic?

Magdalena Tur: I agree with you. You explained very well how it works.

Bartek Podolski: We already talked about the types of LTIPs. We mentioned four types of them: stock-based, cash-based, phantom stocks, and profit shares. Now, I would like to ask another important question: why are LTIPs important? In your opinion, why do companies use LTIPs at all?

Aneta Samkoff: I would say that the main reason for having LTIPs is aligning the shareholders' and executives' interests. Both parties should have the same long-term vision which must beneficial for all the owners. The second reason is to lower the retention of employees.

Bartek Podolski: I see the same reasons. The first thing that comes to my mind is the retention of people in the company. LTIPs may lower the willingness to leave the company.

Aneta Samkoff: In my opinion, the key is to have the same long-term vision of the company that must be shared by shareholders and executives. The other option may be a buyout but it gives a person a gate to leave. However, the long-term vision and performance goals defined by the strategy can be a good incentive for executives to stay in a company. It is important to remember that people mostly focus on the short-term perspective and day-to-day experiences, therefore LTIs can motivate people to think about the long-term perspective not only by employees and executives but also by shareholders and owners.

Bartek Podolski: When I was reading the materials, about LTIPs, I found a pretty old lecture prepared by professor Russell Ackoff who was an organizational and system theorist, As he was a pioneer in the field of operations research, systems thinking, and management science, he was well-known in the field that we are talking about. Unfortunately, he died in 2009 when he was 89 years old. In the lecture that I found, he gave examples regarding interests that management and executives may have and how different they can be from the interests of shareholders and owners. Both sides have different perspectives and LTIPs may become tools to increase motivation. They can be used to attract the company and make sure that the key people of the company feel appreciated and attached to the business.

Aneta Samkoff: Indeed, I feel it is a great way to motivate people in a certain way.

Bartek Podolski: We already mentioned risk management and I think that is also something that we should connect with the LTIPs topic. Magda, you once said that LTIPs are: “short-term controlling of long-term goals”. Could you please tell us a little bit more about what you had in mind while saying about the short-term actions and long-term goals?

Magdalena Tur: It came from my experience. I fully agree that the alignment of the vision is the main purpose of introducing LTIPs to the company. However, we also need to remember about risk management. Setting up short-term goals we usually focus on the company’s growth and development. Somehow we should discourage the top management from making risky decisions that could enable them to achieve short-term goals which will not be good from the bigger perspective. They should have a broader point of view, think about the whole company, and think about the organization’s place in a couple of years. Therefore, long-term incentive plans should control short-term actions and mitigate all the risks.

Bartek Podolski: By short-term incentives, you mean something like hiring 50 more sales representatives, right? If I remember correctly, in 2008 there was a case about encouraging people to sell more mortgages. Such a solution might have worked for one or two years, but in the five-year perspective, it wasn’t the best solution for the company, especially from a social responsibility point of view.

Magdalena Tur: In this case, the financial goal has also not been met in the long-term perspective.

Bartek Podolski: I have an experience here because I was a customer of the Wells Fargo Bank. Apparently, at some point in their existence, they had a target of setting up as many accounts for people as possible. They created an account for me and I was not aware of it. I learned about the situation when they sent me an email with apologies for setting an account on my behalf. The core issue of this situation was about the sales plan, which was set up in a too easy way and enabled achieving the short-term goal and KPIs. As a result, they opened random accounts to random people who were not interested in it.

Magdalena Tur: Unbelievable! It is the perfect case of a situation when you push people too much on achieving short-term goals.

Aneta Samkoff: But from a longer perspective it did not harm the brand that much. Actually, at the end of 2008 Wells Fargo acquired Wachovia, one of the largest diversified financial services companies in the United States.

Bartek Podolski: There was even a situation where they told me what I should do if I want to sue them. I can’t imagine doing that from Poland but it is a good example of the wrong Comp & Ben behavior.

Magdalena Tur: It is an example of a situation when you motivate too much in a short term. It requires broader thinking. As far as I know, in the financial market, it is obligatory to have a mix of bonus plans, including short-term and long-term. It was changed after the crisis in 2008.

Bartek Podolski: From the implementation perspective, I even encourage introducing a deferred matrix. When the bonus is greater than the threshold, you are obliged to defer it by default. With this solution, your short-term incentives change into long-term incentives that can be paid out after reaching the threshold.

