Long-term incentive eligibility: The make or break decision

Long-term incentive eligibility: The make or break decision

The most important decision a client will make when designing and implementing a long-term incentive (LTI) plan concerns who should participate in the plan. While eligibility seems like a simple and somewhat innocuous decision, it can have a great impact on the effectiveness of the plan—as a sustainable & cost-effective tool. This can be a crucial decision for the CEO and Board.

So, why is eligibility so important? In short, if you pick the wrong person for plan participation you will significantly overpay for their retention (if you even needed to retain their services, at all) and they will absorb scarce “value creation” compensation dollars that would be better awarded to a more deserving executive or contributor.

Further (and more painfully), if you find that you have chosen the wrong contributor (or they just up and quit) after they have been in the plan a couple of years, unwinding their agreement can be complicated and costly—particularly if they hold vested rights. 

What can a company do to select the right participants for their long-term incentive plan? Try our three selection criteria or tests.

  1. Only include cannot-lose executives. If you are trying to retain key talent for, say, five years, be sure that the selected participants are those who will have the greatest impact on company success for the next half decade. And, they are one of the very few contributors you cannot afford to lose to competitors. [the competitor test]
  2. Minimize rewards for past contributions. Often clients desire to use LTI plans to reward executives for past contributions or loyalty. If you have such a group of executives and they do not meet the competitor test, limit their participation in your LTI plan. Better yet, create a separate Founder’s Reward plan that is not part of the LTI plan—or is a limited branch of it. [the save your money for the future test]
  3. Limit eligibility to a small group. If you are firm under (say) $100 million in revenue, our experience suggests you will generally select no more than 2-4 eligible executives or contributors. As a company grows to twice or three times that size, you can consider doubling participants. But always ask yourself: “How many key players does it really take to run this company?” We typically find that the answer is less than more. [the run the company test]  

As you can see, we generally come down on the side of limiting the number of select LTI plan participants. This generally yields the most deserving participants, provides better outcomes and preserves future flexibility. And, you can always add more later.

If you are considering a long-term executive incentive plan, weigh the decision of eligibility carefully. Selecting the right contributors will make your plan cost effective for the company and a real winner for company and participant alike. Try applying our three rules and see if they help. And, if you have more rules you believe are helpful, please pass them along.

Wilkening & Company has helped privately-owned and operated clients design and implement long-term incentive plans for key executives for over 20 years. Eligibility is one of the key decisions that must be made as part of LTI design. During the remainder of 2013, we will discuss other decisions.
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