Long-Term Incentive Plans: Understanding Types and Strategies

Organizations are often ambitious in their employee expectations. 

You expect top talents with long experience at a low salary! You expect consistent motivation and enhanced performance without even giving a word of appreciation. 

We have talked about this a lot- the importance of rewards and recognition for bringing desired results to employees. 

While monetary rewards give financial stability to employees, non-monetary rewards including words of appreciation build a sense of satisfaction and belonging to the organization. 

If you are a company looking for long-term commitment from employees then your rewards must also be long-term. There is no other easy solution. 

In a study conducted by Ernst & Young Global Limited titled EY Long-term Incentive Plans (LTIPs) survey - Trend analysis, the study shows how Long-term incentive plans are an effective tool for employee retention.   

It shows how long-term incentives not only encourage employees to deliver the desired outcomes but also share the company’s vision and journey to value creation. 

This is just the tip of the study and one aspect of Long-term incentives. We have more to say about it. 

Explore this article to understand the LTIP meaning and its types, pros and cons. To know who are the recipients of LTIP compensation and its eligibility criteria. We also walk you through long-term incentive plan examples and their tax implications. 

So without much ado, scroll down. 

What are Long-Term Incentives (LTIs)?

Long-term incentives live up to their name. These incentives are provided to executives and stakeholders to ensure performance and growth on a long-term basis. 

LTIs are usually part of the executive compensation package. This means it is provided to employees in the higher ranks. It encourages them to be a part of the company for an extended period and work for its growth and success. 

The incentive is tied to the company’s financial performance, stock price, and other KPIs that align with the company’s strategic objectives. 

Long-term incentive plans aim to attract, retain, and motivate top officials by attaching their incentive gains to the company's growth and performance. 

Types of Long-Term Incentive Plans (LTIs)

There are a variety of long-term incentive plan examples out there. They differ depending on their structure and how they provide rewards to employees. 

Let us explore these LTIP compensations to understand what best suits your business operations: 

Appreciation-Based LTIPs

Appreciation-based LTIPs focus on the increase in the value of the company’s stock over time. 

Based on this compensation structure, the two appreciation-based incentive examples are: 

Stock Options

Stock options provide employees the right to purchase company stock at a predetermined price (also known as exercise price). Employees earn a profit when they sell their stock when the company stock price increases above the exercise price. 

For example, an employee can purchase the company stock worth $50. When the stock value increases to $70, the employee can make a profit by selling the stock at an increased price. 

Stock Appreciation Rights (SARs) 

Under SARs employees don't purchase the stock but receive a profit. Here the employee receives cash or an additional share of stock when the stock value increases. 

For example, an employee receives a company stock worth $50. When the stock price increases to $70, the additional $20 is paid as cash to the employee, or its equivalent share is added to their existing stock. 

Stock-Based LTIPs

Stock-based LTIP provides employees with shares of company stock over a defined period. 

Given this compensation structure, the two illustrations of cash-based LTIPs are:

Time-Based Restricted Stock

Under this incentive plan, employees are granted actual shares of the company stock. It is called restricted stock because it is subjected to certain terms and conditions. 

For example, an employee has to fulfill a vesting schedule or performance criteria before getting full access to the stock. The vesting schedule refers to the period the employee must be part of the company to get full ownership of the stock. 

Performance-shares/units

Employees are awarded company stocks when they achieve certain performance goals or metrics over a set period. 

For example, a company can evaluate the employee based on financial targets, operational objectives, and individual performance. When they achieve these set targets, they are granted incentives. 

Cash-Based LTIPs

Unlike stock-based incentives, cash-based LTIPs provide employees with cash rewards. These are granted based on specific performance metrics over a period. 

According to this compensation structure, the two instances of cash-based LTIPs are:

Long-term Cash Units

Here employees receive cash bonuses based on predetermined performance criteria. 

For example, employees receive cash bonuses when they fulfill performance criteria like financial targets, growth milestones, etc. It also requires them to serve the required period at the company. 

Performance Cash Units

Cash bonuses are awarded to employees based on their level of achievement against performance targets.

For example, a company evaluates its sales team at the end of the three-year performance period against the predetermined sales targets. If the team achieves or exceeds the sales targets, each member receives a cash bonus equivalent to the value of their earned PCUs.

Each of these long-term incentive plan examples has its advantages. Companies often choose a combination of these LTIP compensation to achieve their goals and objectives.

To read more about various incentive compensations, check A Comprehensive Guide to Types of Variable Incentives. 

Pros and Cons of Different Incentive Strategies

No incentive plan is ideal. While it offers a range of benefits to your sales operations we cannot put a blind eye to its shortcomings. 

So let's have a detailed look at what these pros and cons are to help you make the best judgment. 

Businesses can weigh these pros and cons, evaluate your business structure, and understand employee preferences to decide which long-term incentive plan best suits your requirements.   

Recipients of LTIPs and Eligibility Criteria

Long-term incentives are usually reserved for the higher officials of the organization. The executives, senior management, and board of directors are the recipients of LTIP compensation. 

