02. Why should your company offer long-term incentive plans?

Long-term incentive plans have long been important elements of executive compensation in both private and public companies across all sectors. Private companies, in particular, have been instrumental in furthering their spread and adoption. The aforementioned WorldatWork survey shows an increase of almost 90% in LTIPs adoption between 2007 and 2019.

Moreover, at this point, LTI plans are not just offered by the large publicly traded companies, but more and more family-owned businesses, start-ups, and smaller firms adopt them as a significant part of their compensation packages.

So, why are the long-term incentive plans becoming increasingly popular?

There are 5 main purposes behind LTIP implementation and benefits they are believed to provide:

1. Align executive and shareholder interests

LTI plans encourage key employees to achieve or exceed the company’s strategic goals that will maximize shareholder value, promote long-term growth, and increase the share price. Since LTIs are variable pay plans based on performance, the performance criteria can be easily aligned with the specific goals your company wants to achieve. Whether you are focused on maximizing growth and increase in share price typical for venture-backed firms, start-ups, etc., or consistent and steady development with low employee rotation preferred by the family-owned businesses, selecting the right mix of LTIP types can promote each.

The proper blend of cash, stock, or profit share may incentivize the employee to take actions aligned with the vision and intention of the shareholders. The payouts spread in time, after the initial vesting period, promote among the key employees the long-term thinking and planning that ultimately benefits the whole enterprise at the same time reducing the possibility of conflict between the executives and shareholders. When key employees become shareholders themselves, they are motivated to increase company value as the performance of the shares directly affects their own compensation.

2. Attract, retain and motivate top talent

One of the key benefits of a long-term incentive plan from the perspective of the employer is the multi-year vesting period that requires LTIP recipients to stay with the company throughout the duration of the award. Employees that decide to leave or are terminated during that time often lose their award, promoting long-term retention and low rotation for the positions that are crucial to the growth of your company, typically including the C-suite, high-potential employees, and merge and aquisition people. Most LTI plans vest over a period of 3 to 5 years before achieving the full reward value, and the award typically cannot be earned all at once.

A well-designed LTIP will attract and keep top executive talent, motivating these key figures to focus on the long-term performance of your company. LTIs can also engender loyalty and a sense of ownership amidst the rank and file employees. Having a long-term stake in the company gives employees a reason to focus on the longstanding success of your organization, creates better employee engagement, stronger leadership behaviors, and greater personal and organizational growth. Such long-term commitment of the key employees also promotes a positive company culture.

During the current period of economic uncertainty, the fate of many enterprises depends on the ability to attract, retain, and motivate key talent. A well-designed LTI plan will help you achieve that goal.

3. Focus on long-term vision and key performance criteria

In the current economic climate, it is critical to make sure your employees focus on achieving the pre-set long-term goals that will, in turn, build your company’s success. A well-designed LTIP can change mindsets that may otherwise lead to short-term outlooks and poor decision-making. One of the pioneers of system thinking and management science from UPenn, Dr Russell Ackoff, observes in this keynote address that self-interest and company interest can be easily misaligned. LTIs are typically tailored to bridge that gap since they can be customized to measure performance targets, objectives, and outcomes most strongly aligned with your organization’s long-term success.

You can tailor LTIPs to match your company’s particular situation by setting the right performance metrics and choosing a mix of vehicles such as real or phantom equity, profit share, and cash incentives and offering them at full value or appreciation only.

4. The win-win strategy: provide competitive pay based on performance

You will protect your company’s finances by designing long term incentive plan that is performance-based.

In the worst-case scenario, if the executive underperforms or is terminated, the award is not disbursed, and since LTIs comprise around 60% of the average compensation package that means serious cost-savings to your organization. On the other hand, by creating larger compensation distinctions for top performance, you promote motivation for exceeding the set targets that ultimately benefit your company as well. As one of the HR directors explained: “the behavior of the vast majority of people - including senior executives - can be influenced by financial incentives.”

In order to determine the results each employee has achieved, the firm has to carry out a performance review that is based on the pre-set goals and objectives, usually in the form of a combination of individual, organizational, team targets, and performance metrics. You can stimulate a healthy competitive environment and promote motivation among your key employees by choosing the right comparator group for the performance metrics, be it within the company or across similar positions within the given sector.

For these reasons, in the long run, performance-based LTIPs ultimately help companies efficiently manage their long-term fixed costs.

5. Create wealth

Most vehicles included in LTIP ultimately lead to wealth creation. By mixing and matching various types of LTI, you can design a plan that will benefit your particular company in the ways that are most suitable to your current situation.

For example, setting performance objectives that focus on long-term revenue growth and profitability usually makes sense for mature companies ,while investment returns measured against relative or absolute targets are common for family-operated businesses. Similarly, private equity-owned firms tend to grant LTIPs through stock options or appreciation-only vehicles that emphasize value creation, while family offices tend to choose full-value vehicles that promote sustained value preservation. Companies that want to reduce share usage and avoid share dilution may also choose to pay out the rewards in the form of phantom stocks or cash incentives.

Since long-term investment plans usually vest over a couple of years, they give companies further comfort in cementing their long-term operational goals, human capital strategy, and succession planning.

As private companies move beyond the upheaval of 2020, it is now more important than ever for them to implement a long-term incentive plan that aligns management and key employees’ behavior with the organization’s multi-year strategic plan. Such an incentive plan helps management to maintain focus on the long game through any near-term lingering effects of this past year and helps provide a sense of stability during periods of change, thereby enhancing retention of key employees. Importantly, a well-structured long-term incentive plan motivates key employees to balance long-term goals and the potential for their personal wealth enhancement tied to achieving those goals, as compared to short-term opportunities that may side-track the organization from its strategic plan in their decision-making process.

Jeff Mathiesen director, board member of a public and private organization