Phantom Stock Case Studies

I spoke with a business owner today who asked an important question about employee satisfaction with phantom stock: “Do employees value phantom stock as much as they would actual stock?”

In my view, nine times out of ten, phantom stock is better for employees than actual stock. This applies particularly for stock options as well. Therefore, explained correctly, employees should value phantom stock more than actual stock. This is a complex subject so allow me to highlight the main factors.

What do shareholders want from a compensation arrangement for management?

Last time I pointed out a few reasons that LTIPs can actually promote undesirable turnover. Today we’ll emphasize the elements of plan operation that really do encourage retention of premier talent.

First, reverse the errors I described last week, including: (a) do annual, not one-time grants; (b) allow for reasonable distributions without forcing employees to quit to get them; (c) avoid windfall payments, etc.

Does a long-term incentive plan (like phantom stock) improve employee retention? As with most questions like this, my answer: It depends.

We’re always measuring costs. What’s the cost of that new piece of equipment? What will that new addition to our marketing plan cost? What’s the cost of that change in our product line?

I often have prospects ask: “What’s the cost of a phantom stock plan?”

You don’t—at least not in the traditional way.

With a regular stock option the employee is given a window of time to exercise—and it’s totally in his control. For example, he may have to wait three years or so (the vesting period) before he can exercise his options. And there will probably be an expiration date as well (commonly 10 years). Any time between the 3 years and 10 years he can voluntarily choose to exercise.

In a word, “yes.” Stock Appreciation Rights is a term that’s been around for a long-time, and is still in common usage.

SARs were formed decades ago in public companies as a way of providing cash to employees to be used to exercise their stock options. If the exercise cost of a block of options was to be $20,000, SARs were issued at the same time as the options to give the employee $20,000 in cash so that he or she could exercise. Of course, the cash from the SARs was taxable so sometimes the SARs value was “grossed up.”

Perhaps you’ve heard people refer to a type of long-term incentive program called a PUP. What is it? And how does it differ from phantom stock?

PUP is an acronym for Performance Unit Plan. It’s a program that allows the sponsoring company to select two or more financial metrics to be used to value units that are awarded to employees.

One of the main questions business owners have about issuing phantom shares to employees is, “How do I determine the right number of shares to award to employees?”

Another way of saying this: “How do I give shares that are earned or justified in light of the contribution of the employees?” Owners don’t want to over-award. They’re pleased to award value that’s earned, but they don’t want to be locked into a situation that they later regret.

The most important perception to avoid in any company’s compensation programs is a sense of unfairness. Once employees believe that compensation plans are unfair, engagement and productivity will immediately begin to decline.

Owners and CEOs seek to rally employees around the organization’s growth objectives. Employees understand that growth in sales, margins and profits produce wealth for the shareholders. Those employees who recognize that they directly and meaningfully contribute to growth will begin to wonder how and when they get to participate in this value. Successful companies don’t let this happen. They send the right message: “At ABC Company, you participate in the value you help create!”

Successful companies find creative ways to attract and retain premier employees. They don’t settle for top 25% quality, or even top 10%. They are committed to the presentation of a value proposition that appeals to the top 2% caliber talent. Many factors beyond compensation must be included in this proposition. But the compensation offering must resonate with them and differentiate from competitors. For this reason, growth-committed organizations utilize incentive programs that enable top performers to build meaningful wealth. Phantom stock plans, along with other forms of long-term incentive plans, are designed to produce this result.

A well-structured phantom stock program that is linked to a growth oriented business plan can send the right message. Key employees can visualize the potential value that can be earned over time. This allows the company to communicate the uniqueness of its value proposition in a concrete way.

The financial objective of nearly all businesses is value creation—the ultimate dual meaning term. By creating value for customers, a well-run business also creates value for shareholders. Profits and improving equity demonstrate whether a company is achieving the financial purposes for its existence. Business owners are constantly asking “how do we improve our business value” whenever they revise their business model or business plan, hire new employees or strive to improve execution.

Not-so-obvious questions arise when considering the allocation of resources within the business: Should we invest in new equipment or a new bonus plan? Should we expand our marketing territories or upgrade our pay levels to market standards? Should we develop new products or adopt a phantom stock plan?

What business purposes do you want to achieve when you adopt a long-term incentive plan such as phantom stock?