As I began to work with more clients and listen to what they do internally for Long Term Incentive Plans, I realized two things – LTIPs, like fruit, come in many different shapes and sizes and I had a lot to learn. When I began my research, there were three main questions I wanted to answer:
- What are Long Term Incentive Plans, and who do they apply to?
- When do employees receive the benefits of Long Term Incentive Plans?
- What are the different types of Long Term Incentive Plans?
"I wish I was in a place where I could defer my salary" - Renzo Piche, Customer Care Specialist
"I wish I was in a place where I could understand deferrals" - Myself
At Curo, we have industry experts in many different facets of compensation. For Long Term Incentive Plans (LTIPs), I am not one of them – thankfully, I work with knowledgeable individuals such as Glizcel Ditto and Ruth Thomas who are.
What are Long Term Incentive Plans, and who do they apply to?
"A long-term incentive plan (LTIP) is a reward system designed to improve employees' long-term performance by providing rewards that may not be tied to the company's share price. In a typical LTIP, the employee, usually an executive, must fulfil various conditions or requirements to prove that [they have] contributed to increasing shareholder value. "1
LTIP's were very much focused on executive compensation, and that’s where they mostly do apply, but post the financial crisis they have been applied more broadly in order to connect employees’ compensation with the longer term financial success of the company in line with shareholder demands. This is where the long-term aspect of LTIPs comes in, in that the performance period typically runs between three to five years with the pay-out received at the end of that period.
When do employees receive the benefits of Long Term Incentives?
As mentioned previously, most LTIPs run between three to five years before the full benefit of that incentive is received. Individuals may not receive the total incentive at once and this can depend on the vesting schedule of the award.
Vesting Schedule - A period of time, referred to as a schedule, set up by a company that determines when the employee will acquire full ownership of the asset - typically stock options or retirement funds.2
There are two main types of vesting schedules, Cliff Vesting and Graduated Vesting.
Cliff Vesting - Under this type of vesting schedule, the employee earns the rights to the full benefit at a specific point in time, rather than gradually over a period of time.3
Graduated Vesting - happens gradually with a certain % of the award vested per year. It is not uncommon that for the first few years, there is no % of the benefit vested, and then subsequent years would vest at increasing % until the asset is fully vested. 4
In both schedules, the employee only reaps the benefits of the reward if they remain with the company till the vesting date. This is how LTIPs are designed to be able to entice employees to not only perform well, but to stay. It’s important to note that a Long Term Incentive is not a one-time incentive but rather that each year, a new Long Term Incentive award may be granted to an individual. For example, a person is awarded a Long Term Incentive award in 2019 that will vest gradually 5 years from now, and they will also have a % of their incentives vesting from prior awards in 2019 – 20% from an award received in 2018, 20% of an award received in 2017, etc.
For more of a breakdown of what that looks like, see a visual below from an article on equity vesting schedules published from Radford. 5
What are the different types of LTIPs?
There are many types of LTIPs but the most common are Restricted Stock, Employee Stock Options and Performance Shares. Within a company, there will be different criteria regarding the vesting schedule, performance metrics, maximum number of shares allotted, etc.
Restricted Stock – In this type of equity LTIP, the individual is issued unregistered shares of ownership that are non-transferable and restricted in that they cannot be sold until they are vested.6 Restricted stock can be awarded in either Restricted Stock Units (RSUs) or Restricted Stock Awards.
- Restricted Stock Units (RSUs) – an RSU is a promise by an employer to grant a number of shares of the company’s stock at a predetermined time in the future. This type of an award has no voting rights as the individual doesn’t actually receive the stock at that point in time.6
- Restricted Stock Awards – similar to an RSU but in this case, the individual owns the stock immediately and has voting rights.
Employee Stock Option (ESO) – a grant to an individual to buy a number of shares in the company at a set price on a future date. If at the time when the individual can buy the stock, the prices are higher than the set price, the individual would profit by buying shares at the set price and selling them at the market price. 7 An individual does not have to wait for the full shares to be vested before they can purchase the stock – rather once a portion of those shares have vested, they have the option to exercise that portion at that time. If the stock prices is less than the set price, it is not in their favour to exercise the option.
Performance Shares – This type of LTIP is an allocation of company stock that is dependent on companywide performance criteria based on outlined metrics. Their purpose is to align the interest of executives and shareholders to ultimately maximize the shareholder value.8 With performance shares, the executive receives the actual shares rather than the option to buy the shares at a set price to re-sell and make a profit.
Although this is just a few examples of the different LTIPs out there, it gives you an idea of what these plans entail. It’s important to note that LTIPs are just one factor of Total Compensation and there are other components to consider when setting a pay package – including what is important and of value to that individual. The emerging trend of personalization in reward is impacting how employers offer LTIPs to their employees, with options to flex between LTIP plans or even between cash incentive and base pay. Employers also allow their people to defer their salary or bonus – meaning that they can elect to decrease the amount of their salary or bonus now and receive the remainder amount at a later date, when they are in a lower tax bracket. This would reduce their current take home for the year of the award and potentially provide them some tax savings in the awarded year for the non-deferred portion.
I hope you enjoyed the second instalment of the “Beginner’s Guide to Compensation” and now have a better understanding of Long Term Incentive Plans.