What Is Phantom Stocks and How Does It Work?
Phantom stocks are actually a type of compensation that provides access to the employees to the stock without actually owning them. Just as other stocks, these too show transitions (i.e. rise and fall) in value.
“In sink with the underlying organization’s stock, the employees are repaid with the surplus (i.e. the profit) earned from the company stock appreciation.”
-Divya Gupta (Market Analyst, MUDS Management Pvt. Ltd.)
The number of Phantom shares given to a person is directly proportional to his perceived value to the company. Thus, the higher the value if the employee, the higher the number of Phantom shares he/she is likely to receive. Once the Phantom stocks are allocated, a slight delay is observed as the actual financial payout is delayed for over three to five years.
How Does Phantom Stock Operate?
1. Appreciation Stock
The stock price appreciation helps the stock recipient earn the profit that the Phantom stock would earn over its stipulated time period. For instance, an employee receives 100 shares of Phantom stock worth $20 each. Here, the employee must have served the organization for a minimum of 5 years (also known as the vesting period) as per the agreement in order to receive the benefits of the deal.
Now, if during this time, the stock price has risen to $40 per share, then after the five-year tenure is over, such an employee would receive the difference (i.e. 40-20=20$ per share) current value on the date when the deal was closed. He/She would also get $40 per share when they become entitled to gains from the stock. This would. in turn. yield a profit of $2000 to the Phantom stockholder.
2. Full Value
Under this case, the beneficiary receives both the stock price appreciation along with the current value on maturity. Continuing with the same example, the employee would not only get the increased 20$ per share but would also receive the current price appreciation whenever the deal commences.
Why Opt for Phantom Stocks?
- Phantom stocks act as a tool of motivation for the employees. It gives a two-way benefit (i.e. both to the employee as well as the organization) by maintaining the employee retention and increasing productivity.
- Because the shadow stocks are not similar to the regular stocks of the company, opting for Phantom stocks does not dilute their shares.
- The employees do not actually have to purchase the Phantom Stocks like regular stockholders do in the open market. The intent behind offering Phantom Stocks to employees is no money changing hands. Thus, it is a win-win situation for the employees who only share in the stocks without paying to them.
- As Phantom stocks are controlled by the company, it is beneficial for the employer as well. The company dictates the structure of the agreement. The organization even controls the level of equity participation in the form of dividends paid out to the employees.
“Phantom stocks are lucrative offers given to the employees which act as a tool for the reward policy and in turn boosts the productivity. It’s the secret that pushes the stock price higher.”
-Isha Malik (Company Secretary, MUDS Management Pvt. Ltd.)
Disadvantages of Phantom Stock
Organizations that enforce Phantom Stock plans tend to bring upon themselves an additional cost. This typically happens in case any stock valuation overview needs to be achieved by an outside accounting firm.
As the Phantom stockholders possess no voting rights and are even not eligible for dividends, they are usually considered at par for the regular company stockholders.
“Phantom stocks act as a key to employee retention and are beneficial when the stock market shows a general upward trend. In case the events are not favorable and even the stock prices do not show any upwards trends, neither of the parties (i.e. the employer and the employee) loses any money.”
– Shweta Gupta, Founder, and CEO, MUDS