Attracting and retaining top-level management talent and creating incentives to maximize performance are critical for all organizations.

Through economic ups and downs, after periods of great technological innovation, and regardless of whether a business has outsourced to developing nations, quality managerial talent is vital. Long-term incentive plans — such as deferred compensation, phantom stock, and stock options — are important compensation components used in attracting and retaining executives. Additionally, these plans can maximize executives’ performance by providing opportunities for them to share in the value that they help create.

How? To begin, the design and magnitude of the program can attract top talent. For example, a successful middle-aged executive may be attracted by a generous retirement supplement, or a young leader may be enticed by a phantom stock interest to move across the country to lead a new start-up venture. Second, the use of vesting schedules and the prospect of future additions to the amount of the benefit can help retain executives. Finally, program design can tie the benefit to organizational performance, such as stock price, or it can tie the benefit to achieving important organizational goals, such as return on equity or gross margins of a certain business interest. This is true even in smaller organizations.

Executives typically have a need to accumulate much more retirement savings than qualified retirement plans, such as a 401(k), can provide. Moreover, these employees have a desire to do so on a tax-efficient basis. Directly or indirectly, executives tend to want the psychological and monetary benefit of a successful business owner — something to show for their hard work.

Often, organizations will identify a product, like a life insurance policy, and then try to craft a plan design that incorporates the product. Organizations will be better served by first considering goals, needs, performance benchmarks, and key employee values when designing a program, and then finding a product or funding vehicle that fits the program. Using this strategy, the program remains the focus, and the end result will be better suited for both the organization and the executive.

A long-term incentive program can be more than a plan. Large organizations typically use several plans to target specific desired results and provide a balanced compensation package. Since 2000, the trend is: (1) the proportion of a long-term incentive program devoted to stock options has shrunk, (2) performance unit plans, often targeting specific benchmarks, have grown, (3) restricted stock has become a bigger piece of the pie, and (4) programs consist of more components so that all of an executive’s eggs aren’t in one basket. Smaller companies typically desire a simpler program structure and often don’t want to grant actual equity; however, they can employ a long-term incentive plan design that can help achieve key goals. Even in not-for-profit organizations, a long-term incentive compensation component for key executives is rapidly becoming the norm.

Long-term incentive programs should be built to last, but like everything in life, they need frequent tune-ups and occasional overhauls. Over time, organizational goals change, different individuals become key players, and executives’ goals and needs change. Additionally, the tax laws that govern these arrangements are far from stagnant. (Consider, for instance, the new 409A rules.) In order to continue to provide the most value and offer a quality and compliant program, a meaningful review of every program should occur every three to five years. For more information, feel free to give us a call.