Phantom Stock Option Plan

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Phantom Stock : It is an employee benefit plan that gives the selected employees, many of the benefits of stock ownership without actually giving them any company stock. That’s why, also referred to as "Shadow Stocks." The employees are not allotted actual shares, but are issued Options with underlying shares in it, the value of which increases over a period of time and that can be converted into a predetermined cash amount, depending upon the terms of the Stock Option Plan, without any actual allotment of shares. The payment terms may depend upon tenure of employment, performance, appraisal criterion, meeting the targets etc., or any combination of them as well.

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Phantom Stock Option Plan

  1. 1.  
  2. 2.   For any Organization-be it a Start up or a long existing one, the buzz word these days is “Employee Retention”. High employee turnover keeps the CEOs/ HR Heads on their toes and they keep wondering how to Award, Reward and Retain their human asset. In such a scenario, Employee Stock Option Plan (ESOP) have emerged as a handy tool for employee retention. ESOP give the employee a right to buy a specific number of company's shares at a fixed price within a certain period of time. Employees who is granted stock options expect to gain by disposing off their shares at a higher price than at what they were granted. ESOP inculcates a feeling of being the “Owner” and the Employees tend to perform better, thus leading to the Organisation’s betterment as well as the Employee enrichment. ESOP, thus, align the Promoters’ wishlist with the employee interest. ESOPs can even be granted to the employees of the Company’s holding/ subsidiary companies as well. ESOP can be of varied types and forms - Employee Stock Purchase Scheme (ESPS), Restricted Stocks Units (RSUs), Performance Shares, Stock Appreciation Rights (SAR) including Phantom Stocks etc. While all others are comparatively traditional methods of ESOP, Phantom Stocks have surfaced as an interesting and contemporary variation of ESOP. Phantom Stocks are also referred to as “Shadow Stocks”. As the name depicts, these are the Stocks that are not for real, they are like a shadow. The employee is granted the Options, to be redeemed into cash, as per the Scheme, without creating any impact on the Company’s share capital or the voting percentages. Phantom Stocks provide a cash or stock bonus based on the value of a stated number of shares, to be paid at the end of a specified period(s).
  3. 3.   These are favored by closely held or family-owned companies who intend to incentivize their human assets without sharing their equity. Under Phantom stocks, employees get to share the growth, without an actual ownership stake in the company. Definition- Phantom Stocks As mentioned above, it is an employee benefit plan that gives the selected employees, many of the benefits of stock ownership without actually giving them any company stock. That’s why, also referred to as "Shadow Stocks." The employees are not allotted actual shares, but are issued Options with underlying shares in it, the value of which increases over a period of time and that can be converted into a pre determined cash amount, depending upon the terms of the Stock Option Plan, without any actual allotment of shares. The payment terms may depend upon tenure of employment, performance, appraisal criterion, meeting the targets etc., or any combination of them as well. Key Features of Phantom Stocks As mentioned above, Phantom Stocks mirror some of the attributes of actual stock ownership without giving away any portion of the Company. Some of the pertinent benefits are: 1. No dilution: The Promoters need not worry about control and dilution of their voting rights. Thus, Phantom Stocks turn out to be a better option for unlisted companies as no actual shares are issued. 2. Well laid Plan: The terms of encashment are well laid in the Stock Options Plan. Even in case of termination of employment/ death/ disability of the employee, the encashment can happen, depending upon the provisions in the Plan, as approved by the Board and informed to the Employees through the Scheme. 3. Tax implications: Phantom Stock benefits are paid out as ordinary income and taxed as such for the employee, thus serving as a deductible expense for the employer. Since no capital gains are involved, this leads to simplified taxation regime for the employees as well. 4. Impact on Company’s earnings: In a listed entity, another major advantage of a Phantom Stock Plan is that it helps in reduction of share price dilution to some extent, as accounting rules and applicable laws require amortization of fair value of the
