The term phantom stock can be used to describe the broad category of long-term incentive plans that tie value to the performance of the company stock value. It can also be used to describe a specific plan—whether a Full Value or Phantom Stock Option plan.
Full Value Plan
Assume a company’s stock value is determined to be $7 per share. If employees were to receive Full Value shares in the company’s phantom stock plan they would be receiving the $7 value plus or minus any appreciation thereon. Thus, if the company stock price grew to be worth $15 per share by the maturity date the employees would receive $15 for each share they owned.
Phantom Stock Option Plan (PSO)
This approach is designed to mimic a stock option plan. Thus, with the example cited above, each $7 unit awarded to employees would only produce value should the stock price rise above $7. In other words, employees will one day receive the appreciation above the issue price. If redemption occurred at $15 employees would receive $8. For this reason this type of program is sometimes referred to as an “Appreciation Only” or “Stock Appreciation Rights” plan. It’s worth noting that the starting or issue price of the PSO does not necessarily have to equal the actual stock price (i.e., $7). It’s perfectly fine to set the starting price below or above this value (e.g., $5 or $10).
Both types of plans are popular. The sponsoring company should consider the intent of the plan when choosing the appropriate design. Is the company seeking to reward employees for prior contributions to company growth or only for future contributions? Is the company bringing some long-term employees into the plan or are all participants relatively new with the company? Does the company want the employees to focus on value preservation or solely on value appreciation?
A plan can easily be designed to allow for both types of grants. In this case the company could award certain employees Full Value units while others receive PSOs. Alternatively, employees could receive a combination of both.
To complete a simple exercise to determine the right type of long-term incentive plan for your company click here.
