Long-term incentive: Overview, definition, and example
What is a long-term incentive?
A long-term incentive (LTI) is a compensation strategy used by businesses to reward and motivate employees, particularly key executives or high-performing employees, for achieving long-term goals or contributing to the company’s growth over an extended period. Long-term incentives are designed to align the interests of employees with the long-term success of the company. They are typically granted in the form of equity, stock options, performance shares, or other deferred compensation plans that vest over time, often after a period of several years.
LTIs are used to retain talent and ensure that employees have a vested interest in the company’s future performance. These incentives are different from short-term bonuses or commissions, as they are intended to encourage long-term commitment and sustained contributions to the company’s success.
Why are long-term incentives important?
Long-term incentives are important because they help companies retain top talent by offering rewards tied to the company’s future performance and growth. By linking compensation to long-term goals, businesses encourage employees to think strategically about the future and invest their efforts into the company’s long-term success rather than focusing solely on short-term gains.
For businesses, LTIs also serve as a tool for fostering loyalty, enhancing performance, and ensuring that key employees remain engaged with the company for the long haul. For employees, long-term incentives provide the opportunity to benefit from the company’s success over time, which can be particularly motivating for those with a stake in the company’s growth.
Understanding long-term incentive through an example
Imagine a company offering its executives a long-term incentive plan that includes performance-based stock options. The executives are granted stock options that allow them to purchase company stock at a discounted price, but these options only vest after a period of three years. The vesting is contingent on the company’s performance, such as achieving a certain stock price or revenue growth. If the company performs well, the executives can exercise their options and profit from the stock's increased value. This creates an incentive for the executives to focus on the company’s long-term growth and profitability.
In another example, a company might offer its employees performance shares that are linked to achieving specific long-term goals, such as increasing sales or expanding into new markets. These shares vest after several years and are designed to reward employees for their sustained contributions to the company’s strategic objectives.
An example of a long-term incentive clause
Here’s how a long-term incentive clause might appear in an executive compensation agreement:
"The Company agrees to provide the Executive with long-term incentives in the form of performance-based stock options. These options will vest over a three-year period, subject to the Company achieving certain financial targets, including a minimum revenue growth of 10% per year. The Executive may exercise these options only after they have vested and in accordance with the terms outlined in the Stock Option Plan."
Conclusion
Long-term incentives are a key component of employee compensation, especially for executives and high-performing employees, aligning their interests with the long-term success of the company. These incentives foster loyalty, retention, and a focus on strategic, sustainable growth. By offering long-term incentives such as stock options, performance shares, or other equity-based compensation, businesses can motivate employees to contribute to the company’s long-term objectives and reward them for their sustained efforts.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.