Long-Term Incentive Plans: the traps
A Long-Term Incentive Plan (LTIP) is a vital part of most mid-market business remuneration strategy – a plan that is focused on long term performance, growth in equity value and retention of key employees. Unfortunately, the research says that many businesses are getting these plans wrong and would be better off without them!
According to Professor of Management Practice, Andrew Pepper, in the Harvard Business Review, poorly designed LTIPs are common and they often fall into a few common traps:
1. Most executives are more risk-averse than financial theory suggests – executives show a preference for safer choices (especially around remuneration) even if that limits the potential upside. In contrast, younger less senior employees are more willing to take on risk for more upside – the plan must be matched to the target audience.
2. Employees discount heavily for time and care more about relative pay – in other words they would rather receive $1 today than $2 tomorrow and they prefer to earn more than their peers (or at least, appear to). Employees need to understand the plan’s value – regular communication is key.
3. Pay packets undervalue intrinsic motivation – according to the study, executives would reduce their income by up to 28% if it meant a job was more rewarding – especially around achievement, status, teamwork etc. For younger employees, being a part of an equity-based plan (ESOP) is a fantastic way of “binding” them to the company – they feel invested and involved. Importantly tieing any plan to team (rather than individual) performance is important.
4. Plans need to be self-funding – awards need to be directly linked to profit – billable hours or gross profit are all team-based as well as aligning the plan with overall business outcomes. A portion of improved performance (i.e profits) should be used to fund the plan.
5. Changing goalposts is always dangerous – plans that change partway through the year are never successful – they lead to a lack of trust and disappointed employees who feel undervalued at best and at worst ripped off.
In summary, if you match your Long-Term Incentive Plan (LTIP) to the business performance and goals, communicate regularly, focus on team results and ensure they are consistent and self-funded and match the plan design to your target audience, you will have a plan designed to attract, retain and motivate key employees.