Short-Term Incentives (STI) and Long-Term Incentives (LTI) are two primary types of performance-based compensation offered by companies to motivate, reward, and retain employees. While both aim to align employee performance with business objectives, they differ significantly in their time horizons, payout structures, and strategic goals.
Understanding Short-Term Incentives (STI)
Short-Term Incentives (STI) are compensation plans designed to reward employees for achieving specific goals and performance targets over a relatively short period, typically one fiscal year or less. These incentives are directly tied to immediate business results and individual contributions that contribute to annual objectives.
Key characteristics of STIs include:
- How it's Paid: STIs are most often paid in cash, providing an immediate financial reward. However, they can also be offered as company shares, allowing employees to gain a stake in the company's performance.
- Payout Schedule: The payout for STIs occurs on a set, regular schedule, which can be monthly, quarterly, or annually, depending on the incentive plan's design. This frequent payout reinforces short-term goal achievement.
- Purpose: STIs aim to drive immediate operational performance, meet annual sales quotas, achieve specific project milestones, or improve year-over-year financial metrics. They serve as a direct motivator for current performance and productivity.
- Common Examples: Annual bonuses, sales commissions, profit-sharing plans, and individual performance bonuses linked to specific key performance indicators (KPIs).
Exploring Long-Term Incentives (LTI)
Long-Term Incentives (LTI) are compensation plans structured to reward employees for sustained performance and contributions over multiple years, typically three to five years. LTIs are designed to align employee interests with the long-term success and growth of the company, encouraging retention and strategic decision-making that benefits the organization over an extended period.
Key characteristics of LTIs include:
- How it's Paid: LTIs are commonly paid in company shares, such as stock options or restricted stock units (RSUs), or in cash. The equity component helps align employee interests directly with shareholder value creation.
- Payout Schedule: Unlike STIs, the payout for LTIs occurs after a specified long-term period has concluded. This requires employees to remain with the company and contribute to its long-term success to fully realize the incentive.
- Purpose: LTIs are used to foster long-term commitment, encourage strategic planning, retain key talent, and motivate employees to contribute to the company's sustained growth, market position, and shareholder returns. They tie an employee's personal wealth to the company's sustained value creation.
- Common Examples: Stock options, restricted stock units (RSUs), performance shares (shares awarded based on achieving multi-year performance targets), and phantom stock.
Key Differences Between STI and LTI
Understanding the distinctions between STI and LTI is crucial for comprehending their respective roles in an overall compensation strategy.
| Feature | Short-Term Incentive (STI) | Long-Term Incentive (LTI) |
|---|---|---|
| Time Horizon | Typically one year or less | Typically three to five years or longer |
| Primary Objective | Drive immediate performance and annual goal achievement | Foster sustained performance, retention, and long-term value creation |
| How it's Paid | Primarily cash; can also be company shares | Typically cash or shares in the company |
| Payout Schedule/Timing | On a set schedule (monthly, quarterly, or annually) | After the specified LTI period |
| Focus | Operational results, individual/team KPIs, annual profits | Strategic growth, shareholder value, market position, executive retention |
Why Companies Utilize Both STIs and LTIs
Companies strategically employ both STIs and LTIs to create a balanced compensation package that addresses various motivational needs. STIs provide immediate gratification and encourage employees to meet pressing operational goals, ensuring short-term business health. LTIs, on the other hand, encourage a long-term perspective, fostering loyalty and aligning employee interests with the sustained growth and success of the organization, particularly important for senior leadership and critical talent.
By combining these incentive types, organizations can build a comprehensive reward system that drives performance across all time horizons, encourages retention, and promotes the overall health and prosperity of the business.
