Virtually every time I present a webinar about long-term incentive plans (LTIPs), during the Q&A someone asks: “Does every company really need one?” When the question is posed, it’s obvious to me the person asking is hoping the answer is no—and that their business is the type that can get by without one. Essentially, they are looking for me to give them permission not to set up a plan. As a result, they are usually disappointed by my response.
But, for the sake of this article, let’s assume the question is valid. How do you decide whether your company needs a plan that rewards long-term performance—or if it is better off without one?
Before answering that, let me first emphasize that it’s a pretty rare company that does not need some type of LTIP. In today’s business environment, it simply makes sense to share value with those who help create it—so they will push themselves to produce more if it. So, organizations that are trying to engender a high-performance culture must operate under a pay philosophy that says people will participate in the wealth multiple they help create. It’s the expectation of talent that is in high demand.
That said, to determine how relevant and urgent an issue this is for you, there are some questions that can help you make that determination. Of the many that could be considered, here we will focus on just five.
1. Do you have a growth plan for your company?
If so, over the next few years you presumably envision an increase in sales, profits, revenue, market share…or all the above. If that’s your plan, you will likely need the help of talented people to get you there. You will want them looking at the future the same way you do. You will want to create a unified financial vision for growing your business. If you simply pay them a salary and an annual bonus, you are making it more difficult for them to align with your vision. Long-term value-sharing forges a link between the contribution you need your people to make and how they are rewarded if they make that contribution.
2. Are you trying to recruit top talent?
In today’s business environment, skilled, educated, experienced talent is in short supply. This shortage has created a highly competitive environment for premium people. And these individuals know it. As a result, to compete for them, you must have an “irresistible” pay offer. Within it, the single most important compensation element for people who are strategic leaders—those who can significantly impact the growth trajectory of your company—is one that allows them to participate in the value they help create. They are looking for an owner-like experience within an organization that has the resources to build something significant for the future. If you don’t offer them that kind of opportunity financially, they will likely look to start their own business where they have control over the outcome they want to experience. As a result, a long-term incentive plan offers the payoff potential they expect based on the contribution they envision themselves making.
3. Do you want to encourage good profits and prevent bad profits?
Bad profits show up on the books, just as good profits do. But they bear a long-term cost. They damage the ability of your company to generate sustained profits in the future. For example, bad profits are usually derived at the expense of a customer or vendor relationship or by impugning the employer or company brand in the eyes of the public at large (think Wells Fargo a few years back). Conversely, good profits are earned without manipulation and are the result of providing real value in the marketplace. Long-term value-sharing promotes good profits and acts as an insurance policy against bad ones. Bad profits are often the result of individuals acting in their short-term financial interests because there is no (apparent) negative long-term consequence for doing so. Employees want to maximize their bonus payout this year, for instance, and feel no duty to protect the growth priorities of shareholders. This changes when these same people participate in a plan that rewards sustained performance instead of just short-term results. An LTIP communicates that ignoring the long-term implications of their actions is at odds with their own financial interests, not just those of owners.
4. Do you want a more agile pay strategy that can flex as your business grows and changes?
Business leaders that have been around for a while understand that, over time, companies will experience a range of economic cycles. Periods of plenty will be followed by periods of famine. When the latter occur, organizations that have a cash heavy approach to rewards (emphasizing salary and annual incentives) find themselves financially over committed and must make the choice of either digging a significant fiscal trough for themselves or laying people off. Alternatively, when companies adopt a balanced pay strategy that includes both short and long-term value sharing, they can shift their compensation emphasis when the economy goes south. They can postpone or reduce rewards plans such as annual bonuses that significantly increase the business’s current compensation expense while increasing contributions to long-term incentive plans (such as phantom stock or phantom stock options). Many long-term plans do not have an immediate cash impact to the company, thereby granting it more flexibility in how it addresses financial challenges as they come.
5. Do you want your people to adopt a stewardship approach to their roles and an ownership mindset?
Most who head growth-oriented companies want their people to be strategic thinkers who understand the outcomes for which they have responsibility and are willing to assume stewardship for those results. Such people do not need to be closely supervised or constantly coddled. They have confidence in their abilities, are willing to commit their energies to building something and take the long view towards their career development. The compensation strategy you provide for such people needs to encourage that kind of mindset and approach, not impede it. You don’t want a rewards plan that communicates something that is at odds with the stewardship qualities you want them to exhibit. Without a plan that emphasizes the long-term performance expectation you have of your key producers, it will be hard for them to believe you are serious about wanting them to be stewards of shareholder interests.
So, there you have it. Your answers to those questions should tell you whether you should have some kind of long-term incentive plan as part of your compensation offering. Note, there is nothing in those questions about the size of your company, how many employees you have or the amount of annual revenue you produce. Instead, the questions reveal that if you have a long-term growth strategy for your business, if you are trying to attract top talent, if you want to encourage good profits, if you want a rewards approach that can flex with different economic cycles or if you want your people to adopt an ownership mindset, then you should have a long-term incentive plan.
To learn nine different ways you can share long-term value with employees read VisionLink's report: LTIP Options.