How Does a Phantom Stock Plan Work?

An employer enters into an agreement with selected employees. In accordance with the terms of the plan, the employer grants the employees a number of units or phantom shares. The document informs the employees of the starting value of the shares along with other conditions of the plan, such as the vesting schedule, the payment eventsphantom dividend availability (if any), and more.

Upon fulfillment of the plan terms, the employees are eligible to receive a payment in exchange for their units. The amount of the payment will depend upon (1) the number of vested units they hold, (2) the value of the units at the time of payment, and (3) whether the plan was for the full value of their units or strictly the appreciation in the value from the date of grant. For example, suppose an employee received 10 phantom shares with a starting value of $7, and assume the shares are valued on the payment date at $15. At the date of payment the employee would receive $150 under a “full value” plan and $80 under an “appreciation only” plan.

As described, phantom shares are usually redeemed in cash—the payment being treated like a bonus. However, should the plan agreement allow it, the payment obligation may be satisfied by distributing actual stock to the employees.

A phantom stock plan must be supported by more than a verbal commitment. It requires a formal document that describes the plan terms and articles. The document serves to confirm the plan operation, resolve questions and satisfy certain minimum compliance requirements.