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Making a case for long-term incentives

2021 presents an opportune time to review long-term compensation strategy

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Portrait of business man Long-term incentive (LTI) plans, which typically vest or measure performance for periods longer than one year, have long been an important element of compensation at the executive and C-suite level. Private companies, in particular, have played a role in furthering the spread and adoption of LTI plans. According to a recent WorldatWork survey, approximately 62% of private organizations had some form of an LTI plan in 2019, which is up from 35% in 2007 (the first year the survey was conducted).

As 2020 comes to a close, many organizations with calendar fiscal year-ends are beginning their annual review of executive compensation levels and incentive plans for the new 2021 year. Unlike recent years, however, 2021 pay decisions are being made during a period of economic, political, and global health uncertainty. Furthermore, the NACD’s 2019-2020 Private Company Governance Survey listed “increased competition for talent” as the second largest area of concern for boards over the next 12 months. Private company boards and their compensation committees must be sure that their compensation plans are robust, responsive and well-structured to ensure that broader economic trends and increased talent competition do not overly disrupt their 2021 human capital strategy.

A well-designed LTI plan, now more than ever, can help private companies navigate the uncertain economic landscape by providing executives with an increase in targeted compensation without losing immediate cash flow, encouraging long-term retention, and incentivizing key financial or operational performance goals over a multi-year period.

Address compensation gaps “As private companies move beyond the upheaval of 2020, it is now more important than ever for them to implement a long-term incentive plan that aligns management and key employees’ behavior with the organization’s multi-year strategic plan. Such an incentive plan helps management to maintain focus on the long game through any near-term lingering effects of this past year, and helps provide a sense of stability during periods of change, thereby enhancing retention of key employees.

“Importantly, a well-structured long-term incentive plan motivates key employees to balance long-term goals and the potential for their personal wealth enhancement tied to achieving those goals, as compared to short-term opportunities that may side-track the organization from its strategic plan in their decision-making process.”

– Jeff Mathiesen,
director,
board member of public and private organizations
Many private organizations conduct an executive benchmarking study every one to three years to monitor movements in the competitive market and to ensure that their pay levels remain competitive. Organizations that have not conducted a study in recent years, however, may find that their compensation is farther away from competitive levels than initially thought. Implementing a long-term incentive plan (or increasing amounts where plans already exist) can help make up the gap for any market deficits and reduce the risk of executive departure.

Companies implementing a new plan should clearly articulate plan mechanics and amounts to participants to ensure they are maximizing buy-in and overall plan value. An additional benefit of an LTI plan is the multi-year time period between the time of grant and vesting (or payout) that allows organizations to save cash in the short-term while still increasing targeted levels of compensation.

Ensure talent retention As suggested in the name, one of the key benefits of a long-term incentive plan is the multi-year vesting period that requires executives to remain employed at the organization throughout the duration of the award. Executives that leave or are terminated during a vesting window often forfeit their award, providing a safeguard against LTI plans becoming overly costly or dilutive. Most plans vest or measure performance over a three- to five-year period, which can give organizations further comfort in cementing their long-term operational goals, human capital strategy and succession planning. Especially during the current period of economic uncertainty, a well-designed LTI plan can be a valuable tool to help attract, retain and motivate key talent.

Incentivize desired behaviors Lastly, long-term incentive plans can be customized to measure and motivate the performance goals, objectives and outcomes most strongly connected to a company’s long-term success. Through varying vehicles (real equity, phantom equity or a cash-based plan), vehicle types (full value or appreciation only) and performance metrics, companies can easily tailor plans to match their unique situation. Investment returns measured against relative or absolute goals often make sense for family offices, while long-term revenue growth and profitability are common for mature operating companies. Similarly, private equity-owned firms tend to grant long-term incentives through stock options or appreciation-only vehicles that emphasize value creation while family-owned businesses tend to choose full-value vehicles that incentivize sustained value preservation. Regardless of a company’s size, ownership, or stage in their lifecycle, a long-term incentive plan can be designed to address all relevant facts and circumstances.

Conclusion The coming year presents private companies with a unique opportunity to review their executive compensation strategy and question whether a long-term incentive plan is appropriate for them. Grant Thornton is seeing this deliberation occur on a daily basis with our private company clients, with many choosing to adopt an LTI plan for the first time. The immediate increase in targeted compensation (while saving on short-term cash flow), multi-year retention, and connection to long-term value drivers make long-term incentives an attractive option for all types of private organizations as they enter an uncertain economic landscape.

Contacts:
Eric Gonzaga
Principal, Compensation Consulting
T +1 612 677 5336

Rob Storrick
Manager, Compensation Consulting
T +1 612 677 5105

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