Long-Term Incentive Plans In Financial Services

Except for the most senior roles, Financial Services (FS) firms have been late to the Long-Term Incentive Plan (LTIP) party. The direct relationship between revenues and profitability at the product level, combined with the regulatory requirement to defer a significant portion of annual bonuses, means many FS firms believe their organisation's long term-interests are ‘covered’ in terms of reward design.

Now, however, the next wave of innovation is forcing FS leadership to consider the impact of crypto, stablecoins, and other similar token-based products on new and existing financial markets. At the same time, advances in Artificial Intelligence (AI) provide new tools to develop, manage and trade these new asset classes. As a result, the use of LTIPs to focus and drive the transformation demanded by these innovations has never been more appropriate. As senior managers below the C-Suite have primary responsibility for navigating this new FS environment, tying this group’s payouts to multi-year results is the best way to assure the required changes are implemented and pay off.
 
Advantages to LTIPs during transformational shifts
 
A simple revenue-driven model of reward is great at incentivising growth and efficiency in established areas, but new investments that won’t pay back during the annual cycle can become low priority. I have sat in negotiations where product heads lobby for ‘relief’ from revenue targets if new investments are required. While this is one approach to encouraging new investments, it remains tied to the annual cycle and is therefore short-sighted – and managers not tied to performance measures on the investment can take the ‘relief’ and not deliver the goods.
 
A better approach to business development is to establish three-to-five-year goals for an area and base ultimate payouts on the ‘cumulative’ results during that period. The use of a “Payout Matrix” allows balancing two types of investment objectives: Quality and Quantity. Quality measures such as RoI, RoE, Risk Adjusted Return, etc help steer decisions toward valuable business opportunities. Absolute, or quantity-based measures such as revenue, net income, etc would be set for the entire period allowing early low performance to be offset in later years. Importantly, revenues of quality lower than target will negatively impact payout ensuring that it is not growth at any cost. Using both types of targets can ensure that investments made will be yielding high quality results. In addition, given the longer-term nature of the two types of target, a matrix provides some flexibility in performance outcomes as market conditions evolve from those forecast at the time of LTIP launch. We would be happy to discuss which “quality” and “quantity” metrics would be best for your situation. 

Further Considerations
 
If your firm faces a situation where success will be attained over a multi-year period, LTIPs could be worth serious consideration. Examples where LTIPs could be appropriate for leaders below the C-suite include not only areas of new investment, but also acquisition, sale, merger, and reorganisation. Essentially, any situation where a multi-year focus is critical to business success.
 
Before implementing any LTIP, we would recommend a deep dive into the following issues to ensure a new LTIP both drives results and aligns with your firm’s strategic direction:

1. Funding/Targets – is the LTIP paid for from existing bonus arrangements or the long-term results? Is it a ‘carve out’ or ‘on top’ of existing bonuses? What are the target measures and are they ‘stretch’ or in-line with business plans?
2. Participation – How deep should the LTIP reach in terms of participants? It is important to include all key staff who can influence success. LTIPs are a good way to include ‘back-office’ leaders who must modify delivery platforms to achieve target financials.
3. LTIP Period – Two years would be the minimum and five years the maximum that should be considered if the LTIP is to represent a meaningful part of participants’ total reward. Also, whether annual, biennial, or ‘one-off’ grants are appropriate will be determined based on the nature of the targets, the business cycle and anticipated events (IPO, Sale, etc). 
4. Units and Delivery -- Participants are usually awarded Units based on their role determining overall success. These units can be ‘phantom shares’, currency-based or actual RSUs. Use of an LTIP could actually lower required annual bonus deferrals for participants.

Reach out to randal.tajer@mcr.consulting for a discussion on how your current business situation may benefit from the use of an LTIP. The overall approach – as well as a review of the appropriate design issues for your setting – would be a useful starting point for determining if an LTIP is suitable.