Understanding Stock Appreciation Rights (SARs): Advantages, Disadvantages, and Examples

Stock Appreciation Rights (SARs) are a form of equity compensation plan that enables companies to offer their employees the opportunity to benefit from the company’s growth without actually receiving equity. In this article, we will discuss what SARs are, their advantages and disadvantages, and provide an example of how SARs work.

What are Stock Appreciation Rights (SARs)?

SARs are a type of employee compensation plan that gives employees the right to receive cash or stock equal to the increase in the company’s stock price over a set period. SARs are similar to stock options in that they both offer employees the opportunity to benefit from the growth of the company. However, unlike stock options, SARs do not require the employee to purchase shares in the company.

Advantages of Stock Appreciation Rights (SARs)

1. No Need to Purchase Shares: One of the main advantages of SARs is that employees do not need to purchase shares in the company to benefit from the growth of the company. This is different from stock options, which require the employee to purchase shares at a predetermined price.
2. Flexibility: SARs are highly flexible and can be customized to meet the needs of both the company and the employees. The company can choose the vesting period, the exercise price, and the payment terms, among other things.
3. No Dilution of Equity: Since SARs do not involve the issuance of new shares, there is no dilution of equity. This is beneficial to existing shareholders, as their percentage of ownership in the company is not reduced.
4. Employee Motivation: SARs can be a powerful tool to motivate employees to work hard and contribute to the company’s growth. When employees see the value of their SARs increase, they are motivated to work harder to help the company succeed.

Disadvantages of Stock Appreciation Rights (SARs)

1. No Ownership Rights: Unlike stock options, SARs do not give employees ownership rights in the company. This means that employees cannot vote on company matters or receive dividends.
2. No Tax Benefits: SARs do not provide the same tax benefits as other forms of equity compensation, such as stock options or restricted stock units.
3. Complexity: SARs can be complex and difficult to understand, especially for employees who are not familiar with the stock market.
4. Risk: SARs are subject to market risk, which means that the value of the SARs can fluctuate based on the performance of the company’s stock. If the stock price does not increase, the SARs may be worthless.

Example of Stock Appreciation Rights (SARs)

Let’s say that a company offers SARs to its employees. The SARs have a vesting period of three years, an exercise price of $50, and a payout based on the increase in the company’s stock price over the three-year period.

After three years, the company’s stock price has increased from $50 to $75 per share. The employee exercises their SARs, and the company pays the employee the difference between the exercise price ($50) and the stock price at the end of the vesting period ($75), which is $25 per share. If the employee had 1,000 SARs, they would receive $25,000 in cash.

Conclusion

Stock Appreciation Rights (SARs) are a type of equity compensation plan that offers employees the opportunity to benefit from the growth of the company without purchasing shares. SARs are flexible and can be customized to meet the needs of both the company and the employees. However, like any form of equity compensation, SARs have their advantages and disadvantages.

While SARs do not require employees to purchase shares in the company, they do not provide ownership rights or tax benefits. Additionally, SARs can be complex and subject to market risk. Despite these drawbacks, SARs can be a powerful tool to motivate employees and align their interests with those of the company.

Overall, companies should carefully consider the advantages and disadvantages of SARs before implementing them as an employee compensation plan. Employees should also take the time to understand the terms and risks associated with SARs before accepting them as part of their compensation package.