Stage 3: Financial Optimization

A phantom stock plan is a serious long-term commitment. The plan may become the largest variable compensation commitment ever made by the company. As such, the financial implications of the plan should be considered carefully.

Accruals

The company financial officer should examine the accrual schedule and how it might impact the company’s income statement. Two different accrual methodologies are available.

Cash Flow

Next, the company cash flow responsibilities should be assessed. The stage two model should project the years during which payments will be made to plan participants. Financial managers should study the range of possible obligations and feel confident in the company’s ability to meet them.

Funding

Phantom stock programs, as with all nonqualified plans, do not require cash funding. However, some companies do set aside dollars in anticipation of plan payment obligations. Reasons for informal funding include:

• Peace-of-mind—satisfying the desire to know that all future obligations are being handled based on sound long-term cash management principles
• Employee confidence—enabling the company to communicate to employees that it is taking reasonable steps to assure availability of cash (while explaining that plan assets cannot be secured or guaranteed)
• Cost reduction—allowing the company to earn interest on set-aside funds that may help offset the expense of the plan

Following their analysis of the plan’s earnings, cash flow and long-term cash management options the plan decision makers may re-consider grant levels, vesting, payment schedules and other factors that can impact plan design. At this point these decisions should be finalized.

At the end of stage three the company has established its plan strategy for long-term financial management and locked down its key financial decisions.