What are Phantom Stocks?
Phantom stocks are generally known as Shadow Stocks. Most companies give these kind of stocks to its employees as a cash reward. The shadow stocks given are equivalent to the company's existing share market price at the time it is offered to the employees.
These kinds of shares are accorded to senior-most officers and loyal employees of the company.
The two types of Phantom stocks prevalent today are appreciation only and full value stocks. While the appreciation only stocks excludes the worth of the real underlying stocks, full value stocks include the worth of the underlying stock and any appreciation as well.
Rewarding employees with phantom shares
Want to reward your employees for all the hard work that they have put in all these years for the growth and development of your company? The best way to do so is to reward them with Phantom Stocks. Companies issue phantom shares to its employees as a substitute for the actual shares. In other words, the phantom shares do not require the issuance of the real shares but yet the employees will get all the benefits due to the rise in the company's stocks at the share markets. It is, therefore, the best way to reward the employees, no doubt!
Two types of phantom stocks
There are two types of Phantom Stocks that are widely prevalent these days. They are known as Appreciation Only and Full Value stocks. The Appreciation Value stocks will pay out only the company's escalated share price for a certain period of time. In case of Full Value shares, both the escalated value and the underlying stock value will be paid out to the employees. In both these cases, the employees stand the risk of forfeiture of shares once the benefit is paid to them. It is, therefore, well known that the Appreciation Value and Full Value stocks are typical nonqualified stock plans.
How are phantom shares allocated?
Phantom shares are allocated to employees who have a good track record. These shares are allocated to employees who have attained the goals or tasks set by the company for them. The document about the phantom shares will spell out if the employee will get the cash that equals the dividends and any other type of rights. To forgo paying the amount in cash, certain companies also transfer the phantom shares into actual shares. Further, there is no exercise feature in the phantom shares which means the employees are taken into the plan as per the terms and conditions and finally the cash is given to them.
Advantages and disadvantages of Phantom Shares
There are certain advantages and disadvantages in Phantom Shares. For one thing, the employers have the option of placing the shares in the employees name without actually having to transfer the ownership to them. Further, these phantom shares serve as a motivation for the employees who will put in hard work to achieve more and more. The employees will also stay on the company for longer given the fact that they hold the phantom shares which accords them a lot of advantages financially. This is generally known as the Golden Handcuff clause which binds the employees and employers together for years to come.
Employees benefit from Phantom Shares
Employees stand to benefit a lot from the Phantom Shares allocated to them by their companies. In the first place, they get to build their stock portfolio without actually having to spend anything on it. However, the large pay outs to the employees may cause a huge financial burden on the company in most cases. When there is a fluctuation in the company's stock price it can also be a drawback for the company as it will reflect on the company's balance sheet. Therefore, it is pertinent for the companies to disclose what plan it offers to its employees every year.
What are Stock Appreciation Rights?
Stock Appreciation Rights, generally known as SARs, gives the employees a right to appreciation in the stock price but this does not mean that they can claim it on the stock itself. SARs are nonqualified stocks for purposes such as taxes. However, the shareholders will have to sell the shares and from the amount derived from it they have to cover the cost of the shares granted to them originally. The SARs are offered in the form of tangible shares and the number of these shares granted is equivalent to the profits that the shareholder has made during the grant and exercise.
Taxation on SARs
Stock Appreciation Rights (SARs) are quite similar to the non-qualified stock options, known as NSOs when it comes to taxation as they don't draw tax consequences on the date they are vested or on the grant date. Generally, most of the employers will be withholding the additional federal income tax which amounts to about 20 per cent in addition to the local and state taxes, medical insurance and social security. These taxes will also be withheld as shares by most of the employers. In such cases, the employers will only give a few shares and keep the remaining to cover the taxes.
Advantages and disadvantages of SARs
Employees holding Stock Appreciation Rights (SARs) easily use their rights and evaluate the gains but they are not accorded dividends and also do not have the voting rights. Most of the employers prefer SARs due to the fact that accounting rules are very favourable to them than it was in the past. This means it will get the permanent accounting treatment and not as variable. Therefore, they are treated as the orthodox stock options. One disadvantage is that the SARs necessitate issuing of fewer shares and this will decrease the share price when compared with the orthodox stock plans. But it will certainly motivate the employees.
Why Phantom stock and SARs?
What is the necessity of Phantom stock and Stock Appreciation Rights (SARs)? Well, it mainly helps in retaining the employees particularly the most hardworking and dedicated ones. Yet another advantage is that the company will not have to dilute the stocks materially but at the same time provide equity-linked compensation to the workers. However, both these plans have its own advantages and disadvantages and limitations as well. If you are not sure of which of these plans would suit you, the best thing would be is to consult your financial advisor and gain insights on what each of these plans would offer.