In the war for talent, organizations are finding new ways to retain longtime employees. Short-term incentives go a long way to keep workers engaged year-to-year, but as employees move up in an organization’s hierarchy, it’s necessary to consider offering long-term incentive plans (LTIPs).
We'll discuss non-equity based plans and explore some of the standard metrics and measurement methods that dictate payouts.
What are Non-Equity Based Long-Term Incentive Plans?
Non-equity-based plans typically reward employees with cash rather than company stock, and the rewards are not related to stock performance. These plans are meant to reward longer-term organizational performance, usually over three to five years.
Like equity-based LTIPs, these plans are strong retention tools due to multi-year or longer-term reward payouts. But since these plans are not tied to stock performance, employees usually have more control over payouts.
Non-equity based plans can take several forms, such as:
- Performance unit plans (PUP): A fixed number of “units,” each worth a certain dollar amount, are given as a reward. Based on how well a given employee has achieved their set performance goals by the end of the time period, the value of each unit can increase or decrease. For instance, if an employee’s performance goal were based on return on equity (ROE) over four years, with a target of 15% and a reward of 1000 “units” valued at $15 each, they would receive $15,000 (1000x$15). If the average ROE exceeded the 15% target and hit 17%, the employee would receive more than $15,000 (1000 units valued at $17 each for a total of $17,000).
- Book value plans: The total reward amount is based on the change in the organization’s book value (total assets-total liabilities) over the measurement period. This LTIP is more frequently used in private companies.
- Multi-year performance plans: The total reward amount is earned in portions over each subsequent year, and are paid out piece by piece in each year.
Challenges of Non-Equity Based Long-Term Incentive Plans
Here are some of the common drawbacks that your organization should be aware of when considering a non-equity based plan:
- Less focus on performance in the beginning of the measurement period. Since rewards are usually paid out at the end of a given time period, employees may not be as motivated at the start of a performance cycle.
- Employees may perceive that their rewards are being “held back” from them. Because of the long-term nature of many of these payout types, employees may not feel as rewarded early on.
- Typically, only senior management is eligible to participate in these plans. Whereas equity-based LTIPs might potentially be available to more employees, these long-term cash rewards are generally intended for senior
Long-term incentive plans motivate employees to consider your organization’s growth over time and avoid focusing too much on short-term financial success, but you may find that it only makes sense for a handful of individuals.