Magdalena Tur: It is also connected with psychology and I think it works well. It is just a mechanism that motivates people more. Therefore, it is good practice to set goals and encourage people to achieve them.

Aneta Samkoff: In addition, I think that the key is to understand that LTIPs are the largest part of the executives' compensation. These incentives motivate them more than short-term LPIs or salaries. LTIs may reach up to 60% of the total compensation and it has the biggest influence on the behavior of key people in the company. What is also interesting is that the level of LPIs differs from sector to sector.

Bartek Podolski: For example, LTIPs in the financial sector will be different from the healthcare environment. What is also interesting and not available for everyone from the very beginning is the fact that at some point LTIPs may overlap. If you created a five-year plan, the next year you may build up another one based on the first plan. As a result, in five years, your initial plan becomes the major one, but other plans overlap and you simply receive more money.

Aneta Samkoff: It is a snowball effect.

Bartek Podolski: Indeed. And after a certain period of time, you receive benefits from many different LTIPs, which were set up over the years. But tracking all plans is a quite complicated case. Measuring one plan is really simple and you can do it in Excel. But if there are more plans which overlap, it becomes more and more difficult, especially if you want to measure the performance as well.

Aneta Samkoff: They also differ from employee to employee. If you have a lot of employees and many versions of the plan, many LTIPs forms, and a few different currencies, you have a pretty hard task to keep everything under control.

Bartek Podolski: When you actually want to calculate the value of LTIPs, you might just count the average price of the share in a specific period of time. But then you have to define the period of time and set up frames for calculations.

Aneta Samkoff: I think it is a super complicated task that is almost untrackable.

Bartek Podolski: Welcome to my world!

Magdalena Tur: It is trackable. I remember a situation when I had to truck three plans and each of them was delivered in another financial instrument: options, shares, and long-term cash.

Aneta Samkoff: Was it tracked in the Excel file?

Magdalena Tur: Not only in Excel, however, it may also work in Excel. But in this case, we had software that was specialized in supporting Comp & Ben processes.

Aneta Samkoff: I think specialized software is needed for such operations. I can only imagine how many mistakes there are in Excel sheets.

[20:56]

Bartek Podolski: I think we can speak a lot about the technical aspects of the LTIPs calculations. But today I do not want to focus too much on that. I guess we will record another podcast about it.

Aneta Samkoff: We should also add some psychological aspects to it.

Bartek Podolski: Yes, but if you do not mind, I would jump to the second point regarding LTIPs. I would love to talk about challenges. When I was preparing myself for this topic, I came up with two types of challenges. The first group is about the effort and effect challenges that are related to the psychology of LTIPs. The second group of challenges is about technical aspects that we already mentioned, meaning, calculations of many different variations. Let’s now focus on the psychological aspects related to effort and effects. In the literature, you may find a lot of materials about this topic especially because there is no linear proportion between the amount of prepared LTIPs and the final results of the work performed.

Aneta Samkoff: I would say that there are two points here. The first one is about the feeling of getting discounts which are attached to any rewards given in the future.

Bartek Podolski: I have one quote here, which says: “LTIPs are an amount of money with a very high discount attached”. What does it mean?

Aneta Samkoff: It means that in general human beings prefer getting things now. If we receive an award offered to us right now and the same award offered to us in five years, we will choose the first option. We are not able to think that we can get 1 mln dollars now and 1 mln dollars in the future. We rather think that for sure, we receive money today and maybe it will be given later but at that point, it will not be 1 mln dollars but something worth around 500,000 dollars. We make discounts. We have this tendency to depreciate the value of money even in situations when the real value of money in five years may increase.

The second point touches on the issue of proportion. It means that at some point awards are so large that they do not make a big difference in life. There is an effort and pay curve, which is a sinusoid. In the beginning, we can see that the more effort you put in the more money is paid. But when you reach a certain point where awards are really high, the curve flattens. It doesn't matter anymore how much money you offer. It can be either 1 million or 10 million or 100 million dollars, but the effort will not increase proportionally.

Bartek Podolski: And then we have a situation when executives compare themselves to each other…

Aneta Samkoff: But the fact that they compare each other is pretty important. Actually, they would prefer to earn less in absolute value but they will not be able to accept it if they earn less than their friends from another company.

