Many of companies face challenges attracting, motivating, and retaining top executives. To alleviate those challenges, most public companies have some kind of “equity-based” long-term incentive program (LTIP) in place for top executives. LTIPs reward executives for their contributions to value creation as measured by increases in share price. Although private companies face the same talent challenges as their public company counterparts, equity-based compensation is not prevalent among private company executives. There are two primary alternatives to equity based LTIPs: (1) phantom stock and (2) performance units.
Phantom Stock: Phantom stock is like restricted stock. In this program, participants receive annual “phantom stock unit” grants. The initial unit value is based on the company’s book value, a formula, or as determined by an external valuation. After the stock units vest, participants receive a cash payment equal to the full value of the units (plus any appreciation) times the number of units underlying the grant. Vesting can be time-based, tied to a participant’s retirement, or tied to a sale, merger, initial public offering (IPO), or other liquidity event. Phantom stock is based on enterprise value creation and is typically not tied to individual performance goals. As is the case with restricted stock, if vesting criteria are met, phantom stock will always deliver value to the participant. Phantom stock encourages retention and provides a long-term performance orientation.
Performance Units: In this program, participants receive annual “performance unit” grants. The initial unit value can be formula-based, tied to an external valuation, or assigned an arbitrary dollar value. Each grant has a three-year performance period. Unlike phantom stock, individual and company performance goals provide the funding basis for performance units. Performance units are worth nothing if a threshold level of performance has not been attained; upside opportunity is possible (e.g., 150% of the initial unit value for maximum performance levels). Participants receive a cash payment equal to the number of units underlying the award times the “per unit” value at the end of the performance period. In general, participants must be employed at the end of the performance period to receive an award. The “overlapping” performance periods inherent in the program’s design encourage retention and provide a long-term performance orientation.
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