Phantom Stock

What is a Phantom Stock?

Phantom stock is incentive compensation or an employee benefit where the employee receives the benefit of owning a stock without the company giving them the stock in reality. It is an amount that the employer promises to pay to its employees in the near future.

  • The near future can be treated as a certain number of years or retirement of an employee, employee attaining a certain age, or by changing the ownership of the company.
  • These stocks are similar to actual stock, where its value rises and falls as compared to that of actual stock of the companies;
  • Companies use it as a motivational tool for retaining its employee or its top-level executive by promising a cash benefit to the employee at some point in the future, where it is subject to a substantial risk of forfeiture in the meantime.
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Types of Phantom Stocks Plan

Types of Phantom Stocks Plan

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#1 – Appreciation Plans

Companies use this particular plan when the employee doesn’t receive the current value of the stock. Instead, they receive the appreciated value of the stock. Companies are, therefore, able to negotiate with the employee for their working tenure in this particular plan.

Consider the following Example:

Let say Aindrilla was granted 700 shares on May 5, 2013. These shares were worth $43.50 each. Cinderella was asked to stay in the company for the next 6 years. Thereby she will be able to rip the benefits of these shares. On May 5, 2019, the value of these shares was $55.30 each. For each share of Cinderella, she will get the difference of the current value ($55.30) and the initial share value ($43.50), which is $11.8 per share. Multiply the difference with 700 shares. So Cinderella ends up with a bonus of $8,260.

#2 – Full Value Plans

Full Value plans pay out the exact value of the share i.e., the exact worth. Whereas an appreciation plan of phantom stock payout the difference between the initial shares and their current value.

Consider the following Example:

Alex was granted 700 shares on May 5, 2013, form the company where he works. The value of the stock was $43.50 per share. Alex was asked to be with the company for 5 years. After Alex completed his tenure with the company as the five years passed, the share value rose to $55.30 each. The amount that Alex holds now in full value phantom will be $33,180 as he is paid out the full amount.

Advantages

  • It is a motivational tool and fostered retention as well as there is no investment need for the employee’s side.
  • The ownership of shares for the employer is not diluted.
  • It is inexpensive to implement, administrate, and it is structured to meet any number of company needs.
  • If necessary, plans may contain a conversion feature that enables employees to receive actual shares of stock instead of cash.
  • Companies can control the equity participation of employees through dividends paid out to employees. Companies can have a “forfeits” agreement towards the stock allotted through the phantom stock plan to the employee if he/she depart early before the agreement.

Disadvantages

Limitations

Conclusion

Phantom stock plans can be both a good employee motivation tool for the company and a solid cash incentive plan for employees. Even if an event goes otherwise and the stock price doesn’t appreciate, neither employer nor employee loses any money directly in the deal.

It provides more upside than downside for phantom stock plans, an increasingly valuable financial tool at a time when employee retention is vital, and when the stock market is on a general upward trend.

This article has been a guide to What is a Phantom Stock and its definition. Here we discuss the types of phantom share plans along with examples, advantages, and disadvantages. You can learn more about accounting from the following articles –

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