Phantom Stock and Stock Appreciation Rights (SARs)

Companies and corporates have offered various Employee Stock Ownership Plan (ESOP) for a long time, to their upper-level executives for the sole purpose of motivation and retention.

There are several stock-based compensation plans that do not actually use the stock itself but substitute it with hypothetical units or cash benefits. The reasons for this shift are manifold.

• The owners do not actually want to share the equity, they would rather be happy by sharing the value of it.
• The corporate restrictions pertaining to the ownership plans of the company acts as a constraint.
• The rules and regulations of stock plans are too rigid, lack desired flexibility.
• The implementation cost is immense and paperwork extensive.
• It cannot be structured as per the requirement of the company.

Phantom Stocks and Stock Appreciation Rights (SARs) are two such stock-based compensation plans that do not actually use the stock itself but nevertheless, fulfill the desired outcome completely.

Phantom Stock And It’s Chief Attributes

Phantom Stock or Shadow Stock is a fairly new vehicle of incentivizing higher-level management employees without diluting the shares of a company.

Phantom Stocks are gaining immense ground with companies and corporates in recent times due to some of its unique features.

1. It is hypothetical in nature and no physical transfer of stocks takes place.
2. No dilution of shares, no actual rights transferred, hence, no threat to the owners.
3. It provides complete freedom to the company to structure and implement the agreement as desired by it.
4. Not bound by rigid rules and regulations, therefore, fewer hassles.
5. Less paperwork and formalities are involved.
6. Employees do not pay for the stocks; thus, the motivational factor is multiplied.
7. One-time taxation during maturity is another factor that makes it a favorable incentive tool with the recipients.

Also Read: Why Phantom Stock Can Be Better Than Real Stock?

Types of Phantom Stocks

There are two types of Phantom Stocks-

1. Appreciation Only- As the name suggests the employee who has been offered this kind of Phantom Stock, they will receive cash benefit only on the appreciated value and not the full value.

2. Full Value- When a Phantom Stock is offered for full value then at the time of settlement the employee will get the exact value of the stock.

Stock Appreciation Rights (SARs) And Its Attributes

SARs is an alternate tool of equity compensation for employees, a simplified version of the conventional stock option plan.

1. It gives recipients the right to the appreciation in the value of the company stock over a specified period of time, without awarding the real stock.
2. The shares are not diluted and hence, no threat to owners.
3. SARs have a lock-in period of one year as specified in Section 24(1) of SEBI (Share-Based Employee Benefits) Regulations, 2014.
4. Like Phantom Stock, it enjoys great flexibility and gives ample structural space to the company.
5. Participants do not pay for SARs, and the appreciation amount is just like a bonus.
6. It attracts one-time taxation, i.e. when the right to benefit is exercised.

The Final Word!

Both, Phantom Stocks and Stock Appreciation Rights, are equally popular tools for incentivizing the employees. They are almost similar in nature and are favored greatly as the real stocks are not transferred, therefore, fewer rules, regulations, paperwork and expensive. At the same time, both help in fulfilling the purpose of working as an effective tool to motivate and retain the participating employees.

“Both vehicles of incentivizing give immense flexibility, but, this also results in a great challenge as they can be designed in various ways! To be effectively successful, all factors should be kept in mind while drafting the agreement!”
– Shweta Gupta, Founder, and CEO, MUDS