What are Stock Appreciation Rights?
A stock appreciation rights (SARs), similar to employee stock options, is a method for giving a bonus to the employees in the form of shares instead of cash, and they benefit from these SARs when the share price increases in the future.
What are the Elements of Stock Appreciation Rights?
There are some key dates and key terms which need to understand before going for SARs: –
- Grant Date: – This is a significant date, and all the process of stock appreciation rights will start only after this date. The grant date is the date when stock appreciation right is given to employees.
- Exercise Price/Grant Price: – Exercise price is the market price of the stock on the grant date. This price is used to determine the worth of stock.
- Vesting Date: – This is the date when an employee can exercise his stock appreciation right.
- Expiration Date: – This is the last day when the employee can exercise his option.
Example of Stock Appreciation Rights (SARs)
Now we will take one example for understanding these SARs:
ABC Inc has declared stock appreciation rights to his employees for which conditions are as below:
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- Grant Date: 1st Jan’2015
- Grant Price/Exercise Price: $ 100
- Number of Shares: 100
- Service Period: 3 Years
- Vesting Date: 1st Jan’ 2018
- Expiry Date: 31st Dec’2019
Lets us assume one of the employees exercises his right as on 1st Jan’2018, and the market price of the share as on 1st Jan’2018 is $ 200 it means he will earn $ 10000 against his right.
- (Market Price of share – Exercise Price) * No of Shares
- = ($ 200 – $ 100) *100
- = $ 10000
This $ 10000 he can get in the form of cash or in the form of a share. If the right is settled in the form of shares, then no. of shares will be calculated as per market price. which is as follows:
Net Money Value of Shares = $ 10000
Market Price of share = $ 200
- No. of share received = $ 10000/ $ 200
- = 50 shares
Participants can exercise the rights at any time during the vesting period, i.e., between vesting date & expiry date, but the unexercised rights will be subject to fluctuation of the market price.
Process of Stock Appreciation Rights Scheme
Below are the process of Stock Appreciation Rights (SARs)
- The board of a director will approve stock appreciation right inboard meeting and appoint a compensation committee who will take decision relating to this scheme.
- The compensation committee (CC) will identify the participant who will be eligible for this scheme.
- CC will finalize the total number of stock appreciation rights to be offered to these participants and the ratio in which these rights will be distributed.
- Defines the objectives/targets/goals which need to be achieved by these participants as their vesting conditions.
- After defining the goals, the compensation committee will also define the parameter of a measurement tool for the evaluation of their performance.
- Defines the grant date, grant or exercise price, vesting date, and expiry date of SARs.
- Arranging the funds for financing the scheme by issuing the bonds, debentures, or by making some investment. In some cases, it also mentioned by the company that if the company is not able to arrange funds, then this scheme will not be paid.
- After defining the above things compensation committee will draft the stock appreciation right in which all the terms and conditions are mentioned like grant date, grant price, vesting period, expiry date, vesting conditions, performance goals, evaluation parameters, or any other conditions which are related to the scheme.
- The compensation committee will prepare the grant letter by which participants will enter into this scheme.
- All the above things have to be at the initial stage of a stock appreciation right now after completing all the above things compensation committee, and participants will wait for the end of the vesting period.
- Once the vesting periods end compensation committee will evaluate the performance of participants on the basis of their performance and decide whether the participants have fulfilled the vesting condition or not.
- After the fulfillment of the vesting condition, as and when participants exercise the rights during the exercise period defined by CC money will be paid to the participants.
Advantages of Stock Appreciation Rights
Below are the advantages of SARs.
- It is a method to give incentives to the employees without giving up equity.
- It is a retention plan of the company so that employees can stay in an organization for a longer period of time.
- It has lesser compliance as compared to Employee stock option plans or employee stock purchase plan.
- This scheme is more flexible as compared to other options.
Disadvantages of Stock Appreciation Rights
Below are the disadvantages of SARs.
- There is no cash infusion when an employee buys this option /stock.
- This option is required to approve by the board of directors and shareholders.
- Funds are required by the company to finance the SARs, which is being exercised by the employees, and this may lead to liquidity issues in the company.
Conclusion
Stock appreciation right is part of compensation which is paid to the employee as an incentive or bonus on the basis of their performance during the service period, but the amount of this incentive will depend on the exercise of the rights by the employee because the incentive amount will be the difference between the market price on the exercise date and grant date.
In this option, an employee does not have to own the assets or contract but at the same time company has to arrange the fund for financing this stock appreciation rights but this is also beneficial for the employers because they do not have to issue any additional shares which may change the share price.
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