What is long term incentive plan? examples and best practices

A long term incentive plan is an important part of how companies pay their key employees. It goes beyond regular pay to connect employee goals with the company's long-term plans. This strategic approach aims to foster a deeper alignment, encouraging employees to invest in the organization's future success.

In this guide, we break down what LTIPs are, how they work, provide examples, and share some best practices for designing LTIPs within your organization. We'll also explore eligibility criteria for the LTI plan and discuss when employees receive LTIP benefits.

What is a long term incentive plan (LTIP)

A long term incentive plan, or LTIP, is a program that rewards employees for achieving specific goals that boost shareholder value. It acts as a performance-based incentive bonus, offering extra income through options like stock options or restricted stock awards.

Unlike short term incentive plan, LTIPs help retain top talent in a competitive job market by aligning employee objectives with the company's long-term growth.

Definition of long term incentive (LTI)

Long term incentives, a crucial aspect of incentive compensation management, are rewards for employees who contribute over time and align their interests with the company's long-term success. Common components include stock options and performance awards.

With a vesting period spanning years, LTIs foster loyalty and a sense of ownership, proving effective in attracting top talent. This approach provides professionals with a stake in the company's long-term success.

Introduce types of LTI

There are various types of long term incentives used to motivate and retain employees. Here's a breakdown of some common categories, along with their advantage and disadvantages:

Appreciation-based

Appreciation-based awards are a type of incentive compensation that offers the potential to benefit from increasing stock prices without owning the shares. Some examples of appreciation-based incentive include:

• Stock options: Give the right to buy company shares at a predetermined price in the future. If the stock price rises, the employee can profit by exercising the option and selling the shares for a higher price.

• Stock appreciation rights (SARs): Grant the right to the value of the stock's appreciation without actually owning the shares. When the award is given, the employee receives the difference between the grant price and the market price at that time.

Time-based

These awards vest automatically over a predetermined period, regardless of the company's performance or the employee's individual achievements. Some examples include:

• Restricted stock: Grants ownership of company shares after a vesting period. Employees typically cannot sell the shares until the vesting period is complete.

• Restricted stock units (RSUs): Similar to restricted stock, but instead of receiving actual shares, employees receive a claim on a specific number of shares that vest over time.

Performance-based

These awards link the size of the reward to the achievement of specific performance goals, such as company growth, profitability, or individual targets. A few examples are:

• Performance shares/units: Grants shares or units that vest based on the achievement of predefined performance metrics. The number of shares/units awarded may increase or decrease depending on the company's performance.

• Performance bonuses: Cash bonuses awarded based on the achievement of individual or team targets.

Cash-based

These awards provide employees with a direct financial incentive, regardless of the company's performance or the employee's individual achievements. Some examples include:

• Profit-sharing plans: A portion of the company's profits are distributed to employees based on a predetermined formula.

• Deferred compensation: A portion of an employee's salary is set aside and paid out at a later date, often with interest.

Choosing the right long term incentive for your company depends on factors like company culture, industry, and long-term goals. Each LTI type has pros and cons, so it's crucial to pick the one that aligns best with both the company's and the employee's needs.

What is a long term incentive plan (LTIP) and how it works

As mentioned, a long-term incentive plan rewards employee for contributing to the company's long-term growth over several years. They earn shares or cash bonuses by achieving specific performance goals.

The purpose of LTIP is to align the interests of employees with those of shareholders, as the value of the awards is tied to the company's long-term performance and stock price. Employees may need to meet specific performance goals, stay with the company for a predetermined period, or witness sustained growth in the company's value for the awards to fully vest.

Long term incentive plan examples and best practices

Here are samples of an LTIP from an American multinational automotive manufacturing company and a lighting equipment manufacturing company, along with some best practices when designing one:

Examples of an LTIP

1. 2020 Long Term Incentive Plan of General Motors Company

   The General Motors Company 2020 LTI Plan aimed to motivate selected employees and others by aligning their interests with the company's stockholders. The plan included various awards like Options, Stock Appreciation Rights (SARs), Restricted Stock, RSUs, Performance Awards, and other stock-based awards.

