Turnover at the executive level is high. The economy has grown following the Great Recession and baby boomer retirements are accelerating, since the peak birth years between 1953 and 1959 translate to current ages between 60 and 66 years old. This has placed greater emphasis on compensation packages that can not only attract but retain executives.
One component of executive compensation packages getting increased attention is the long-term incentive.
This significant increase in attention on long-term incentives is because of its ability to both attract and retain executives. Through various long-term incentive programs companies can establish a proper linkage between enterprise success and the opportunity to earn additional compensation in the future… but only if the company performs.
The primary vehicle for rewarding executives in publicly-held companies is stock, either through stock options or restricted stock. However, stock is not always available in privately-held companies. Nonetheless, privately-held companies still need a sound long-term compensation program to retain and motivate high-quality executives and key managers.
Ability to Attract
Many privately-held companies realize that the talent they need either comes from publicly-held companies or larger privately-held companies that already have long-term incentive or non-qualified plans. To attract this talent, the privately-held company must implement one of these plans or be forced to increase base salary and/or short-term incentives to compensate for the lack of a long-term plan.
Ability to Retain Key Talent
The war for talent has always been considerable but will increase as the economy expands and baby boomers retire as noted above. In addition, talented people are no longer staying at only one or two companies throughout their career. There are three compelling reasons for shorter tenures:
- Companies are less loyal to their employees as evidenced by layoffs and downsizing
- Defined pension plans or generous retirement programs created to retain employees have been reduced or eliminated
- The stigma of job-hopping has disappeared as people move every five years or so
Long-term incentive plans (LTIP) can be an excellent vehicle to retain executives because of the walk away cost. A well-designed long-term incentive plan will typically include un-vested compensation plus potential future value an executive must walk away from.
Top 5 Reasons for LTIP’s
- Attract top talent
- Retain top talent
- Drive shareholder value or longer-term financial goals
- Share long-term success with key people
- May reduce the need to increase base salaries and annual incentives
Reasons Executives Want LTIP’s
- Supplement their 401k or qualified retirement plan/build wealth
- Share in the financial success of the company
- Defer income to later years
- Typically provides more upside if company is sold
Two types of long-term compensation plans:
- Long-term incentives provide executives with an incentive based on corporate performance or value creation. Stock options and restricted stock are mainly used by public companies, and stock appreciation rights and phantom stock are used for privately-held companies.
- Non-qualified deferred compensation plans provide executives with long-term financial opportunities that are not based on performance. Supplemental retirement plans are non-qualified deferred compensation plans focused on providing additional retirement benefits.
The decision of which plan to select often has a lot to do with the company’s business and industry. With some variations, long-term incentive plans need to address several areas, including the following:
- Plan types – What are the different variations of the plan? Which works best in a given situation and/or industry?
- Eligibility – Who will be eligible? Will the program be broad-based or targeted toward certain key executives?
- Frequency of grants/awards – How often will shares, units or cash awards be granted?
- Size of grants/awards – How will the size of awards be determined? By performance? By organizational level? An equal allocation across the board?
- Vesting – How long will it be before participants are eligible to exercise and/or participate?
- Performance measurement – Are the performance measures based solely on the market? Internal measures?
Long-term compensation plans should be seriously considered for privately-held companies. In a nutshell, they can help companies attract, retain and engage the talent they require to drive the company’s longer-range vision. These plans, however, should be carefully designed and implemented with appropriate communications to ensure they achieve the desired results. A well-thought-out plan can have a very positive long-term impact, while a poorly designed plan can result in an extremely negative outcome.