A helpful guide to provide you with all the information you need to know about phantom stocks
Some businesses provide senior employees with the opportunity to purchase phantom stock. It provides these workers with some of the financial benefits of owning shares, but they don't actually own any of the company stock themselves. Because shadow stocks are not the same as regular company stocks, the value of actual company stockholders' shares does not decrease due to this arrangement because shadow stocks are not comparable to regular company stocks.The Concept of Phantom Stock, Along with Some Examples
Phantom stock is a type of employee compensation that gives workers the appearance of ownership in a company's stock but does not actually grant them ownership of the stock. The value of a phantom stock, just like the value of any other type of stock, rises and falls in tandem with the stock of the underlying company. On a predetermined schedule, employees receive compensation in the form of profits accrued from any appreciation in the value of the company's stock. As a component of an employee's total compensation package, the use of phantom stocks is rapidly gaining popularity. They are not limited to those in the technology industry. There are some businesses that link the award to the achievement of certain goals.Phantom stocks are alternately referred to as "shadow stock"
How the Phantom Stock System Functions
The perceived value of an employee or manager to the organization is frequently taken into consideration when determining the number of phantom shares to be awarded to that individual. When an employee is considered more valuable, there is a better chance that they will be awarded a greater number of shares. When phantom stocks are awarded, a "delay mechanism" will begin to take effect. The actual financial payout may be made after a long period, anywhere from two to five years, but this is contingent upon the agreement between the company and the employees. Companies use phantom stocks not only to reward and motivate their employees but also to provide those employees with "skin in the game." The increased productivity in the workplace will hopefully result in increased profits for the company.Different kinds of Phantom Stock
Companies typically use "appreciation only" phantom stocks or "full value" stocks in their accounting practices.Appreciation Only Phantom Stocks
The recipients of an appreciation stock will not be able to obtain the phantom stock's current value. Instead, recipients are entitled to any potential profits that the phantom stock might make over a given time period, such as an increase in the stock's price. If employee "A" were to receive 1,000 shares of phantom stock, with each stock being worth $20, the current value of the company stock would be $20,000 if this scenario were to play out. Imagine that for the employee to receive the full benefits of the phantom stock deal, the terms of the agreement stipulate that they must remain employed by the company for five years. The period in question is referred to as the "vesting" period. At the conclusion of the vesting period, the price of a share of the company's stock increased to $40. Employee "A" would be entitled to receive the sum equal to the difference between the value of one share of stock, which was $20 on the date that the transaction was finalized, and the price of one share, which was $40 on the date that Employee "A" became eligible to receive any profits from the stock. In this scenario, the appreciation is $20 per share, which would result in a profit for the phantom stockholder of $20,000 in this scenario.Full Value Phantom Stocks
Under the terms of a full-value phantom stock deal, the recipient is entitled to receive both the current value and any appreciation in the stock price once the due date has passed. Staff Member "A" "would be entitled to the $20 price increase per share after the elapse of five years in this scenario. They would also be entitled to the profits from the price appreciation that has occurred on the shares since the beginning of the transaction.Phantom Stocks –– The Benefits and Drawbacks
The advantages of phantom stocks
- When the value of the company's stock goes up, employees stand to gain.
- It is not necessary for employees to take any action in order to purchase stocks.
- The company is allowed to keep control of the stocks at all times.
The disadvantages of phantom stocks
- If the stock price continues to fall, employees do not have any options or control over the situation.
- If an employee is fired, even for reasons that were beyond their control, the employee may be disqualified from receiving benefits.
- It's possible for companies to rack up additional expenses by using phantom stock plans.
The advantages of phantom stocks –– explained
Employees come out ahead when there is an increase in the stock price
The use of phantom stocks as a motivational tool is an effective way to ensure that key employees remain with the company throughout the entire vesting period. They make employees more productive overall. When the value of the phantom stock goes up, the recipient of the gift also comes out ahead.It is not necessary for employees to take any action in order to purchase stocks
There is no requirement for these employees to acquire phantom stock shares on the open market, as is the case for regular stockholders, because they do not need to do so. Employees are compensated with phantom shares, and there is no cash exchange for these shares. That is a significant advantage provided to workers. They are entitled to a portion of the profits made by the stock but are not required to pay for it.The corporation is allowed to maintain its ownership of the stocks
Employers stand to benefit from having control of the company's phantom stocks. Under the terms of a standard phantom stock charter or contract, a company has the ability to impose its will on the arrangement of the agreement. It has the ability to exercise control over the amount of equity participation that is distributed to workers in the form of dividends. A provision that "forfeits" any phantom stock benefits can also be included in a phantom stock agreement by a company. This occurs when an employee leaves the company before the agreed-upon date that all of their phantom stock benefits have been "vested."The disadvantages of phantom stocks –– explained
If the stock price continues to plummet, employees have neither options nor any control over the situation
In a phantom equity deal, the company makes all of the decisions, and the employees have very little control over the situation or room for maneuvering if the share price drops. Phantom stock deals also involve the consideration of tax implications. Companies must strictly adhere to tax rule 409A of the Internal Revenue Service (IRS), which restricts the options available to companies when instituting distribution dates. In addition, it prevents employees and managers from speeding up phantom stock payouts even if they have reason to believe that the company is experiencing severe financial strain.If an employee's employment is terminated, they may no longer be eligible for benefits
Suppose an employee is fired before the deal goes into effect, even for reasons that are beyond their control. In that case, they will be ineligible to collect any phantom stock cash benefits due to the termination.Companies may incur additional expenses due to the use of phantom stock plans
Phantom stock plans can result in additional costs for companies that choose to implement them, particularly if any stock valuation overview needs to be completed by an external accounting company.Key Takeaways
- Phantom stock plans have the potential to be an effective tool for employers looking to motivate their workforce, as well as an excellent cash incentive program for employees.
- In the event that things don't go as planned and the stock price doesn't go up, neither the employer nor the employee will suffer any direct financial losses as a result of the deal.
- The potential benefits of phantom stock plans far outweigh the potential drawbacks.
- They are becoming more and more common as benefits are included in employee compensation packages.
