The Strategic Leader's Guide to Long-Term Incentives

If there is one thing HR leaders know, it is that employees are motivated by different rewards. Some like rewards they can receive now. Others like rewards that grow over time. And these differences are important.

Without long-term incentives, organizations rely only on short-term pay. That only limits retention, engagement, and alignment with the company's strategic goals. Long-term incentives give rewards in the future, and these rewards often depend on company growth or employee performance.

This guide explains what long-term incentives are and why they are important. It also explains the common types and simple steps to create a program.

Along the way, HR can find some practical solutions that support their LTI efforts and improve employee retention and financial performance.

Chapter I. What Are Long-Term Incentives?

Long-term incentives (LTIs) are extra pay that employees can earn over a long time. This type of pay is not guaranteed. Employees only get it if they reach goals or stay in the company for a set time, often more than one year.

LTIs also come as company shares or long-term cash rewards. Common examples are:

• restricted stock units (RSUs),

• performance share units (PSUs),

• stock options,

• and cash plans that pay after several years.

Moreover, a long-term incentive plan (LTIP) is the program that manages these rewards. Such programs explain who can receive the rewards, what goals employees must reach, and how long they must wait before they fully earn them. Many LTIPs use a vesting period of three to five years.

Equity planning and tracking are also important in long-term incentives. Companies should record each award, follow tax rules, and update plans when business needs change. Fortunately, solutions CompXL® by Salary.com help make this whole process easier. It can help companies plan, manage, and track long-term awards in a clear and organized way.

1.1 Utilizing long term incentives vs short term incentives

The main difference between these two types of variable pay is how long they focus and why they are used.

1.1.1 Short-Term Incentives (STIs)

These are often given through annual incentive plans (AIPs), discretionary bonuses, or spot awards. They are meant to reward employees for reaching specific goals set at the start of a performance period, often one year or less.

They also focus on short-term results and daily business performance. And most of the time, these rewards are paid in cash because they are based on immediate achievements.

1.1.2 Long-Term Incentives (LTIs)

These rewards focus on results over many years, often three to ten years. The goal is to balance the yearly performance with steady and lasting growth.

While short-term incentives (STIs) encourage strong performance in the current year. In contrast, long-term incentives (LTIs) help connect leaders' interests with shareholders, support long-term organizational stability, and encourage executives to own and purchase company stock.

1.2 Long-term incentives plan: advantages and disadvantages

Setting up a long-term incentive plan make employees work harder but also needs careful handling of costs and rules. Below are the pros and cons:

1.2.1 The advantages

• Retain key employees: Long-term incentive plans (LTIPs) act like "golden handcuffs" as employees lose big rewards if they leave before meeting the rules.

• Matching goals: LTIPs also make sure employees' rewards depend on the company doing well.

• Thinking long-term: Rewards based on several years' results help employees focus on company's long-term success instead of quick gains.

• Attracting key talent: Giving a share of future profits brings in top employees in a competitive market.

1.2.2 The disadvantages and risks

• Hard to manage: Setting up these plans can be tricky due to complicated rules about law, taxes, and accounting.

• Fewer shares for others: Giving employees company shares can reduce the value of existing shares, which may worry investors.

• Stock risk: Changes in the economy possibly make stock prices drop, which make stock rewards worthless even if employees work hard.

• Cheating the system: If goals are unclear, employees might focus only on hitting them and ignore what is best for the organization.

1.3 Real-life examples of long-term incentives

Top companies make long-term reward plans (LTIPs) that fit their business. Some focus on fast growth, while others want to beat their competitors. Here are some examples of how big companies do this:

1.3.1 NVIDIA

NVIDIA's executive plan shows a "growth + R&D" focus. They give Performance Stock Units (PSUs) that depend on reaching big revenue and profit goals. At the same time, the plan uses multi-year Total Shareholder Return (TSR) with set minimum, normal, and high goals to encourage employees to help the company grow.

1.3.2 Apple

Apple uses a "percentile-based Relative TSR" model for its performance RSUs. Employees earn shares based on how Apple's TSR compares to the S&P 500 over three years.

The rule is simple: If performance is below the 25th percentile, they get nothing. If it is at or above the 85th percentile, they can earn up to double.

Apple also has a rule that limits vesting to 100% if the company's overall TSR is negative. This means that it stops executives from getting big rewards when the market is down, and even if Apple does better than others.

1.3.2 Starbucks

Starbucks has a two-part equity plan for the company. For executive compensation, it gives multi-year performance RSUs that adjust based on "talent" and "sustainability" goals, so rewards connect to their financial and non-financial results.

For frontline workers like baristas and store teams, Starbucks offers "Bean Stock," a company-wide equity reward. Eligible partners receive Bean Stock RSUs, which turn into shares over two years, as long as they stay employed.

