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Long-Term Incentive Plan (LTIP)

Definition

A Long-Term Incentive Plan (LTIP) is a reward system used by businesses to incentivize and retain key employees via significant financial benefits, typically through shares or cash bonuses. These incentives are contingent upon achieving certain goals or criteria over a long-term period usually spanning several years. The intent is to align the interests of such employees with stakeholders to advance the company’s growth and performance.

Phonetic

The phonetic pronunciation of “Long-Term Incentive Plan (LTIP)” would be:Long-Term: “lɔŋ tɜrm”Incentive: “ɪnˈsɛntɪv”Plan: “plæn”LTIP: “el-tee-eye-pee”

Key Takeaways

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  1. Employee Retention and Motivation: LTIPs are designed to incentivize and retain key employees by aligning their long-term rewards with the success and growth of the company. This encourages staff to work harder and stay with the organization longer, which is often beneficial for business continuity and growth.
  2. Performance-based: LTIP rewards are often tied to the achievement of certain pre-determined performance metrics over a specific period of time. These performance metrics could be related to the company’s financial performance, share price, or individual performance targets. This ensures that rewards are linked to the creation of shareholder value.
  3. Deferred Compensation: Payments under an LTIP are typically deferred and vested over a period of time to incentivize sustained performance. This deferred nature of payouts ensures that employees have a continual incentive to perform and contribute to the long-term success of the company.

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Importance

A Long-Term Incentive Plan (LTIP) is a critical business/finance term because it’s a company strategy designed to motivate and retain key employees or executives by providing them with a special compensation based on meeting certain performance goals. LTIPs often play an essential role in attracting highly skilled professionals and maintaining a competitive edge in the market. They help align the interests of employees with shareholders as the incentives are typically tied to company performance. When done correctly, LTIPs can lead to increased employee productivity and engagement, a boost to company performance in the long run, and greater shareholder value.

Explanation

The primary purpose of a Long-Term Incentive Plan (LTIP) in the business domain is to motivate key employees to accomplish specific long-term strategic goals that drive the company’s growth and increase shareholder value. By offering a tangible reward for significant performance over an extended period, usually three to five years, LTIPs align the interests of the employees with those of the shareholders. These plans aim to retain top-level management and strategically important employees, ensuring the stability and the continuity of the business, by keeping their focus steadfast on long-term objectives rather than short-term monetary gains.Long-Term Incentive Plans serve as a valuable tool for companies to foster loyalty and dedication since the realization of benefits generally requires an employee to stay with the company over the long course. Furthermore, these programs are structured such that they reward employees for improving the company’s performance metrics like earnings per share (EPS), return on investment (ROI), or total shareholder return (TSR) which are typically of direct importance to the shareholders. So, LTIPs also enable the bridging of interests of the company’s management and its shareholders, promoting a culture of ownership among the employees which is crucial for the company’s success in the long run.

Examples

1. Alphabet Inc. (Google): The parent company of Google, Alphabet Inc., uses a long-term incentive plan (LTIP) for its top executives. The executives are offered stock options and performance shares that are set to vest over a certain period of time. The vesting of these stocks and shares is usually based on performance metrics such as the company’s share price, earnings per share, or revenue growth. In this way, Alphabet Inc.’s LTIP encourages the executives to improve the company’s performance over time.2. General Electric (GE): General Electric is another company that offers LTIPs to its key executives. Under its LTIP, executives are rewarded with Performance Stock Units (PSUs) that vest over a period of three years. The ultimate value of these PSUs depends on the company’s performance in terms of industrial cash flow and adjusted earnings per share. This incentive plan aligns the executives’ interests with those of the shareholders, with the aim of improving the company’s performance in the long term.3. Ford Motors: Ford uses a LTIP for its executives that’s based on certain performance metrics that include metrics such as return on invested capital and vehicle quality. The LTIP includes cash and equity awards that mature over a multiyear period. This encourages long-term strategic planning and sustainable growth, enhance shareholder value and promotes retention of their key executives. Ford’s approach is intended to balance the attraction and retention elements of their program with the need to provide a strong link between pay and performance.

Frequently Asked Questions(FAQ)

What is a Long-Term Incentive Plan (LTIP)?

An LTIP is a reward system used by companies to incentivize and retain key employees. It is aimed at promoting loyalty and company performance by tying rewards to long-term goals and objectives.

How does a Long-Term Incentive Plan work?

LTIPs work by setting tangible goals for employees over a specific period. If the employee meets the goals, they become eligible for a preset reward, often paid in company shares, stock options, or cash.

Who typically receives a Long-Term Incentive Plan?

LTIPs are typically awarded to executives, senior management, and key employees within a company, individuals whose performance significantly impacts the company’s success.

What types of rewards are involved in a Long-Term Incentive Plan?

The incentives provided in an LTIP can either be cash bonuses, company shares, or stock options. The exact nature of the reward varies based on the company’s structure and goals.

How long is a long term in a Long-Term Incentive Plan?

The definition of “long term” can vary based on the company’s goals and strategies, but it typically ranges from 3 to 5 years.

How are the goals in a Long-Term Incentive Plan determined?

The goals in an LTIP are set by the company’s board of directors or a designated committee. Frequently, they are linked to the company’s strategic objectives or financial performance measures.

How do Long-Term Incentive Plans contribute to business success?

LTIPs can improve a business’s success by motivating key employees to work towards the company’s long-term goals. They also help to retain these key employees, reducing turnover.

What is the tax implication of a Long-Term Incentive Plan?

The tax implications of LTIPs can vary depending on the specifics of the plan and the recipient’s personal tax situation. They are generally taxed in the year they are vested or received.

Can employees sell or transfer shares obtained through LTIP?

The ability to sell or transfer shares obtained through an LTIP is typically subject to specific rules set by the employer such as holding periods or vesting schedules.

Related Finance Terms

  • Vesting Schedule
  • Performance Shares
  • Executive Compensation
  • Stock Options
  • Deferred Compensation

Sources for More Information

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