Long-Term Incentive and Equity-Based Compensation: Diversification Trend Continues

Stock options, once the king of long-term incentives, are gradually losing their status as the predominant form of equity-based compensation. For example, the results from a recent Culpepper Pay Practices & Policies Survey reveal that long-term incentive (LTI) plans for U.S. employees in technology and life science companies continue to shift away from plans using only stock options toward plans using a mix of multiple types of long-term incentives.

Most technology and life science companies report that they continue to offer long-term incentives to employees. However, the types of LTI plans used, the number of eligible employees, and the size of equity awards have changed dramatically in recent years.

Are Stock Options Losing Their Grip?

Historically, stock options were the LTI vehicle of choice, used by nearly all companies offering long-term incentives. However, the use of stock options has declined significantly over the past three years, with only 59 percent of companies now offering options to employees. Accounting rules requiring companies to expense options, backdating scandals and declines in the stock market have had a dramatic impact on the use of options and other types of LTI awards.

As the use of stock options continues to fall, the prevalence of other types of LTI plans is rising. Restricted stock (51 percent), performance-based LTIs (38 percent), stock appreciation rights (11 percent), and phantom stock (8 percent) are all gaining ground on stock options.

Table 1. Percent of Companies Offering LTI & Equity Compensation Plans
Type of Long-Term Incentive / Equity Plan	Percent of Companies Offering
Stock Option Plan	59%
Non-Qualified Stock Options (NQSOs)	44%
Incentive Stock Options (ISOs)	28%
Restricted Stock Plan	51%
Restricted Stock Shares (RSSs)	32%
Restricted Stock Units (RSUs)	22%
Performance-Based LTI Plans	38%
Performance Cash Awards	18%
Performance Share Awards	17%
Performance Units	5%
Other LTI and Equity Plans
Stock Purchase Plans (ESPPs / MSPPs)	15%
Stock Ownership Plans (ESOPs / KSOPs)	11%
Stock Appreciation Rights (SARs)	11%
Phantom Stock	8%
Unrestricted Stock Shares	2%

Diversification of LTI Plans

Instead of using a "one-size-fits-all" approach, over half of the surveyed companies (53 percent) diversify their long-term incentives with a mix of different types of plans.

Only 17 percent use stock options as their sole long-term incentive, while 42 percent offer stock options with a mix of other types of LTI plans.

Restricted stock and performance-based plans have both gained popularity in recent years; however, only 19 percent of companies offer either of these types of plans as their only LTI option.

Table 2. Mix of Long-Term Incentive Plans
Type of Long-Term Incentive / Equity Plan	Percent of Companies Offering
Combination of LTI plans (with stock options)	42%
Stock option plan (only)	17%
Combination of LTI plans (without stock options)	11%
Restricted stock plan (only)	11%
Performance-based plan (only)	8%
Phantom stock (only)	3%
SARS (only)	2%

Criteria to Determine LTI Eligibility

The most common criteria used to determine whether an employee is eligible for long-term incentives is job level. Individual employee performance, salary grade/level and job title are also frequently used as factors to determine eligibility for LTI awards.

Table 3. Criteria Used To Determine LTI Eligibility
	Percent of Companies (respondents could select more than one response)
Job level	63%
Employee performance	41%
Salary grade or level	36%
Job title	34%
Discretionary	27%
Tenure	10%
Group/unit/organization performance	9%
Other	8%

LTI Trigger Events and Award Frequency

The most common event triggering LTI awards is at the time of hire. Seventy-two percent of companies offer long-term incentives to newly hired employees. Although hiring someone may trigger an LTI award, eligibility requirements or waiting periods may apply.

The second most common situation to trigger an LTI award is an annual grant process. Sixty-two percent of companies grant new LTI awards as part of an annual grant process.

	Table 4. Events Triggering LTI Award
			Percent of Companies (respondents could select more than one response)
	New hire		72%
	Annual grant process		62%
	Job promotion		46%
	Retention purposes		38%
	Recognition of outstanding performance		37%
	Discretionary		25%
	Meeting performance goals		18%
	Year-end bonus		5%
Initial grant fully vested		5%
Other		5%

While nearly three-quarters of companies offer long-term incentives at the time of hire (Figure 3), only 2 percent restrict LTI awards to only at time of hire (Figure 4). Most companies continue to grant new LTI awards to eligible employees on an annual basis.

	Table 5. LTI Award Frequency
			Percent of Companies
	Only at time of hire		2%
	Monthly		4%
	Quarterly		8%
	Semi-annually		4%
	Annually		63%
	Every two years		2%
	Every three years		1%
	Varies		13%
Other		5%

Alternatives to LTI Plans

Organizations without long-term incentive plans were asked to report what other rewards and incentives they use to attract, retain and motivate employees. The most common strategies for companies without LTI plans are to offer above-market benefits plans, non-cash awards/perks, and short-term cash bonuses/incentives).

Table 6. Alternatives to LTI Plans
	Percent of Companies (respondents could select more than one response)
Above market benefits plan	69%
Non-cash awards & perks	50%
Short-term cash bonuses & incentives	50%
Above market base salary	44%

W. Leigh Culpepper, CCP, GRP, CBP, is president and CEO of Culpepper and Associates Inc., which conducts worldwide salary surveys and provides benchmark data for compensation and employee benefit programs. Jeremy Greenup, CCP, is a research analyst at the firm.

Reposted with permission

Source: Culpepper Pay Practices & Policies Surveys, July 2008, www.culpepper.com

Data source: Culpepper Pay Practices and Policies Survey of 145 organizations, June-July 2008. Breakdown by industry sector: Technology: 75%. Life sciences: 12%. Other industry sectors: 13%. Breakdown by number of employees: Up to 100: 21%; 101 to 1000: 35%; 1,001 to 5,000: 26%; Over 5,000: 18%. Breakdown by corporate status: Private 51%; public 46%; not-for-profit 2%; other 1%.