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2024 Roundup for Stock Appreciation Rights

  • Written Written by Sanya Gupta 09 February 2024 | 4 min read
  • Editor's Note :

    Explore the complications of Stock Appreciation Rights (SARs) and their benefits for employees and companies. Learn about taxation, vesting, and how SARs can be a valuable tool for incentivizing talent.

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What are Stock Appreciation Rights (SARs)?

SARs are a type of employee compensation that grants the holder the right to receive a cash payment based on the appreciation in value of a company's stock over a specified period. Unlike stock options, SARs don't require employees to purchase shares upfront. Instead, they receive a pay-out based solely on the stock's price increase. SARs are profitable for employees when the company's stock price rises, which makes them similar to employee stock options (ESOs). However, employees do not have to pay the exercise price with SARs. Instead, they receive the sum of the increase in stock or cash.

How SARs Work?

how sar works

  1. Grant: Companies grant SARs to employees, typically with a vesting schedule that specifies when they become exercisable.
  2. Vesting: Vesting periods often range from 3-5 years, encouraging employee retention.
  3. Exercise: Once vested, employees can choose to exercise their SARs, receiving a cash payment based on the difference between the current stock price and the grant price.
  4. Payout: This payout can be made in cash, shares of stock, or a combination of both, depending on plan rules.

Process of owning Stock Appreciation Rights (SARs)

Initially, the company allocates SAR units from the predetermined option pool to eligible employees. These SAR units enable employees to benefit from the appreciation in the value of a specific number of shares issued by the company, exceeding the designated price in the SARs Grant. This is part of the company's SAR scheme.

The SAR Grant must adhere to the vesting period established by the company. Upon completion of the vesting period, employees have the option to exercise or retire their accrued SARs within the specified exercise period outlined in the SARs scheme.

During the exercise, the company compensates the difference in share price from the issuance date to the exercise date. This compensation can be settled entirely in shares, cash, or a combination of both. However, they have to act on their rights before the SAR expiration date, which typically occurs 7-10 years from the grant date. Once the company fulfills the SARs, they are considered retired.

Process of granting Stock Appreciation Rights (SARs)

The process of granting of SARs follows different procedures in listed and unlisted companies.

Taxation Guidelines for SARs

Taxation is more straightforward with SARs. SARs follow a tax approach similar to non-qualified stock options (NSOs). Employees do not face any taxes during the granting or vesting phases. When cash-settled SARs are exercised, they are considered part of the salary and taxed accordingly. In the case of equity-settled SARs, taxation occurs twice: first as salary income and then as capital gains tax when the employee sells the shares. Typically, employees retain a few shares to cover the tax amount.

Cover the Tax Amount. Stock Appreciation Rights Stages
Taxation for Employees
Grant
Non-Taxable
Vesting
Non-Taxable
Mon
Taxable as regular income (income slab applied)
Sale (in case of equity-settled SAR)
Capital Gains Tax

How SAR is different from ESOPs?

ESOPs and SARs differ in how employees pay and get taxed.

But the basic idea is the same: employees make money when the company's share price goes up, whether through ESOPs or SARs.

Example?

Let's delve into the concept of SARs using an example.

ABC Inc. has awarded stock appreciation rights to its employees under the following conditions:

Now, let's consider that an employee decides to exercise their right as of January 1, 2026, and on that date, the market price of the shares is $300.

Net Money Value of Shares = (Market Price of share – Exercise Price) * No of Shares

No. of Shares Received = Net Money Value of Shares/Market Price

This means that they would gain $18,000 from their 60 SARs

Particulars
Amount
Market Price
$300.00
Exercise Price
$120.00
No. of Shares
100
Net Money Value of Shares
$18,000.00
No. of Shares Received
60

Advantages of SARs

For Employees:

For Companies:

Disadvantages of SARs

For Employees:

For Companies:

Conclusion

SARs can be a valuable tool for companies seeking to attract, retain, and motivate employees by aligning their financial interests with the company's success. However, it's essential to carefully consider the advantages and disadvantages, along with the company's financial position and goals, before implementing a SAR plan.

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