Long-Term Incentive Plan Designs in the Canadian Mid-Market

Publicly traded organizations typically use share-based or option-based awards to deliver long-term incentives (LTI) that encourage equity ownership among executives. These awards offer greater upside potential compared to straightforward cash compensation plans. By providing executives with equity stakes in the company, these incentives help align their interests with those of shareholders, ensuring that executive compensation is closely tied to company performance and shareholder returns.

In the 2024 proxy season, the most prevalent LTI vehicles among TSX mid-cap companies (the approximately 100th to 300th ranked companies by market capitalization) are stock options, time-based ("restricted") share units, and performance-based share units, used by 44.3%, 69.8%, and 65.6% of organizations, respectively. A smaller proportion of companies utilize long-term cash, deferred share units, or do not offer any LTI at all.

Stock Options

A stock option is the right to buy a company share at a specific price in the future as stated by the option. Options provide a more leveraged payout if the underlying stock over-performs, allowing for higher potential upside than other LTI vehicles. Stock options have historically been tax-advantageous compared to other LTI vehicles, but new limitations on the preferential tax treatment of options has resulted in a gradual shift away from options among larger TSX issuers.

Restricted Share Unit

A restricted share unit (RSU) is a notional unit that has a time-based condition, with no performance requirements for the executives, other than still being employed with the company. RSUs can be settled in either cash or shares.

Performance Share Unit

A performance share unit (PSU) is a notional unit that has a performance condition attached, with the intention that certain targets be achieved by the end of the performance period. The final number of PSUs received will vary based on the achievement of the performance conditions. PSUs can be settled in either cash or shares, but unlike RSUs, do not guarantee a payout.

Deferred Share Unit

A deferred share unit (DSU) is a notional unit that only pays on cessation of employment, usually upon retirement or departure from the company. DSUs can be settled in either cash or shares. While less common for executives, DSUs are far more commonly used as compensation for Board members.

Long-Term Cash

Long-term cash awards are awards with a performance condition attached, similar to performance share units, but settled in cash. 

Prevalence of LTI Vehicles

Below is a chart outlining the prevalence of various combinations of LTI vehicles in the mid-market:

Long-term Incentive Conditions

Other conditions may be applied to these LTI vehicles, depending on the desired effect on the participant:

Stock Option Term

Stock options have a term, which refers to the period of time after the grant date during which the option can be exercised. For example, an option granted in January 2020 that expires in January 2025 has a term of 5 years. The typical term for stock options ranges from 5 to 10 years. In contrast, the term for RSUs and PSUs is usually 3 years.

Vesting Period

The vesting period of an LTI award refers to the amount of time the award must be held before it can be sold or exercised. An LTI award may vest either on a ratable (gradual) basis (e.g., one-third of the award vests each year, starting from the grant date) or on a cliff basis (e.g., the award vests all at once on the third anniversary of the grant date). Vesting periods for stock options typically range from 3 to 5 years, whereas the vesting period for RSUs and PSUs is generally 3 years. The vesting period for stock options is always shorter than the term, otherwise the holder of the options would be limited in how much time and flexibility they would have to exercise the options. The vesting period and the term of RSUs and PSUs generally align.

In the Canadian mid-market, 97% of stock option plans use ratable vesting, 54% of RSU plans use ratable vesting, and 88% of PSU plans use cliff vesting (often tied to a multi-year performance target).

Performance Conditions

Performance conditions are often attached to LTI awards to link compensation to organizational performance and ensure that the incentive is earned, rather than simply granted. The most used performance metric is relative total shareholder return, typically measured against a peer group or index. Some other commonly observed performance conditions are return on invested capital (ROIC) and revenue growth.

These performance conditions are commonly applied to performance share units (PSUs) and long-term cash incentives and can also be included with stock options. However, performance conditions on stock options are relatively uncommon in Canada.