After one year, employees get the first half of the shares; after two years, they get the second half. Once received, shares can be held or sold.

1.3.3 Microsoft

Microsoft uses a multi-metric model to balance growth goals with market performance. Its performance stock awards are based on different measures, like 35% for commercial cloud revenue growth and 35% for Microsoft 365 Consumer revenue growth.

And to make sure final rewards match shareholder results, the tech giant often adjusts these operational goals using a relative TSR factor.

1.3.4 Walmart

Walmart's LTIP gives long-term performance rewards based on ROI, sales, and stock results. The plan starts with a one-year performance period and includes extra time before the rewards fully vest.

1.3.5 Konecranes PLC

In 2016, Konecranes PLC introduced a share-based LTIP where rewards depended on employees staying with the company and on the group's adjusted EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization).

To help employees manage the financial impact, part of the award was paid in shares and part in cash, with the cash meant to cover taxes and related costs. The shares then came with a restriction period during which eligible employees could not be sold or transferred.

Chapter II. Selecting the Right Equity-Based Vehicles for Talent Alignment

To make a good Long-Term Incentive Plan (LTIP), companies need to choose the right mix of rewards that fits how stable their business is and how their money is set up.

Here are some common types of long-term incentives:

LTI Type	Meaning	How It Works
Restricted Stock Units (RSUs)	A promise to give shares or cash later	The employee gets shares after staying in the company for a set time (vesting)
Performance Share Units (PSUs)	Shares given based on company performance	The number of shares depends on goals met over several years
Stock Options / NQSOs	A right to buy shares at a fixed price later	The employee can buy shares at the set price within a time limit

2.1 Restricted Stock Units (RSUs)

Restricted Stock Units (RSUs) are commitments to grant a specific number of shares or a cash equivalent at a future date once service-based vesting requirements are met.

As "full-value awards," they are considered less risky than stock options because they almost always retain positive value as long as the share price remains above zero.

Restricted Stock Units (RSUs) are promises to give a certain number of company shares (or their cash value) at a future date, as long as the employee meets the required service period.

They are also called "full-value awards" because, unlike stock options, they hold value as long as the company's stock price stays above zero, which make them less risky.

RSUs are the most common long-term reward in public companies. About 91% of public companies use them to keep employees from leaving, like a "golden handcuff."

But one problem is that employees have to pay regular income tax when the RSUs become theirs. This can make them sell some shares right away to pay the taxes.

2.2 Performance Share Units (PSUs)

Performance Share Units (PSUs) are rewards given to employees that depend on reaching certain goals over several years, often three. The amount an employee gets can change depending on how well the goals are met and how the company's stock price moves. They help connect employee rewards directly to the company's long-term goals.

About 64% of public companies use PSUs. People who own the company like them because they reward employees for doing well. PSUs can give no reward if goals are not reached, or a big reward if goals are done very well.

2.3 Stock Options & Non-Qualified Stock Options (NQSOs)

Stock options, like Non-Qualified Stock Options (NQSOs), let employees buy company shares at a fixed price for a set time, often up to ten years. They let employees earn more if the stock price goes up a lot.

But stock options can be risky. They can become worthless if the stock price drops below the set price. They are still common in fast-growing or new companies, but fewer companies use them now because of accounting rules and a move toward rewards that depend on performance.

Chapter III. How to Structure a Long-Term Incentive Plan

A good Long-Term Incentive Plan (LTIP) needs a clear and simple plan. First, the company understands its long-term goals. Then, it uses strong rules and oversight to make sure the plan follows guidelines and supports those goals. Here are the steps:

Step 1: Identify Company Goals

The base of any LTIP is knowing the long-term goals of the company, like growing market share, improving financial results, or creating new ideas. Management can do a pay gap analysis to see if current results are low because employees are not fully motivated.

If employees have the skills but do not give steady effort for long-term projects, a clear incentive program can help improve their effort and behavior.

Step 2: Determine Eligibility

Companies need to decide who can join the LTIP based on factors like job level, pay grade, job title, or job duties. In the past, LTIPs were mostly for top executives. Now, about 53% of public companies also give them to employees below the vice president level. In private companies, LTIPs are still often given only to senior leaders.

Step 3: Select Appropriate LTI Vehicles

Boards need to choose a mix of reward types that fit the company's money setup and how stable the business is. Public companies often use a mix of rewards, often RSUs to help keep employees and PSUs to reward strong performance.

On the other hand, private companies and non-profits often have stock that is hard to sell, so they often use long-term cash plans or phantom stock. The type of reward chosen shows if the reward depends on stock growth, time, or performance.

Step 4: Define Performance Metrics and Outcomes

After the goals are set, the company needs clear and easy-to-measure targets, like Total Shareholder Return (TSR), Earnings Per Share (EPS), or profit. The company can also add extra factors, like talent or sustainability, to show other important sources of value.

