While Annual Incentives motivate year-over-year performance, the purpose of Long-Term Incentive (LTI) plans is sustained company growth, key employee/executive retention, and shareholder value creation. LTI aligns the interests of your key leaders with the long-term vision of the organization.
What Defines LTI?
LTI differs fundamentally from annual pay:
- Extended Horizon: LTI plans operate over a performance period of two or more years (often three to five years).
- Focus on Value Creation: Payouts are tied to metrics that measure durable success, such as Total Shareholder Return (TSR), cumulative profitability, or multi-year growth targets.
- Retention Vehicle: Because the payout is typically deferred and subject to vesting, LTI is one of the most effective tools for retaining mission-critical talent.
The Different LTI Vehicles
The specific type of LTI used is typically determined by the company’s maturity and ownership structure (Public vs. Private).
Equity-Based LTI (Common in Public/Pre-IPO Companies)
These plans grant employees a stake in the company, linking their wealth directly to the value created for shareholders.
- Stock Options: Give the employee the right to purchase company stock at a predetermined price (grant price) sometime in the future. The value is realized only if the stock price rises above the grant price.
- Restricted Stock Units (RSUs) and Restricted Stock Awards (RSAs): The employee is granted units of company stock with value that vest over time. They are subject to a simple employee service condition (time vesting).
- Performance Share Units (PSUs): The employee is granted units of company stock with value but either the number is variable based on performance or units vest only if specific multi-year performance goals are met (e.g., hitting a three-year revenue target).
Cash-Based LTI (Essential for Private/Non-Profit Organizations)
For companies that cannot or choose not to grant equity, cash-based LTI is the primary tool.
- Phantom Stock/Stock Appreciation Rights (SARs): Similar to stock options and track the increase in the company’s value (or phantom stock price) over the vesting period but pay out in cash, not actual shares.
- Performance Unit Plans (PUPs): These are multi-year plans where the payout (cash) is tied to the achievement of defined financial goals over the full 3–5-year period.
- Long-Term Cash: This is the most straightforward cash LTI. It is a specific, deferred cash award promised today but paid out after two or more years, contingent on the executive’s continued employment (service vesting) and often tied to broader, long-term financial milestones.
Evaluating Your Plan: Critical Questions for LTI Effectiveness
A well-designed LTI plan must be continuously tested against the organization’s long-term strategy and cultural goals by asking these questions: .
Strategy and Alignment
- Does it foster long-term, value-creating thinking and responsibilities? The performance metrics must encourage decisions that build durable value over the multi-year performance period, not just short-term results.
- How much is it weighted based on performance versus service (time)? A strong plan requires all or a meaningful portion of the payout to be tied to quantifiable value creation, not just remaining employed for the duration of the vesting period.
Participation and Understanding
- Are the right levels of jobs included in the plan? LTI should be reserved for those roles, typically key employees, executives or senior leadership, whose decisions directly influence the company’s multi-year success and long-term value.
- Is it well understood? Participants must clearly comprehend the performance expectations, the metrics, the conditions for payout (vesting) and how much they can earn. A complex plan is not a motivator.
- Do participants know how their efforts will be rewarded? Clarity on the payout mechanism ensures that leaders can connect their daily, weekly, and quarterly actions to the potential long-term reward.
Stakeholder Perception
- How would a major payout be viewed by the shareholders, employees, customers, and the community? A successful LTI payout should be defensible and celebrated across all stakeholder groups because it signals value creation. If any major stakeholder would view a payout as excessive or unearned, the plan’s integrity is compromised.
Why LTI Is Non-Negotiable for Key Talent
The value of LTI for an organization is about governance and risk management.
- Alignment: LTI ensures executives/key employees make the best decisions for the company. By tying their incentive opportunity to a multi-year performance cycle, their focus must remain on the long-term health, sustainability, and value of the enterprise.
- Retention: The multi-year vesting schedule creates a powerful retention tool, discouraging valuable leaders from leaving before the performance cycle is complete and the reward is realized.
- Strategic Focus: The chosen LTI metrics (e.g., Return on Invested Capital, Earnings Growth) clearly communicate to the management team exactly how owners define long-term success.
Focusing on long-term incentives enhances your company’s competitiveness by effectively retaining key leaders and fostering decision-making aligned with multi-year financial objectives. If you’d like to discuss how to tailor this framework to your organization’s unique context, we’d be delighted to help.
