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Long-term incentives may be defined as a reward system designed to improve employees' long-term
performance by providing benefits that may not be tied to the company's share price. In a typical
long-term incentives plan, the employee (usually an executive) must fulfil various conditions and/or
requirements that prove that he or she has contributed to increasing shareholder value.
The purpose of the long-term incentive is to reward executives for achievement of the companys
strategic objectives that will maximize shareholder value. These may be provided in the form of
stock-based compensation, such as stock options, restricted stock, performance shares, cash, or
stock-settled performance units. Usually, long-term incentives are a mix of types of equity and may
include a cash component. The performance period for a long-term incentive typically runs between
three and five years, with the executive not receiving any pay from the incentive until the end of the
performance period.
Long-term incentive goals vary by company but the most prevalent are focused on total return to
shareholders, operational measures such as earnings per share and return measures, such as return
on assets. Like annual incentives, long-term incentives are typically structured to include a targeted
level of performance, as well as a stretch component to reward executives for achieving superior
performance. Long-term incentives are important part of a well-balanced pay plan, as they ensure
alignment with the shareholder interest, especially when combined with appropriate stock
ownership guidelines.
Long-term incentives are forms of variable (at risk) compensation based on the achievement of
longer-term performance and objectives. Primary objectives are to:
Align executive interests with shareholders, and executive pay with company
performance and strategy
Balance annual incentives with focus on long-term (3- to 10-year) results
Retain executives
Facilitate long-term executive stock ownership
Types of Long-term Incentives
Performance-based
Vested Stock Bonus
--An award of stock given to executives to reward specific performance.
Outright Award
Taxable to employee based on full market value at the time of the grant
Deductible to employer at same time and same amount
Restricted Stock Bonus
--an award of stock that has further restrictions that must be satisfied before the stock
can be owned.
Requires that the executive must stay with the company during a vesting schedule or
meet some specific performance goals.
Taxable to employee when restrictions are removed (Deductible to employer at same
time and same amount)
Stock Option Plans
--gives the executive the right to purchase company stock in the future at a price that
is fixed at the date of the grant.
Value of options not reported on accounting records
Options given to executives dilute value of stock owned by other shareholders
Strike price of stock options are set at time of grant and may be set at market price of
stock on day of grant, or some other price of the stock.
Stock options are given a period when they can be exercised which in most cases is
around 10 years.
Stock Appreciation Rights (SARs)
SARs mirror stock options - receives cash difference between strike price and market
value of stock
No investment on part of executive required
Gives executive feel of ownership without giving up control to executive
Non-Performance-based
Founders equity
Restricted stock tied to Executive tenure - golden handcuff
Stock options given as a Recruiting Bonus
In addition, there are some assured benefits given the employees at the time of retirement. For
example, health insurance coverage, pension plan, gratuity, provident fund, etc. However, for most
of the workers, social security payments alone will not replace the income acquired from on the job
earnings. Hence, companies offer a variety of long-term incentives which can significantly enhance
their social security and pension plan earnings.
The recognition of the relationship between organizational survival and long-term incentives is
promoting a willingness to perform in a manner that helps ensure organizational success. Thus,
long-term incentives have become psychological imperative which in turn augments employee
commitment, involvement and engagement with the organization.