Stock Appreciation Rights (SARs) are a type of equity-based compensation granted to employees by companies. SARs provide employees with the opportunity to receive the appreciation in the company's stock value over a specific period without actually owning the underlying shares. SARs are typically settled in cash or stock, depending on the company's policy.
Here are three pros of receiving Stock Appreciation Rights:
- Direct Participation in Stock Value Increase: SARs allow employees to benefit directly from the increase in the company's stock price. When SARs are exercised, employees receive the difference between the market price at the time of exercise and the grant price as cash or stock, providing potential financial gain.
- No Need for Ownership: SARs do not require employees to own the underlying shares, which means they can participate in the value appreciation without the associated risks and responsibilities of share ownership, such as voting rights or dividends.
- Flexibility in Settlement: SARs offer flexibility in settlement options. Employees may have the choice to receive the appreciation in cash or company stock, depending on the company's policy and the employee's preference.
However, there are also some potential drawbacks associated with Stock Appreciation Rights:
- No Dividend Payments: Since SARs do not involve actual share ownership, employees typically do not receive dividend payments associated with the underlying shares. This can be a disadvantage compared to actual stock ownership.
- No Voting Rights: Similar to the lack of dividend payments, SARs do not provide employees with voting rights in the company. Employees do not have a say in corporate matters, such as electing board members or voting on significant company decisions.
- Market Risk: The value of SARs is tied to the performance of the company's stock. If the stock price declines or fails to meet expectations, the SARs may lose their value, potentially resulting in lower financial gain or even financial loss for employees.
Example: Let's say you work for Company XYZ and receive a grant of 1,000 Stock Appreciation Rights (SARs). The SARs have a three-year vesting period and can be settled in cash or company stock, depending on the company's policy.
Here's a timeline outlining the key events for the example provided:
Year 1:
- You receive a grant of 1,000 SARs from Company XYZ.
- The SARs have a three-year vesting period, during which you continue working for the company.
Year 2:
- You complete another year of service at Company XYZ, and the SARs continue to vest.
Year 3:
- The third year of the vesting period passes, and you remain with Company XYZ.
- The SARs are now fully vested and eligible for exercise.
Year 4:
- The stock price of Company XYZ has increased significantly since the grant date.
- You decide to exercise the SARs and settle them in cash.
After Year 4:
- You receive the cash equivalent of the appreciation in the stock price of the SARs.
- The cash settlement is determined by the difference between the market price at the time of exercise and the grant price multiplied by the number of SARs exercised.
- The amount received is subject to applicable taxes and any withholding requirements.
It's important to note that the specific terms, vesting schedule, settlement options, and tax implications of SARs can vary between companies and individual circumstances. Consulting with a financial advisor or tax professional is recommended to fully understand the implications and potential tax liabilities associated with SARs, especially considering the evolving tax laws and regulations.