Payouts follow vesting schedules, typically lasting three years. Companies choose between cliff vesting, where employees get full ownership on one date, or graded vesting, where ownership is given in steps over time.

Step 5: Establish Governance and Compliance

The last step is to make sure the plan follows the law, accounting rules, and tax rules, including IRC §409A, to avoid big fines. Companies should also have safety rules, like clawback policies (used by half of public companies) and anti-hedging rules.

Then, companies need to explain the plan clearly in award agreements and summaries so employees understand how their work and time with the company affect rewards. Many organizations use special software like CompXL® to make this easier and track results in real time.

Chapter IV. Precision in Performance Measurement & Benchmarking

It is very important to measure performance carefully because the goals in Long-Term Incentive Plans (LTIPs) guide executives to work toward specific company results.

Companies also need to set clear goals that can be measured, usually looking at sales growth, profit, or stock price, so it is easy to see if employees earned their rewards.

In public companies, the most common goals for long-term rewards are profit (65%) and Total Shareholder Return (TSR) (47%). In non-profits, the main goals are profit (74%) and other strategic goals (48%).

4.1 Relative Performance and Benchmarking

Checking performance against other companies makes sure employees get rewards for doing better than others, not because the economy is growing.

Relative Total Shareholder Return (rTSR) is the most common performance goal. About 76% of performance based award plans use it, either as part of the reward or to adjust how much is paid.

For example, Apple uses performance-based RSUs that depend completely on how its Relative TSR ranks against the S&P 500. Employees can get between 0% and 200% of the target amount.

To stop employees from "winning by losing less," Apple has a rule that limits vesting to 100% if the company's TSR is negative, even if it ranks high compared to others.

4.2 Multi-Metric Design and Strategic Modifiers

Modern LTI scorecards now use several financial goals to give a fair and complete view of performance.

Microsoft shows a multi-goal method. As mentioned, they give 35% weight to commercial cloud revenue growth and 35% to consumer revenue growth, then adjust based on relative TSR. This setup helps managers see their work goals clearly while keeping rewards tied to how shareholders do.

Also, companies like Starbucks are including "talent" and "sustainability" factors, and these can increase or decrease rewards based on important non-money goals.

4.3 Achievement Levels: Threshold, Target, and Maximum

Good LTI plans set clear goals using payout curves. Most public companies set three levels: Threshold (52%), Target (74%), and Maximum (63%).

• Threshold: The lowest performance needed to get any reward; 28% of public companies set this at half of the target.

• Target: The reward given for expected results.

• Maximum (Stretch): The highest reward for very strong performance, usually up to twice the target.

Because of uncertain economic conditions, some companies make the range from threshold to target wider. This makes it more likely employees get a reward and reduces the chance of getting nothing, and helps keep the plan motivating even when the market is unstable.

Chapter V. FAQs

Now that the main types and setup of long-term incentives are clear, here are some common questions with simple answers about how LTIs work in real companies.

5.1 Who is usually eligible for LTI plans?

Before, long-Term Incentive Plans (LTIPs) were mostly for senior executives, especially in private companies. Now, more companies give LTIs to more employees. About 53% of public companies give them to employees below the vice president level.

CEOs and officers almost always get these rewards, but managers and other salaried employees may or may not, depending on the type of reward. Restricted Stock Units (RSUs) are the most common for giving to more employees. Companies often decide who can get LTIs based on job level (63%), individual performance (41%), and salary grade (36%).

5.2 How often are these awards typically granted?

In public companies, most LTIs are given every year. About 90% to 92% of companies do this, so part of an employee's pay is always linked to future performance and service. Private companies and non-profits give LTIs every year less often, about 64% of the time. LTIs are also often given when someone is newly hired (72%) or gets a promotion (46%).

5.3 What is the most common vesting period?

In all types of companies (public, private, and non-profit), a three-year vesting or performance period is the most common. About 65% to 66% of public companies use three years, 61% of private companies, and 86% of non-profits. Most companies use a mix of time- and performance-based vesting to keep employees and meet company goals.

5.4 Are LTIs paid in cash or stock?

LTIs can be paid in cash or company shares, depending on the type of company. Public companies usually give real shares, with RSUs (91%) and performance shares (64%) being the most common. Private companies mostly use long-term cash plans (34%) because their shares are harder to sell and value. Non-profits use cash plans even more, with 80% using cash and almost no share awards.

What happens to the incentives if an employee leaves the company?

LTIs have a risk of being lost, which means employees give up awards that are not yet vested if they leave the company before meeting the time or performance goals. This "golden handcuff" feature helps keep top talent for a long time. Good LTIPs also include clear rules about what happens to awards if someone leaves, retires, or if the company changes ownership.