Equity-based stock plans align employees with shareholder interests, encouraging them to feel a sense of ownership in the organization’s success. Employees can accrue wealth over time if equity grows, especially when the equity is paired with restrictions, such as a multi-year vesting period. In turn, this long-term incentive plan serves as a retention tool and allows your organization to save money by giving employees shares rather than actual cash.
These long-term incentive plans (LTIPs) can be based on stock or stock value.
What is an Equity Plan based on Stock?
Equity-based plans that reward employees in stock can take several forms, such as:
- Stock options: Employees are given the right to buy shares of stock at a set price over a certain period of time. If the price of the stock rises above the initial purchase cost within that time period, employees can sell their stock at a higher price and pocket the difference.
- Stock grants (stock awards): Employees are given stock without an associated cost (except income tax).
- Performance shares: Employees are rewarded with stock based on how they met predetermined performance goals.
What is an Equity Plan based on Stock Value?
Equity-based plans that reward employees in stock value can take several forms, such as:
- Stock appreciation rights (SARs): Employees are given the right to receive the monetary equivalent of the appreciation value of company stock over a period of time. For instance, if the measurable time period were two years, and the stock increased by $25 during that time, an employee who owned one SAR would receive $25 at the end of the period.
- Phantom shares: Employees are given the right to monetary rewards after a certain period of time that is worth the dollar value of a predetermined number of shares, without actually granting them any company stock. For instance, if the time period were four years, an employee was granted the dollar value of 100 shares after this time period, and at the end of four years the company’s stock price was $20, the employee would receive 100x$20=$2000.
Challenges of Stock and Stock Value Equity Incentive Plans
Both stock and stock value plans come with similar drawbacks that compensation professionals should be aware of:
- Stock performance is not always related to individual performance. Since stock value is affected by factors outside of employees’ control, this incentive type does not necessarily reward employees according to their performance.
- Equity Plans are a weak retention tool if stock price falls. Organizations risk losing the retention effect of this plan if the stock price falls below the initial purchase price or if stock value does not grow over time.
- Equity Plans are limited to a select number of employees. Like other LTIPs, these plans are usually reserved for long-term employees higher up in an organization. In addition, they require approval from shareholders.
Deciding which LTIPs are right for your organization vary widely depending on your business, organizational goals, and how you want to motivate and evaluate your employees.