  4. 4.   Compensation Cost (i.e. aggregate liabilities of the Company towards the Employees) during the vesting period of the plan. Accordingly, the earnings of the Company automatically get adjusted in tandem with the change in the Compensation Cost without any dilution of actual stock ownership percentages. 5. Flexibility: The Companies have full flexibility in designing their Plans and can have graded vesting schedules/ exercise periods/ pay out tranches etc. 6. Employee’s liability: Under a Phantom Stock Plan, the employee does not become a shareholder and thus is not responsible for additional capital contributions and not required to personally guarantee any liabilities of the Company. 7. Adjustment in Value: Phantom stock is treated in the same way as deferred cash compensation as the value gets adjusted in tandem with the market value or fair value of the shares. 8. Freedom from Market related worries: Even from the employees’ point of view, they remain free of the worries arising on account of market fluctuations and as it does not involve any cash outlays to purchase shares/ exercise the options. Suitability Phantoms can be issued in any kind of a Company-be it listed/ unlisted/ closely held, but from the nature of the instrument, it becomes more suitable for the following types of corporates: 1. They are more apt for cases, where in the Promoters intend to share the Company’s growth with the employees, but without hampering their equity stake or relinquishing their control in the Company. 2. Phantom Stocks also turn out to be a better option, in cases, where options are to be granted to lower cadre employees, who might not appreciate a stock/ share as such, but can surely understand the concept of getting hard cash after a pre determined period. 3. In cases, wherein further allotment of equity shares is under litigations/ barred by any Authority, even in such cases, Phantom Stocks stand out as a savior for the purpose of employee retention. 4. Even in cases, wherein Companies do not intend to increase the Authorised Share Capital and bear the Stamp Duty thereon, Phantoms are suitable.
  5. 5.   As per market reports, some of the Indian companies that have offered phantom stocks are Bajaj Allianz, DLF, Birla Sunlife, Apollo Tyres, Cairn India, etc. Vesting and Award Payment Phantom shares may vest similar to other stock option plans over a 3-5 year period. Vesting in private companies may be longer than what is typical in public companies. The company has wide discretion over the vesting of phantom stock. However, unusually long vesting periods may make the Plan non lucrative for the employees. Awards are typically paid in cash upon exercise or maturity and may be in a lump sum or in installment payments. In the event of any Corporate Action that takes place during the currency of the Plan, the Phantom stock options granted under the Plan are also accordingly revalued. Alternatively, in case of Corporate Actions like Merger or Amalgamation, if required, the value to the Employees may be ensured by re-shaping the existing Phantom Plan to a new plan such as stock options or restricted stock in the new-fangled Company. Pre mature payments may also be made upon early retirement, death, or permanent disability, depending upon the provisions in the respective Stock Options Schemes. Valuation In any Stock Option Plan, the Valuation/ the accounting aspect of the same plays a very crucial and also a very tricky part. In next few paragraphs, we have tried to explain and exemplify the Valuation & Accounting aspects of a Phantom Stock Plan. The value of phantom stocks is needed to be determined upon grant, during interim periods and at the final payment date to facilitate the calculation of the award. For Phantom Stocks, there are basically 2 types of Valuations: (1) ESOP Valuation for Accounting: This Valuation is required to amortize the Employee Compensation Cost during the vesting period. Accordingly, the compensation value is
