Stock Appreciation Right - Explained
What is a Stock Appreciation Right?
Written by J. Mance Gordon
Updated at April 20th, 2024
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What is a Stock Appreciation Right?
A stock appreciation right (SAR) refers to a financial incentive offered to employees that is equivalent to the increase in the value of a company's stock over a given period of time. Just like employee stock options, employees can take advantage of SARs when there is an increase in the company's stock. However, the only difference is that employees are not required to bear the exercise price, and can enjoy the total rise in stock or cash. With SARs, employees tend to obtain proceeds from the rise in stock prices without having to purchase or invest in anything.
For instance, an employee receives 200 SARs. In a pre-established timeline of 2 years, the company's stock jumps to $35 per share. This means that the employee would receive $7000, which is 200SARs * 35.
SARs and Phantom Stock
SARs and phantom stock have a lot in common. However, phantom stocks represent more of stock splits and dividends. Phantom stock is a promise made by the company that employees will get a financial incentive or bonus that equals to either the company's shares worth or the amount that the stock prices rise in a said time period. The bonus received by employees is taxed like an ordinary income depending on the time period they received it. As phantom stocks don't qualify for tax, they don't have to stick to similar rules like employee stock and ownership and 401(k) plans.
On the other side, stock appreciation rights provide the right to the cash that is equal to the increase in the value of stocks over a pre-stated period of time. Employees always receive such bonuses in the form of cash. However, it is up to the company to offer employee bonuses in terms of shares. Mostly, SARs are exercised once they vest, and when it happens, it implies that they can be exercised. Companies usually issue SARs in compliance with stock options so as to make the funding the buying options more convenient, or to pay off taxes while exercising SARs. They are referred to as tandem SARs.
Benefits and Challenges
SARs has the greatest benefit of the flexibility of designs. They can be formed in numerous designs so as to meet the requirements for every person. However, there are numerous options and decisions that the company should make including which segment of employees should be given a bonus, what should be the number of such bonuses, liquidity problems, vesting policies, etc.