Long Term Incentive Compensation

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Long-term incentive compensation (LTIC) is a strategic component of executive remuneration designed to align the interests of senior managers and shareholders by focusing on sustained performance and company growth.

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These incentives typically take the form of stock options, restricted stock, performance shares, or other financial rewards that vest over a period of several years. The key objective behind LTIC is to encourage executives to prioritize long-term corporate health.

What is long-term incentive compensation?

Long-term incentive compensation (LTIC) refers to a variety of reward systems used by organizations to motivate and retain key employees, particularly senior management and executives, by tying a portion of their compensation to the company's long-term performance.

These incentives are designed to align the interests of executives with those of shareholders and ensure the pursuit of long-term organizational goals over immediate financial results.

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What are the features of long-term incentive compensation?

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Long-term incentive compensation (LTIC) programs come with several key features designed to align employee interests with the company's long-term success.

Here's a breakdown of some of the most prominent features:

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1. Focus on long-term performance:

Vesting schedules: Unlike bonuses or commissions tied to short-term goals, LTIC awards typically vest over a period of 3-5 years or more. This encourages employees to think and act beyond quarterly targets and focus on the company's long-term growth and sustainability.

Performance conditions: Some LTIC plans, like performance shares, base the value of the award on achieving specific company performance goals (e.g., reaching profitability targets or increasing market share). This directly links employee compensation to the company's overall success.

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2. Equity-based awards:

Stock options: Employees are granted the right to buy a certain number of companies shares at a predetermined price (strike price) within a specific timeframe. If the stock price increases above the strike price, employees can profit by exercising their options and purchasing the shares at a discount.

Restricted stock units (RSUs): Employees are awarded company shares that vest over time. Once vested, employees become full owners of the shares and can benefit from future stock price appreciation or receive dividends if applicable.

Performance shares: Similar to RSUs, but the number of shares awarded or the value received depends on the company achieving pre-defined performance goals. This directly ties employee rewards to the company's success metrics.

Stock appreciation rights (SARs): These grant employees the right to receive cash equal to the difference between the stock price at the grant date and the stock price at the vesting date. Employees don't own any company shares but benefit from stock price appreciation during the vesting period.

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3. Alignment and retention:

Shared ownership mentality: Owning or having the potential to own company stock (through options or RSUs) can foster a sense of ownership among employees. They become more invested in the company's success as their financial rewards are tied to the stock price performance.

Retention incentive: Vesting schedules create a retention incentive. Employees forfeit unvested awards if they leave the company before the vesting period ends. This encourages them to stay with the company for the long term to fully benefit from their LTIC grants.

What types of long-term incentive compensation plans are most effective?

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LTIC plan types tend to be more effective in achieving specific goals:

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1. For attracting and retaining top talent:

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Stock options: In a growing company with good stock price appreciation potential, stock options can be a significant perk for attracting high-caliber employees. The opportunity to share in the company's success through stock ownership can be a strong motivator.

Restricted stock units (RSUs): These offer a more predictable reward structure compared to stock options, making them attractive to a wider range of talent. They are particularly useful for startups or companies with less volatile stock prices.

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2. For aligning employee interests with long-term company goals:

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Performance shares: By tying the value of the award to achieving specific company performance goals, performance shares directly incentivize employees to focus on metrics critical to the company's long-term success.

Stock appreciation rights (SARs): These can be effective for companies hesitant about stock dilution through options or RSUs. SARs provide employees with the benefit of stock price appreciation without actual ownership, aligning their interests with shareholder value growth.

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3. For striking a balance between risk and reward:

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Performance shares with a guaranteed minimum: This variation offers a base number of shares regardless of performance, along with additional shares awarded upon achieving specific goals. It provides a safety net for employees while still incentivizing them to push for performance targets.

Combined LTIC plans: Many companies utilize a combination of different LTIC options (e.g., stock options and RSUs) to cater to a broader range of employee preferences and offer a more comprehensive long-term reward structure.

How does a long-term incentive plan impact employee performance?

Here's a breakdown of the potential benefits and drawbacks:

1. Positive impacts on employee performance:

Increased focus on long-term goals: By tying compensation to the company's long-term success, LTIC programs encourage employees to look beyond short-term targets and prioritize strategies that contribute to sustainable growth.

Enhanced motivation and engagement: The potential for future financial rewards through stock options, RSUs, or performance shares can motivate employees to go the extra mile and exert greater effort towards achieving company goals.

Alignment of interests: LTIC programs create a sense of shared ownership between employees and shareholders. When employees see their compensation directly linked to the company's performance, they become more invested in its success.

Improved retention: Vesting schedules that require employees to stay with the company for a certain period to earn their full LTIC awards create a retention incentive. This helps reduce turnover and maintain a stable, experienced workforce.

Attracting top talent: Competitive LTIC programs can be a significant advantage when attracting and retaining high-performing employees who value long-term career growth and the opportunity to share in the company's success.

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2. Potential drawbacks to consider:

Misaligned goals or metrics: If the performance conditions attached to LTIC awards are poorly defined or don't align with employee roles or responsibilities, it can demotivate employees and hinder performance.