Bartek Podolski: In the final comparison they need to feel and look good.

Aneta Samkoff: Exactly. For example, if a friend in another company earns 100,000 dollars and I earn only 80,000 dollars, I will not be happy. I will have an issue with that. But when I force myself to look wider into the average wages in society I would stop worrying about my salary.

Bartek Podolski: I think we can conclude that human beings are pretty complex…

Aneta Samkoff: We are just people who like to compete sometimes.

[25:25]

Bartek Podolski: Now I would like to talk a little bit more about the first point that was mentioned during the conversation. It was about the nonlinear effect and the correlation between effort and money. It was already said that at the beginning the amount of money paid for certain efforts matters but later on, it does not make any difference how much money we receive for the effort that we made.

Aneta Samkoff: Indeed, at the beginning the correlation between the effort and payment is exponential. When we earn a small amount of money the effort curve rises pretty intensely. At some point, it hits the middle point where everything is linear and then it flattens.

Bartek Podolski: It was also already mentioned that people prefer now over the future

Aneta Samkoff: Yes, we already explained the discount phenomenon that is related with  it…

Bartek Podolski: I think we can also find the explanation for why we have interest rates and other saving instruments. People prefer to have everything now rather than wait for it in the future. They do not care so much about what will happen in the next few years…

Magda, do you have any comments regarding this topic?

Magdalena Tur: I am a psychologist and I fully agree with your statements. What you said about people is all true. And the most important thing is to have everything balanced correctly. It is all about finding the right amount of effort, time used for planning, and actions that make you feel appreciated.

Aneta Samkoff: Do you know how companies verify all these things? Do they interview employees privately or do they have some kind of a system or specific research methods for it?

Bartek Podolski: Or maybe companies just pick something out of their beliefs? The general question is about the psychological process that helps in keeping everything well-balanced.

Magdalena Tur: I have never set up such a process from scratch. But there are external advisory companies that take part in such processes. However, for such actions market research is the key. Very important is also a comparison with peer companies.

Bartek Podolski: While setting up LTIP most probably you will involve a third party. Sometimes you may involve companies from the big four who will set up your plans or just tell you how to do it. Then you need to set them up which means that you need to have either Excel or LTIP software that will track everything and calculate and pay automatically. You also need an institution that will help you in shares management, that will tell you some information about shares and how much you should buy. Then you also need somebody who will handle the payroll because it is very hard to be on track with every payment in every country. As every country is different, it is better to ask an accountant to calculate all taxes needed to be paid in countries per person.

Aneta Samkoff: I think taxes are the next topic that we should talk about.

Bartek Podolski: I prefer to speak about the technical aspects next time. We can even combine it somehow and talk not only about taxes but also about technical issues. Coming back to the topic of our today's conversation, I think we should wrap it up. We have already discussed the topic for some time and in the next episode, we can tackle the technical aspects of it.

Aneta Samkoff: We can still talk about challenges because there are more of them.

Bartek Podolski: Ok, let’s leave it for the next time. Now, let me summarize what we covered today. We spoke about LTIPs and other types of bonuses in the Comp & Ben world. We explained stock, stock-based, cash-based, and phantom shares. We talked a little bit about the psychology of challenges and benefits related to the LTIPs.

Aneta Samkoff: We talked about rationales for why LTIPs should be implemented in a company. The scientific research during which executives were interviewed really claims that LTIPs are good tools that do good work and are becoming more and more popular.

Bartek Podolski: I rarely see private companies which do things without any sense.

Aneta Samkoff: More and more companies are adopting plans. It comes from the enterprise level, but now LTIPs are in the mid-size businesses, emerging companies, family-owned businesses, and startups.

Bartek Podolski: LTIPs are even introduced in Poland, which is a good thing for us… Magda, is there anything you want to add today?

Magdalena Tur: I think we are good with this topic. At least, for now. We will probably continue it next week or so.

Aneta Samkoff: Thank you for the conversation. It was a pleasure to have you here, Magda.

Magdalena Tur: Thank you very much.

Bartek Podolski: Thank you, everyone! If you want to have any materials that we talked about during this episode, do not worry - we will attach them. I would recommend you to check our e-book that is available on our website. I think it is worth reading and feel free to comment on it.

Aneta Samkoff: Do not be afraid to reach out to us. Thank you so much!