Leveraging Long-Term Incentives (LTI) in Executive Pay

LTI integral to Total Remuneration

Long Term Incentives (LTI) are defined as share/stock or cash-based payments provided to employees over and above 1-year period as a reward for the achievement of service or performance objectives.

Long-term Incentives are a valuable part of the total remuneration package for executives, which helps in delivering rewards while enabling leaders to focus on desired future objectives. There are varying types of LTIs – cash-based or equity-based, which work as a strategic compensation vehicle to promote long-term retention and alignment with company & shareholder goals.

How does LTI factor in the overall pay mix of Executives?

The typical approach followed for Pay Mix [Fixed: Short term incentives (STI): Long term incentives (LTI)] is:

The higher the level in the hierarchy, the higher the pay at risk.
Higher quantum is delivered through deferred incentives at senior levels.
Pay mix likely to vary by Organisation Size, Business Cycle Maturity, and Industry.
Pay mix may vary by the nature of the role. E.g.: Head of Sales is likely to have more STI compared to the Head of Operations or Head of Strategy.

The pay mix we see in India across mature organizations and start-ups is illustrated below. LTI represents – Long Term Incentives; STI represents – Short Term Incentives / variable Pay. Data Source – Mercer India Total Remuneration Survey

What works well – cash-based, or equity-based LTI?

There are varying LTI instruments across the Cash and Equity continuum that can be used to design an effective incentive plan.

Cash-based plans are more flexible and simpler to administer, equity-based plans may provide participants with a stronger sense of ownership and alignment to value creation now and over the long term. Based on the objectives and business context, the right category of plan is chosen.

Should LTI be given as a one-time award or annual award?

Whether to give Annual vs. one-off awards is a decision based on the company's growth stage and the objective of the plan (wealth creation/retention / sustained delivery of total rewards)

	Annual awards	One-off award
Strengths	Provides incentive for ongoing delivery of company value. Lower maximum opportunity Easier to set targets annually for a 3-year performance period, in case of performance-linked vesting. Typical market practice	Quantum is typically higher (as it replaces more than one year’s awards) and this can be highly motivational. Provides better alignment with a slightly longer-term plan and focuses on milestones. Typical plan for start-up or turnaround situations
Considerations	May build an expectation of the same award size every year. Works better for companies in the mature stage	Can be de-motivational if targets are not met after a few years. Can create a retention risk at the end of the plan

Will the same LTI plan deliver across different levels of leadership talent?

The same plan may not deliver the organization’s & shareholders’ objectives. The more strategic or senior the level with the higher scope of influence, the higher should be the linkage between pay and performance.

Performance Parameters under consideration for LTI plans of Executives and the role of ESG.

There is a wide spectrum of performance measures that can be considered to link performance-based vesting of LTI plans. Most companies use 2-4 metrics for performance vesting. Mature organizations will typically include 2-3 internal measures like Revenue Growth, EBITA, Return on Investments, etc, and have an external metric like Relative Total Shareholder Return (RTSR) blended in the plan.

ESG is quickly moving into Executive Incentive Plans across markets.

72% of the S&P 500 either uses ESG metrics in their incentive plans (47%), in NEO performance assessments (16%), or will next year (9%).
Weighting of ESG metrics as a percentage of all plan metrics is typically 5% to 10%.
In ESG, common Human Capital metrics include employee engagement, diversity, pay equity, safety, and learning and development.
Employee safety is the most common metric tracked in STI focused more on operational efficiencies; DE&I is the most tracked ESG metric in LTI.

The Governance View

Investors in India are becoming more vocal, which is reflected in the increased pushback on shareholder resolutions on new LTI plans in recent times. While several resolutions were still passed because of the promoters’ vote, a growing awareness among investor groups has led to higher scrutiny of LTI plans in recent times.

Institutional investors like SBI Mutual Fund and UTI Mutual Fund gave 54% and 61% ‘against’ votes for LTI plan proposals in 2022-23. The top reasons for rejection are:

Deep discounts on ESOPs
Sole discretion of NRC on pricing of Stock options
Replacement of vehicles at discounted prices
Lack of coverage of ESOP plans
Only RSUs are being given to senior levels.

How to get Long-Term Incentives Right?

Considering the above, it may feel like getting LTI right is a complicated process. In reality, getting LTI right for the intended recipient is a process of navigating through key decisions of – Eligibility, Award Size, Instrument Type, Vesting Tenure & Conditions, and Grant Frequency in a structured way.

At Mercer, we are committed to helping our clients navigate through this journey as knowledge experts.

Author

Debasmita Das
Principal | Senior Director
Compensation Consulting Mercer India