Short-term neglect: In some cases, an overemphasis on long-term goals through LTIC programs might lead to neglecting crucial short-term objectives that require immediate attention.

Focus on individual rewards: While LTIC programs can foster a sense of shared ownership, focusing solely on individual rewards through stock options or performance shares might discourage collaboration and teamwork.

Dilution of ownership: Granting stock options or RSUs can dilute ownership for existing shareholders, potentially creating friction or misaligned interests.

Administrative complexity: Designing, implementing, and administering LTIC programs can be complex and require careful planning to ensure compliance and avoid confusion among employees.

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3. Maximizing the positive impact:

Clear communication: Clearly explain the LTIC program to employees, including how it works, how awards are calculated, and how it aligns with company goals.

Tailored plan design: Choose an LTIC plan structure (stock options, RSUs, performance shares, etc.) that aligns with your company's stage of growth, industry standards, and overall compensation strategy.

Performance metrics: Ensure performance conditions attached to LTIC awards are clear, measurable, and directly linked to the employee's role and the company's strategic objectives.

Balance short-term and long-term: While promoting long-term focus, acknowledge and reward employees for achieving short-term goals critical to company success.

Transparency and fairness: Ensure the LTIC program is perceived as fair and transparent across all employee levels to maintain trust and motivation.

What are the challenges in implementing a long-term incentive plan?

Implementing a long-term incentive compensation (LTIC) plan can be a rewarding endeavor for companies seeking to align employee interests with long-term success. However, there are several challenges to consider throughout the process:

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1. Plan design and complexity:

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Choosing the right LTIC vehicle: Deciding between stock options, restricted stock units (RSUs), performance shares, stock appreciation rights (SARs), or a combination requires careful consideration of company goals, employee preferences, and tax implications.

Setting clear performance metrics: Defining measurable and achievable performance goals that are directly linked to employee roles and the company's strategic objectives is crucial to avoid confusion and demotivation.

Balancing risk and reward: Finding the right balance between potential rewards for employees and dilution of ownership for existing shareholders can be tricky.

Administrative burden: Designing, implementing, and administering an LTIC plan requires careful planning and attention to detail to ensure compliance with regulations and avoid errors.

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2. Communication and transparency:

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Employee understanding: Effectively communicating the LTIC plan details to employees, including vesting schedules, performance conditions (if applicable), and the overall purpose of the program, is essential for buy-in and motivation.

Potential for confusion: The complexities of LTIC plans, especially regarding vesting schedules and stock option calculations, can lead to confusion among employees. Clear and ongoing communication is key.

Perceived fairness: Employees need to perceive the LTIC plan as fair and equitable across all levels and departments to maintain trust and avoid resentment.

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3. Alignment and performance impact:

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Misaligned goals: If the performance conditions attached to LTIC awards are poorly defined or don't align with employee roles and responsibilities, it can demotivate employees and hinder performance.

Short-term neglect: An overemphasis on long-term goals through LTIC programs might lead to neglecting crucial short-term objectives that require immediate attention.

Focus on individual rewards: While LTIC programs can foster a sense of shared ownership, focusing solely on individual rewards through stock options or performance shares might discourage collaboration and teamwork.

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4. Additional challenges:

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Cost considerations: Granting stock options or RSUs can dilute ownership for existing shareholders, potentially impacting stock price and valuation.

Retention challenges: Vesting schedules create a retention incentive, but if employees leave before vesting, the company loses the potential benefit of their long-term contributions.

Market volatility: The value of stock options and SARs is directly tied to the company's stock price. Fluctuations in the market can create uncertainty and impact employee motivation.

Employee pulse surveys:

These are short surveys that can be sent frequently to check what your employees think about an issue quickly. The survey comprises fewer questions (not more than 10) to get the information quickly. These can be administered at regular intervals (monthly/weekly/quarterly).

One-on-one meetings:

Having periodic, hour-long meetings for an informal chat with every team member is an excellent way to get a true sense of what’s happening with them. Since it is a safe and private conversation, it helps you get better details about an issue.

eNPS:

eNPS (employee Net Promoter score) is one of the simplest yet effective ways to assess your employee's opinion of your company. It includes one intriguing question that gauges loyalty. An example of eNPS questions include: How likely are you to recommend our company to others? Employees respond to the eNPS survey on a scale of 1-10, where 10 denotes they are ‘highly likely’ to recommend the company and 1 signifies they are ‘highly unlikely’ to recommend it.

Based on the responses, employees can be placed in three different categories:

Promoters
Employees who have responded positively or agreed.
Detractors
Employees who have reacted negatively or disagreed.
Passives
Employees who have stayed neutral with their responses.

Long Term Incentive Compensation

What is long-term incentive compensation?

What are the features of long-term incentive compensation?

What types of long-term incentive compensation plans are most effective?

How does a long-term incentive plan impact employee performance?

What are the challenges in implementing a long-term incentive plan?

Employee pulse surveys:

One-on-one meetings:

eNPS:

Based on the responses, employees can be placed in three different categories:

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