Multi-year share-based variable compensation, also known as long-term incentives (LTI) is facing key challenges in the wake of the Covid-19 pandemic, supply chain problems and war. hkp/// group consultants Barry Kitz and David Voggeser discuss individual impacts and the need for crisis-related adjustments to LTI as well as options for action in times of economic uncertainty.
The article comes from COMP & BEN. The German online magazine reports in six issues per year as well as on the website personalwirtschaft.de about compensation and benefits topics. >> To the interview on personalwirtschaft.de
Mr. Kitz, Mr. Voggeser, are LTI actually still useful in an economic environment like the one we have at the moment?
Barry Kitz: It’s true that HR and Comp&Ben managers are currently confronted with challenging compensation issues. First, the Covid-19 pandemic with its lockdowns and subsequent supply problems, and now the effects of the Russian invasion of Ukraine accompanied by an energy crisis; all these elements point towards weaker economic development and, at first glance, argue against the use of compensation plans based on economic success factors.
David Voggeser: LTI in particular are compensation plans that are geared to long-term success and incentivize opportunity. Ideally, those eligible receive a financial reward in the form of shares or equity-based instruments, i.e. payouts of equivalent value, for exceptional performance and success over a defined period of time – generally around three to five years. In this context, it's accepted that there will also be weaker phases that need to be overcome.
But this can also lead to tranche payouts being lower than their target value or, in the worst-case scenario, even dropping down to no value at all.
David Voggeser: And that's important to remember: LTI incentivize a realistic chance of success, but there is also risk involved. At the end of the day, the fundamental principle here is that compensation responds to a company’s sustainable success.
Barry Kitz: As LTI are granted annually, more than half of payouts of healthy companies are positive. And that is in no small part due to the fact that LTI focus on a sustainable increase in company value and the achievement of long-term goals.
Given today's uncertainties, is it still possible to attract executives and other employees by offering LTI? Are they still effective as a performance incentive?
David Voggeser: It's exactly this involvement in increasing company value that has such a motivating and identification-boosting effect. We’ve seen this happen in our consulting projects at both national and international level, and studies have confirmed it as well. Research shows that identifying with an employer has a positive impact on corporate performance. And that’s another reason why companies continue to include LTI in their compensation toolkit.
Barry Kitz: A growing number of companies are also incorporating ESG targets into their LTI plans, which is increasing the focus on sustainability, environmental and social aspects – lots of managers and employees now see these as extremely important and are calling for them to be taken into account when setting targets and consequently when determining compensation.
Are there any contractual provisions for adjustments to LTI in the event of exceptional events such as a natural disaster, war, etc.?
Barry Kitz: For this, we need to differentiate between adjustments made before an LTI tranche is granted and adjustments made during its term. The first can of course reflect exceptional developments and also takes into account things like changes in corporate strategy.
But existing tranche terms make things more difficult?
David Voggeser: Adjustments to existing tranches aren’t common practice. However, there are sometimes adjustment options in place within plans for specialists and executives below Executive Board level.
What are these options?
Barry Kitz: Exceptional external events can be excluded at the end of a tranche's term. This can be done, for example, by calculating EBIT as a basis for assessment as though certain exceptional factors never happened.
David Voggeser: Market comparison, i.e. comparing your own company's targets with those of competitors, is another option. Here, it's no longer the absolute increase in value that matters, but, for example, if your own share price has fallen less than that of a competitor in a similar situation.
How often do you see such adjustments being made? Don't these create certain expectations among those eligible?
Barry Kitz: Even if there is an option for subsequent adjustments in LTI plans, such modifications should only be made in exceptional cases, ultimately because they can generate expectations among recipients that counteract the principle of performance-based participation and in turn the promotion of entrepreneurship.
David Voggeser: That's why we also frequently encounter the strict view that crises are part of economic life and are to be managed in the spirit of entrepreneurship, and that such developments, both positive and negative, should also be reflected in compensation.
Is there a minimum payout level for LTI plans?
Barry Kitz: Share-based variable compensation over several years isn’t subject to minimum compensation. It is designed such that compensation is paid out based on the achievement of targets. Therefore, a payout can even drop to nothing in the event of poor performance.
Aren't STI plans more appealing to executives in volatile times?
Barry Kitz: That sounds reasonable, but it always depends on individual preferences. In purely economic terms, direct or indirect participation is often more profitable, because in addition to specific KPIs, the company’s value also has an impact on payout.
What impact do you think LTI have on retention?
David Voggeser: Research shows that participation, including employee share programs, can significantly increase loyalty among employees. However, these results will have to be put to the test given an increasing shortage of skilled workers and a coinciding severe crisis situation. Nevertheless, we believe in the effectiveness of a balanced mix of short and long-term variable compensation in attracting, retaining, and motivating specialists and executives.
Mr. Kitz, Mr. Voggeser, thank you for your time.