These roles occupy crucial positions in driving the company’s growth and success. Hence, their consistent motivation, sense of ownership, and long-term retention are important. 

However, LTIP compensations are widening its horizon. The EY report states that for equity-based LTIPs organizations are looking beyond the executive members. It no longer rewards high performance but is also used to attract talent. 

Even though, primarily, they belong to the leadership team, the eligibility criteria for achieving long-term incentives are objective and based on metrics. 

• Only those employees who occupy higher levels and positions are eligible for LTIP compensation. This group includes executives, senior management, key employees, etc. 
• Performance and contribution are also factors in eligibility criteria. Key performing employees who show high performance and consistently contribute to drive business growth are considered for LTIP. 
• LTIP eligibility also takes into consideration long-term tenure. This ensures that LTIPs incentivize long-term commitment and contribution from employees.
• Even the Long-term Incentive Plan follows an objective evaluation. Senior management must fulfill performance metrics and achieve targets to be eligible for incentives. 

Creating this eligibility criterion even among senior officials makes the incentive process clear and transparent. This helps ensure fairness and consistency that aligns with your company goals and values. 

Examples of LTIP Implementation in Companies

Large multinational corporations to startup companies explore the possibilities of long-term incentives. This helps them attract top talents, ensure their consistent performance, and guarantee long-term commitment. 

Especially for new-age companies and startups, employee wealth creation is one of the key objectives of implementing an LTIP.

Let's take examples like Apple, Google, and IBM to understand how these top companies make use of LTIP compensation. 

The Apple Idea

Apple launched its Executive Cash Incentive Plan in 2022. It aims to motivate executives and align their efforts with the shareholder objectives. 

Based on the performance goals set for each fiscal year, executive officers and other key employees will receive cash awards. The plan follows set eligibility criteria, and performance goals and evaluates its achievement. 

The Google Innovation

Google’s LTIP compensation is called Alphabet Inc. 2021 Stock Plan and grants restricted stock units to their employees. 

When employees join Google they are offered stock options. However, employees must fulfill an employment period to get full access to the stocks. The plan aims to build a sense of ownership and long-term tenure in the organization. 

The Tesla Methodology

In 2019, Tesla set its Equity Incentive Plan. It is aimed at attracting and retaining top talents, aligning employee interests with stakeholders, and driving business success. 

The plan grants stock options, restricted stocks, SAR, and performance units to awards. Based on the performance criteria, the awards will be granted to employees.   

The above examples show how companies prioritize retaining and rewarding employees by fostering a sense of belonging and ownership among their employees. 

For further reading, check 20 Effective Employee Incentive Programs to Motivate Employees. 

Tax Implications of LTIPs

Long-term incentive compensation is subjected to taxation. 

The tax implications vary depending on various factors. This includes the nature of the reward, the time of taxation, the tax laws of the place, etc.  

For this reason, both employees and employers must be well informed of the tax process and regulations. They must also seek the guidance of tax professionals to ensure they comply with the tax laws and optimize tax planning strategies. 

The taxation process and regulations vary depending on the nature of the incentive compensation. 

For example, stock-based rewards are subjected to taxation at vesting. This means when the employee gets ownership of the stock. It is also subjected to capital gain tax when the stock is sold. The tax rate depends upon the holding period and the employee's overall income. 

On the other hand, cash-based rewards are taxed as ordinary income when the employees get paid. This means the tax rates of cash rewards are similar to salary.     

Even the time of taxation of these two types of compensation varies. 

Tax laws and regulations also vary depending upon jurisdiction. Thus, it's important to consider the local tax rules while managing your long-term incentives. 

A Lot of factors determine and differentiate your incentive taxation process. Hence, companies must seek help to ensure they follow accurate and timely taxation and comply with the rules of the tax authorities. 

Final Thoughts

The EY Long-term Incentive Plan Survey shows a changing landscape in Indian companies. 

The dynamic nature of the talent market and evolving business models are encouraging Indian companies to take up long-term incentive plans in their operations. 

Its increasing popularity is due to its diverse, flexible, and strategic nature in design and implementation.

With the dynamic pace of the business landscape changing, organizations need to step up. Especially since LTIP compensation aids in employee retention, wealth creation, and performance enhancement. 

If you have a well-designed LTIP it can aid in attracting, retaining, and motivating top talents. These efforts will directly impact the overall performance of the company in future competitions. 

However, designing and implementing long-term incentives are not the actual challenge. What you need is assistance in managing the plan effectively. 

From an administrative side, you must gather correct data and timely payout incentives. At the same time, you need to give clarity and transparency in calculation and sales commission rates to employees. 

Managing all these requirements with more than 50 or 100 salesforce on a long-term basis is challenging. Book A Demo with us. 

Kennect will supercharge your Incentives with our cutting-edge solution and automate your entire sales incentives process. Saving you time and ensuring accuracy. No more spreadsheets, no more errors – just efficiency.