Why is my long term incentive plan not working?

February 10, 2020 | Private Companies, LTIPs, Plan Design



 

There are lots of great reasons to offer your employees a long term incentive plan (LTIP). One of the main reasons is right there in the name – you’re giving your employees incentive to remain engaged and focused in the long term. Not only that, but with plans that reward their participants with shares, the employee feels connected to the company and its success.

We’ve talked before about why you need an LTIP, but there’s an important caveat. It’s not enough to have a plan, you need an effective plan.

Unfortunately, there’s a lot of room for error, and again, the reason is in the name. If you set up an ineffective plan, you’re stuck with it for the long term.

A 2016 article in the Harvard Business Review argues against LTIPs for executives, citing research from a Professor of Management Practice, Andrew Pepper.

Pepper makes some interesting points about how executives view their LTIPs, and he believes this shows why LTIPs don’t work in general.

But what Pepper actually shows are the common reasons why some LTIPs fail – the designers don’t build an effective plan that fits their company and employee needs. They fall into the all-too-common, but easily avoidable, pitfalls of setting up an Long Term Incentive Plan.

We’ve provided an antidote for each pitfall here.

 

‘Executives are more risk-averse than financial theory suggests’

Pepper’s research shows that executives show a preference for safer choices, particularly when it comes to bonuses. In fact, they would generally accept less of a bonus, if it’s a safer choice.

So, if you’re offering an LTIP, it wouldn’t make sense to offer these executives an appreciation-based award – where there’s a huge upside, but more risk. Instead, these executives will prefer a stock-based award, where there is less room for upside, but the award is guaranteed to have value when it vests.

And in contrast, if you are trying to incentivize your younger, less senior employees – they would probably be more willing to take a risk for an upside that they ordinarily wouldn’t have access to. So, an appreciation-based award would motivate them.

By ensuring that your LTIP design matches your target population, you can easily sidestep this pitfall.

 

‘Executives discount heavily for time and care more about relative pay’

These are two points that Pepper makes, but they go hand-in-hand. For the first point, that executives discount heavily for time, Pepper means that executives would rather get €1 today, than €2 tomorrow. And regarding relative pay, Pepper explains that executives prefer to earn more than their peers – or at least, appear to. So, to these executives, a €100,000 salary with no benefits looks more appealing than €85,000 with great benefits. For them, it’s more what the money says, rather than the money itself.

One executive in the study sums the pitfalls up: ‘Companies are paying people in the currency they don’t value.’ And if you’re not accounting for these pitfalls in your LTIP, then it is absolutely true.

Luckily, there’s an easy fix. Make sure your employees understand the plan’s value, and that they actually value it.

Communications are key here. Your plan needs to be communicated in simple language, so the benefits are clear. And the length of the plan is crucial too. Make sure that ‘long term’ doesn’t read as ‘never’ to your employees.

The best way to ensure your employees value your currency is to involve them in the process from the start. Not only do you get valuable feedback about what incentives they value, and which ones they don’t – but you’ll also build awareness and understanding of the plan from day one. After all, the plan is for them.

 

‘Pay packages undervalue intrinsic motivation’

This is a big one. There’s more to life than money, and if work is going to take up a large portion of your life, then it needs to be about more than money as well. Nobody knows this better than executives. According to Pepper’s study, on average, executives would reduce their pay package by 28% if it meant a job that was more rewarding in other metrics – achievement, status, teamwork etc.

But that’s executives. For employees, a Long Term Incentive Plan that offers shares or options is a fantastic way of ensuring they get more satisfaction from their job. They feel invested in the company – like every action they take will have an impact on their own investment. Not only that, but as shareholders, they will be able to participate more in the company’s direction.

And there’s another way to help get around this pitfall, especially for executives – tie the targets to team performance. In a company, it’s rare for an individual to achieve a target in isolation. They generally need help from a colleague, or department, or management, to get that goal over the line. Making sure that everybody is fairly rewarded for helping their colleagues leads to increased teamwork and improves company morale.

From just that one change to your LTIP, you’ve not only incentivized your employees – you’ve created a company culture, an important intrinsic benefit.

 

A plan that isn’t self-funding will lead to trouble

Now that we’ve covered all of Pepper’s warnings, we want to discuss one last important point. Plans need to be self-funding.

This means that awards need to be directly linked to profit. Otherwise, your teams could hit their targets – at the exact moment, the company hits a rocky patch. If you link your plans to key financial results, like billable hours or gross profit, this means that you need to pay out at an inconvenient time. (And targets like these tend to be more team-based as well.)

 

Pepper believes his study shows why long term incentive plans are an inefficient motivator for companies. But really, he just highlights the common pitfalls that companies fall into when setting up an LTIP. Now that you have the antidotes, you can be sure that your LTIP accomplishes its goal – bringing out the best in your employees.

Here at Global Shares, we spend all day coming up with ways to help our clients avoid pitfalls that they haven’t even thought of. It’s what has made us an award-winning equity compensation company for 14 years. Contact us for a demo, to see how we can help your company succeed.

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Click here to read more about Long Term Incentive Plans and how we can help you.

Please Note: This publication contains general information only and Global Shares is not, through this article, issuing any advice, be it legal, financial, tax related, business related, professional or other. The Global Shares Academy is not a substitute for professional advice and should not be used as such. Global Shares does not assume any liability for reliance on the information provided herein.


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