   The Committee, in charge of the plan, had the authority to make decisions and could delegate responsibilities. They determined eligible participants, award types, share numbers, terms, conditions, exercise prices, and settlement methods. The plan allowed the issuance of up to 50,000,000 shares, with adjustments possible.

   The plan detailed termination conditions and award impacts. Death or disability triggered immediate vesting, while other terminations allowed participants to keep vested options and SARs for a defined period. Performance awards could be adjusted based on achievement in case of termination, including those under approved separation agreements.

2. LSI Industries Inc. 2019 Long Term Incentive Plan

   On August 21, 2019, LSI Industries Inc. implemented a LTI Plan that served as a mechanism for issuing share-based incentive awards to employees, including Named Executive Officers (NEOs), with the primary goal of retaining talent and fostering long-term commitment to the company.

   The plan included stock options (ten-year exercise term), performance stock units (PSUs) tied to three-year performance metrics, and restricted stock units (RSUs) vesting annually over three years. General terms covered award allocation, CEO discretion for additional allocations, and various conditions for vesting and payout.

   Provisions covered definitions, potential adjustments for leaves of absence, and the company's right to amend the plan. Overall, the LTIP sought to align employee incentives with company performance and long-term objectives.

Best practices for designing LTIPs

Here are some of the best practices for designing effective LTI program:

• Align LTIPs with the company's long-term strategic goals.

• Define and communicate metrics tied to strategic objectives.

• Choose a suitable performance period (3-5 years).

• Set challenging yet achievable targets.

• Choose the right mix of stock options, RSUs, or performance shares.

• Determine a reasonable vesting schedule.

• Clearly communicate the LTIP structure.

• Regularly measure performance against targets.

• Establish an independent oversight committee.

• Benchmark LTIPs against industry peers.

• Seek and incorporate shareholder feedback.

• Ensure compliance with laws and regulations.

• Periodically review and revise LTIPs.

Pros and cons of long term incentive plans

LTI program offers both advantages and disadvantages for both companies and employees.

Pros

• LTIPs boost stability by encouraging long-term commitment.

• Tying rewards to objectives fosters focus on long-term value creation.

• Competitive LTIPs help attract and retain skilled employees.

• Performance-based LTIPs align interests for long-term value focus.

• Stock options or performance shares enhance engagement.

• LTIPs encourage long-term career investment in skills for company growth.

Cons

• LTIPs affect short-term profits; value hinges on meeting performance targets.

• Administering LTIPs requires legal and financial expertise.

• Stock-based LTIPs may dilute existing shareholders' stake.

• Poor metrics may prioritize short-term gains over value creation.

• LTIP value relies on uncertain performance targets influenced by external factors.

• Vesting periods limit mobility, creating a lock-in effect.

• Awards may be taxed, reducing net benefit based on LTIP type and jurisdiction.

LTIP eligibility and benefit distribution timing

Organizations adjust eligibility and benefit timing based on goals and workforce needs, a critical factor impacting LTIP success.

Who is eligible for the long-term incentive plan?

The eligibility for an LTIP can vary based on the company’s policy, but generally, the following criteria are considered:

Employee Status

The participant must be classified as a permanent employee.

Employment Duration

The participant must be employed with the company during some portion of the period for which the award is being measured.

Performance Goals

Employees are usually eligible to receive the benefits after three to five years if they meet the company’s performance goals.

When do employees receive LTIP benefits?

The eligibility for a long term incentive plan can vary based on the company, but generally, it depends on two key aspects: the vesting schedule and performance goals.

Vesting Schedule

• Cliff vesting: No LTIP benefits until a cliff (e.g., 3 years), followed by yearly portions (e.g., 25% for 4 years).

• Graded vesting: Smaller LTIP portions at fixed intervals (e.g., 20% yearly for 5 years).

Performance Goals

• Achievement-based: LTIPs tied to performance goals, adjusting value based on achievements (e.g., stock price growth, profitability).

• Time-based: LTIPs depend on employment and reaching vesting period, irrespective of performance.