What is a Phantom Stock?

  • The near future can be treated as a certain number of years or retirement of an employee, an employee attaining a certain age, or changing the company’s ownership.These stocks are similar to actual stock, where their 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 their 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.

You are free to use this image on you website, templates, etc., Please provide us with an attribution linkHow to Provide Attribution?Article Link to be HyperlinkedFor eg:Source: Phantom Stock (wallstreetmojo.com)

Types of Phantom Stocks Plan

#1 – Appreciation Plans

Companies use this particular plan when the employee doesn’t receive the stock’s current value. Instead, they receive the appreciated value of the stock. Therefore, companies can negotiate with the employee for their working tenure in this particular plan.

Consider the following Example:

Let’s 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 six years. Thereby she will be able to rip the benefits of these shares. On May 5, 2019, these shares were $55.30 each. For each share of Cinderella, she will get the difference between 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.

Alex was granted 700 shares on May 5, 2013, from the company where he works. The value of the stock was $43.50 per share. Alex was asked to be with the company for five 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 the full amount.

Advantages

  • It is a motivational tool and fosters retention as well as there is no investment needed for the employee’s side.The ownership of shares for the employer is not diluted.It is inexpensive to implement and administer and 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 they depart early before the agreement.

Disadvantages

  • During due time employers must have sufficient cash on hand to pay benefits.Employers can incur an additional cost if the overview of stock valuation is needed to be completed by an outside company.To all true shareholders and the SEC, if the company is publicly traded, employers must report the status of the phantom stock plan at least annually to all participants.All benefits are taxed as ordinary incomeOrdinary IncomeOrdinary income refers to an individual’s or business entity’s earnings that are taxable at the regular rates. Such earnings include salary, wages, rent received, royalty, commission, interest received, profit, etc. It excludes all incomes with tax deducted at source and capital gain.read more to employees – as the benefit is paid in cash, capital gains treatment is unavailable.Participants in “appreciation-only” plans may not receive a thing if the company stock does not appreciate it at a price.Participants in “appreciation-only” plans may not receive a thing if the company stock does not appreciate it at a price.

Limitations

  • Companies need to make sure that they comply with Internal Revenue Code Section 409A.A phantom stock plan is a costly form of long-term incentive requiring a charge against the company’s income statement.It is potentially an “uncapped liability” to the company.For executives, phantom stock rights do not represent a true ownership position in privately held companiesPrivately Held CompaniesA privately held company refers to the separate legal entity registered with SEC having a limited number of outstanding share capital and shareowners. read more that do not have publicly traded shares.Phantom equity shares do not carry voting rights or similar rights associated with stock ownership.

Conclusion

Phantom stock plans can be 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 –

  • Opening StockPenny StockLoan StockESOPControlled Company