Frequently Asked Questions about Stock Appreciation Rights

Curating an enticing compensation package is pivotal in enabling employers to attract, retain, and motivate crucial employees, especially in competitive labor markets. Stock appreciation rights (SARs) present a compelling option for incentivizing key employees, as their worth aligns directly with the company's growth. Furthermore, in structuring a SAR program, employers' benefit from the flexibility of settling SARs through either cash disbursement or share transfer. Before determining your organization's most suitable executive compensation mechanism, explore some commonly posed questions regarding SARs.

This blog delves into the Frequently Asked Questions (FAQs) surrounding Stock Appreciation Rights to provide clarity and insight. Let's explore!

Navigating through Stock appreciation rights FAQs

Source:Quist valuation

Q.1- How do Stock Appreciation Rights Work?

Ans. SARs work by letting employees benefit from the company's shares, which get more valuable over time. This benefit is calculated by comparing the stock price when the SAR is granted to the price when it's exercised.

When employees exercise SARs, they get money that equals the company's stock value increase. SARs can be paid in cash or shares. Most of the time, they're settled in money because it's easier. But sometimes, instead of cash, employees might get actual company stock shares.

Q.2- What happens when you exercise stock appreciation rights (SARs)?

Ans. When an employee exercises SARs, they accept payment in cash equal to the difference between the stock's market price at the time of exercise and the grant price.

Q.3- What is the difference between stock options and appreciation rights?

Ans. A SAR works much like a stock option, but there's one big difference. You must pay the grant price to get the actual stock when you exercise a stock option. But with appreciation rights, you don't have to pay anything to get the stock. Instead, you get the extra value that the stock gained, which is the current market price minus the grant price.

Q.4- How to do accounting in books for Stock Appreciation Rights?

Ans. Accounting for SARs involves recognizing the compensation expense over the vesting period, with the fair value of SARs being expensed on the income statement and recorded as a liability on the balance sheet.

Q.5- What are the benefits of Stock Appreciation Rights to Employees?

Ans. A significant benefit of SARs for employees is that they are not obligated to buy company shares. When the value of the company's stock increases, employees will gain from the SARs since they will get an increase in either cash or stocks (typically the case). The anticipated prize will only come to pass if the stock price increases.

In other words, employees face no risk when utilizing SARs. Nevertheless, they are susceptible to fluctuations in the stock market.

Q.6- What happens to SARs if an employee leaves the company or retires?

Ans. The treatment of SARs upon an employee's departure depends on the terms outlined in the company's SAR plan. Typically, SARs may be forfeited upon resignation but may be exercisable for a limited period after retirement.

Q.7- Can SARs be transferred or sold?

Ans. SARs are generally non-transferable and cannot be sold to third parties. Unless specified otherwise, they are typically granted solely to the employee and are not transferable by assignment.

Q.8- Are there any risks associated with SARs?

Ans. Stock Appreciation Rights (SARs) comes with risks that employees should consider. These include market volatility impacting stock prices and the potential for SARs to become worthless. SARs typically lack dividend benefits, have expiration dates, and their value depends on company performance. Dilution from additional share issuance and taxation upon exercise can also affect SARs' value. There's also a risk of forfeiture if employees leave before SARs vest. Despite their potential rewards, employees should carefully evaluate these risks before participating in SAR programs and seek advice from financial and tax professionals.

Q.9- How are Stock Appreciation Rights typically granted?

Ans. SARs are often granted as part of an employee's compensation package or as a performance incentive. They are generally subject to a vesting schedule, which may be based on the passage of time or the achievement of performance targets.

Q.10- How are Stock Appreciation Rights taxed?

Ans. The process of taxation is also more straightforward with SARs. SARs are taxed like non-qualified stock options (NSOs). Employees do not face taxation during grant or vesting periods. Cash-settled SARs are considered part of the salary and are taxed accordingly upon exercise. In the case of equity-settled SARs, taxation happens twice: first as salary income and then as capital gains tax when the employee sells the shares. Typically, employees retain a portion of shares to offset the tax liability.

Q.11. What are the different types of SARs?

Ans. Stock Appreciation Rights (SARs) can be categorized into different types based on their payout structure and conditions. In India, there are primarily two types of Stock Appreciation Rights:

Phantom Stock Appreciation Rights: Phantom SARs are cash bonuses tied to the appreciation in the value of the company's stock. Employees receive the monetary equivalent of the increase in the stock price over a specified period without owning any company shares. These rights are settled in cash.

Equity SARs: Equity SARs, on the other hand, grant employees the right to receive actual shares of the company's stock or the equivalent cash value based on the appreciation in the stock price. Unlike phantom SARs, equity SARs involve the issuance of shares or their cash equivalent to the employees upon exercise.

Both types of SARs typically have vesting schedules and exercise periods, during which employees can exercise their rights. The taxation treatment of SARs in India can vary depending on some factors like- whether they are considered part of an Employee Stock Option Plan (ESOP) or other employee compensation schemes, and both employers and employees should consult tax advisors or experts for guidance on tax implications.

Q.12. How does SAR mature or liquidate?

Ans. Stock Appreciation Rights (SARs) typically mature or liquidate when an employee exercises them, usually without purchasing underlying shares. After the exercise, the employee can retain or sell the shares. SARs are subject to terms like vesting periods and performance targets. Upon satisfaction, employees can exercise SARs before the expiration date specified. The agreement outlines that settlement may occur in cash, shares, or both. SARs may also be settled upon corporate events such as mergers.

Final Thoughts

Therefore, Stock Appreciation Rights offer employees a unique opportunity to benefit from the appreciation in their company's stock value without purchasing shares upfront. However, understanding how SARs work, their accounting treatment, taxation, and associated risks is essential for employers and employees. We would like to provide clarity and guidance on this increasingly popular form of employee compensation by addressing these FAQs. Schedule a demo with us to gain a deeper understanding!