  6. 6.   required to be computed initially i.e. at the time of Grant and at the end of each reporting year till the liability in respect of Phantom Stock gets settled. This Valuation can be conducted by any Independent Valuer i.e. Chartered Accountant/ Merchant Banker. (2) Perquisite Valuation: This Valuation would be conducted at the time of Exercise of Options by the Employee to know the value of the perquisite to be added in the Employee’s salary for the month in which he makes the exercise of his option. This Valuation can be done only by a SEBI Registered Merchant Banker. Accounting Aspects For accounting purposes, employee share-based payment plans are classified into the following categories: (a) Equity-settled: Under these plans, the employees receive shares. (b) Cash-settled: Under these plans, the employees receive cash, based on the price (or value) of the enterprise’s shares. (c) Employee share-based payment plans with cash alternatives: Under these plans, there is a choice available to settle the payment in cash or by issue of shares. From the above, it can be inferred that the Phantom Stock is covered under the category of Cash- settled plan. Accordingly, the liability under the Plan is required to be determined initially and at each reporting year until settled at fair value by applying an option pricing model. The accounting treatment for phantom stock is outlined with the help of following example: Suppose X Ltd grants 1 Lac options of face value of Rs. 10/- each under Phantom Stock Options Plan and the said options are to vest in the following manner: a. 1/3rd of Total Options to vest at the expiry of 3rd year from the date of Grant of Options
  7. 7.   b. 1/3rd of Total Options to vest at the expiry of 4th year from the date of Grant of Options c. 1/3rd of Total Options to vest at the expiry of 5th year from the date of Grant of Options Accounting Treatment at the end of First Year Presuming Fair Value at the end of first Reporting Year: Rs. 10/- per share. Provisions required to be made at the year-end:(No. of Options*Fair Value/Vesting Period) For 1st Grade Vesting: 111110 For 2nd Grade Vesting: 83332.5 For 3rd Grade Vesting: 66668 Expenses for the year 261110.5 Accounting Treatment at the end of Second Year Presuming Fair Value at the end of second Reporting Year: Rs. 12/- per share. Provisions required to be made at the year-end: (No. of Options*Fair Value/Vesting Period) For 1st Grade Vesting: 155554 For 2nd Grade Vesting: 116665.5 For 3rd Grade Vesting: 93335.2 Expenses for the year 365554.7 Accounting Treatment at the end of Third Year Presuming Fair Value at the end of third Reporting Year: Rs. 13/- per share. Provisions required to be made at the year-end: (No. of Options*Fair Value/Vesting Period) For 1st Grade Vesting: 166665 For 2nd Grade Vesting: 124998.75 For 3rd Grade Vesting: 100002 Expenses for the year 391665.75
  8. 8.   Accounting Treatment at the end of Fourth Year Presuming Fair Value at the end of third Reporting Year: Rs. 14/- per share. Provisions required to be made at the year-end: (No. of Options*Fair Value/Vesting Period) For 2nd Grade Vesting: 141665.25 For 3rd Grade Vesting: 113335.6 Expenses for the year 255000.85 Accounting Treatment at the end of Fifth Year Presuming Fair Value at the end of third Reporting Year: Rs. 15/- per share. No. of SARs expected to Vest: 1,00,000 Provisions required to be made at the year-end: (No. of Options*Fair Value/Vesting Period) For 3rd Grade Vesting: 126669.2 Expenses for the year 126669.2 Conclusion As compared to a plain vanilla ESOP, Phantom Stocks come with a cherry as a topping. With all the motivating factors, as contained in any other ESOP, Phantoms have an added flavor of no equity dilution. However, as is said, nothing is perfect, one major drawback in Phantom Stocks is that these plans do not extend ownership benefits and other benefits like dividend, bonus, etc. to the Employees, which otherwise they would be entitled to in case of other ESOP forms.
  9. 9.   Contact us: An Online Venture of For any clarifications or Professional Advisory, feel free to contact: Ms. Anjali Aggarwal Ms. Simran Kaur Vice President Associate M: +91 9971673336 M: +91 9999702150 Ph: 011-40622230 Ph: 011-40622219 Email: anjali@indiacp.com Email: simran@indiacp.com For online ESOP Management, please visit: www.esopguardian.com Disclaimer: - The entire contents of this document have been developed on the basis of relevant statutory provisions and the information available at the time of the preparation. Though the author has made utmost efforts to provide authentic information however, assumes no responsibility for any errors which despite all precautions, may be found herein. The material contained in this document does not constitute/substitute professional advice that may be required before acting on any matter. The author and the company expressly disclaim all and any liability to any person who has read this document, or otherwise, in respect of anything, and of consequences of anything done, or omitted to be done by any such person in reliance upon the contents of this document. © 2013, Corporate Professionals. All rights reserved Our ESOP Services: Scheme Conceptualization | Scheme Designing & its Implementation | MB Certifications | Online ESOP Management | ESOP Valuation | ESOP Statutory Compliances | ESOP Tax & Legal Advisory

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