What Does Stock Appreciation Right Mean?
A stock appreciation right (SAR) is a bonus given to employees that is equal to the appreciation of company stock over an established time period. Similar to employee stock options (ESO), SARs are beneficial to the employee when company stock prices rise; the difference with SARs is that employees do not have to pay the exercise price, but receive the sum of the increase in stock or cash. The primary benefit that comes with SARs is the fact that the employee can receive proceeds from stock price increases without being required to buy anything.
Understanding Stock Appreciation Rights (SAR)
As an example, consider an employee is given 200 SARs. The stock of the company increases $35 per share over a pre-established period of two years. This results in the employee receiving $7,000 (200 SARs x $35 = $7,000).
SARs and Phantom Stock
SARs and phantom stock are largely similar. The major difference is that phantom stocks are typically reflective of stock splits and dividends. Phantom stock is just a promise that an employee will receive a bonus equivalent to either the value of the company’s shares or the amount that the stock prices increase over a given period of time. The bonus an employee receives is taxed as ordinary income based on the time that it is received. Because phantom stock is not tax-qualified, it does not have to follow the same rules that employee stock ownership plans (ESOPs) and 401(k) plans must follow.
SARs, on the other hand, offer the right to the cash equivalent of value increases of a certain number of stocks over a predetermined time period. This bonus is almost always paid in cash; however, the company may pay the employee bonus in shares. In most cases, SARs can be exercised after they vest; when SARs vest, it simply means that they become available to exercise. SARs are generally issued in conjunction with stock options in order to assist in funding the purchase of options or to pay off taxes due at the time the SARs are exercised; these are referred to as "tandem SARs."
Benefits and Challenges
SARs have many advantages, the greatest of these being flexibility. SARs may be created in a variety of different designs that work for each individual. This, however, comes with numerous choices and decisions that must be made, including which employees receive bonuses and the value of those bonuses, liquidity issues, eligibility and vesting rules.