What Are Stock Appreciation Rights (SARs), And How Do They Work?

When companies' stocks perform well, what do they do to reward their employees? SARs are the answer. SARs full form is Stock Appreciation Rights. SARs are rewards that employees receive when stock prices rise for their companies. In this article, let’s understand what SARs are, what they do, how they work, and their pros and cons. Also, we will discover how employees can choose between cash and stock rewards, how taxation works, and even how SARs compare to phantom stock.

Understanding Stock Appreciation Rights

Stock appreciation rights are like a special reward given to employees. These rewards let employees make money when the company's stock price goes up. The employees get these rights for a certain time, and after that time, they can't use them.

When the stock price goes up, employees can turn this increase into either extra money or more company shares. It depends on how the company sets up these rewards.The stock market's fluctuations highlight the dynamic nature of investment landscapes, urging investors to adapt their stock appreciation rights strategies with well-informed choices.

There are two types: one where these rewards stand alone and another where they work together with other stock options. These rewards are like a bonus for employees, and the amount of the bonus depends on how much the stock price went up.

The special thing is employees don't need to actually own the company's shares. The company needs to figure out how to pay for these rewards. Also, this helps the company because it doesn't have to make more shares, which could change the stock price.

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What Are Stock Appreciation Rights?

SARs meaning refers to the corporate method to reward their employees when the company achieves a specific goal. This stock appreciation right is directly linked to the company stock's performance. A stock appreciation right is a profit for employees if the stock price rises.

It is important to keep in mind that SARs usually have a specific validity period. After expiration, the rights are worthless. As a result, SAR holders must exercise their rights within the validity period to benefit from the employee SAR. Furthermore, these rights can only be exercised after a certain period of time, known as a vesting period.

How Do Stock Appreciation Rights Work?

SARs work by giving employees money based on the difference between how much a company's stocks were worth when they got them and how much they're worth now. This extra money is usually given as cash, but sometimes companies might give extra company shares instead. Employees get to choose which one they want, especially if they think the stock's value will go up even more later.

However, employees can only get this extra money or shares after they've waited for a certain time. Vesting is the term for this waiting period. Usually, companies also give these extra benefits along with something called stock options, which are like another way to own part of the company.

Another interesting thing is that employees can share these extra benefits with others, like their  co-workers. However, they must adhere to certain rules. Also, companies might have some rules about giving these benefits back if an employee leaves and starts working for a rival company.

Stock Appreciation Rights Example

For a better understanding of stock appreciation rights, here is a practical example.

Assume you join a company that offers SAR. You are given 100 shares at a base price of Rs 50. Vesting is two years, after which you can exercise the SAR. Say the company stock appreciates to Rs 150 after two years. 

You can now exercise your SAR in cash or stock. In cash, you will receive ((Rs 150- Rs 50) x 100) = Rs 10,000. However, if you prefer to receive your SAR as stock, you will receive (Rs 10,000/150)= 66 more shares.

Advantages And Disadvantages Of Stock Appreciation Rights

The stock appreciation rights provide cash benefits to employees if the stock appreciates. The SAR is a motivational factor for employees to work hard and push the company toward greater success since the stock price is directly related to how the company performs. Also, SAR allows for better employee retention since the employees tend to stay with the company for the vested period.

However, when stock values depreciate, SAR is disadvantageous. Upon exercising SAR, the employee will suffer losses. As a result, employees may also become demotivated, and turnover may increase.

An effective way for companies to motivate employees is through SAR. Employees can choose between the cash reward and bonus stocks, making it a versatile and profitable way to reward their hard work. Nonetheless, employees should always exercise caution when leveraging SAR, as they can sometimes result in loss.

Taxation Of Stock Appreciation Rights

SARs are taxed similarly to non-qualified stock options (NSOs). This means that when SARs are given to you (grant date) or when they become yours to use (vested), you don’t have to pay any taxes at those times. However, when you exercise SARs, you might need to pay taxes on the difference between the value of the shares at that time and what you paid for them.

Usually, your employer gives you some shares, and they take back some to cover the taxes. When you eventually sell these shares, the amount of money you get from the SARs when you exercise them becomes the starting point to determine how much money you made or lost.

So, you don’t pay taxes when you first get SARs, and you also don’t pay taxes when they become available to use. However, when you use them and get actual shares, you might have to pay taxes. You pay taxes on the extra money you made from the difference between their value and what you paid for them.

Special Considerations: Similarity With Phantom Stock

A few striking similarities exist between SARs and phantom stocks. The concept of Phantom Stock refers to an agreement where employees receive cash payments as a result of stock price increases over a specified period. Those granted phantom stock options are subject to ordinary income tax. 

Conclusion

Stock appreciation rights, or SARs, give employees a unique opportunity to share in the company's success. With SARs, employees can benefit from rising stock prices, which fosters loyalty and hard work. SARs offer employees a choice of cash or stock rewards, allowing them to tailor their benefits to their preferences. Yet, the stock market fluctuates, so it's best to be careful. Consider using the stock trading app to dive into the world of stock trading. The BlinkX stock trading app makes it easy for new and experienced investors to navigate the exciting world of stocks and financial markets.