I read an article recently that posed the question: Which is better? An ESOP or Phantom Stock.
The author suggested that phantom stock may often be a better alternative for employers because it is more flexible and avoids the complications of share dilution and financial disclosure. I thought I’d weigh in.
The reality is that the plans have a common objective—share ownership value with employees. But they are generally targeted for different outcomes.
An ESOP (Employee Stock Ownership Plan) is a qualified retirement program, similar to a pension. Under these plans the company establishes a tax-deferred trust to hold stock on behalf of employees. The plan sponsor must follow non-discrimination rules. This means that there are limited opportunities to favor highly compensated employees. Employees rarely gain actual ownership of the shares. Instead, the vested shares allocated in their name are intended to be cashed out at retirement. Nevertheless, since the value of the employee’s retirement account grows if the company does well, all participating employees should be motivated to do whatever they can to improve company results.
An ESOP is a great plan to consider for companies looking to involve employees in ownership accountability and value sharing. They are a growing and effective employee benefit.
A phantom stock plan varies in a number of ways. They’re usually adopted solely for a selected (small) group of employees—most commonly the company leadership team. Thus, they do offer more flexibility than ESOPs. However, employees don’t actually receive actual stock. Phantom shares may offer economic value but do not represent actual equity. The value earned by employees under the plan is almost always settled in cash.
There’s no reason a company can’t consider both plans. They shouldn’t be thought of as competing solutions to the same problem. They’re complementary compensation programs that can work independently or together to stimulate an ownership mentality, link employees to shareholder results, and reward and retain great talent.
