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Stock Appreciation Rights (SARs) and Phantom Stock Stock appreciation rights (SARs) and phantom stock are specialized compensation tools designed to provide employees with the economic benefits of stock ownership without any actual transfer of stock occurring. A form of deferred compensation, a SAR is a grant to an employee giving him or her the right at some specified time in the future to receive a cash or stock award equal to the appreciation in value of a certain number of shares of company stock. Phantom shares, generally used as incentive compensation, are units of value that correspond to an equivalent number of shares of stock. As with SARs, the value of a phantom stock award is typically paid to the employee in cash, although the award could also be in the form of stock. .
Considerations that may support the use of this type of arrangement over an actual equity plan include exemptions from securities registration requirements, accounting and tax treatment, and the flexibility to tie rewards to a specific aspect of the company's business (such as a division that is not separately incorporated). SARs and phantom stock are popular with family-owned businesses where the family does not want to give up any stock ownership. They can also be used to provide equity-like incentives that are tied to the performance of a corporate division or subsidiary and to provide equity-based awards to foreign-based employees where the legal and administrative complexities of a foreign jurisdiction make it difficult to award actual securities. Phantom stock and SARs are often used by smaller firms that are not in a position to actually share ownership, and by larger, well established companies to provide employees with sufficient cash resources to exercise large option awards and/or to help pay taxes on NSOs.
If structured properly, there are no tax consequences upon grant of a SAR or phantom stock. Tax recognition by the employee on the value of the award is generally deferred until exercise or maturity. If the SAR is exercised for cash, the company receives a corresponding deduction as a compensation expense. If it is exercised for stock, the company may deduct, as a business expense, the amount of income recognized by the employee.
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