How do phantom stock plans work

Where appreciation-only phantom stock pays out the difference between the shares' initial value and their current value, full-value phantom stock pays out exactly what it's worth. For example, let's say that Mary is granted phantom shares on June 5, , for the company she works for. Go Mary! For employees, phantom stock rewards the time and effort they invest into the company. When phantom stock matures, companies will either pay employees the cash value of the shares or, less often, convert the phantom shares into actual stock.

For company owners, phantom stock can help grow their business. Strong leadership is essential to a company's success, and replacing senior leadership can be expensive. Phantom stock gives top employees a reason to stay and help the company succeed. Phantom shares could be granted every year, even if they take five years to mature. This means that once leaders have been at the company for five years, they can expect to benefit from these rewards annually.

On the other hand, if they leave the company before the shares mature, they will not receive any of those rewards. Phantom stock is not a good idea if the company is planning on issuing them to most or all employees, especially if the shares will be paid out when the employee leaves the company or retires. To change or withdraw your consent choices for Investopedia. At any time, you can update your settings through the "EU Privacy" link at the bottom of any page.

These choices will be signaled globally to our partners and will not affect browsing data. We and our partners process data to: Actively scan device characteristics for identification. I Accept Show Purposes. Your Money. Personal Finance. Your Practice. Popular Courses. Investing Stocks. What Is a Phantom Stock Plan?

Key Takeaways A phantom stock plan, or 'shadow stock' is a form of compensation offered to upper management that confers the benefits of owning company stock without the actual ownership or transfer of any shares.

By simulating stock ownership, without actually providing it, management ensures that equity does not become diluted for other shareholders. Large cash payments to employees, however, must be taxed as ordinary income rather than capital gains to the recipient and may disrupt the firm's cash flow in some cases. Phantom stock plans have a lot in common with traditional nonqualified stock plans.

Article Sources. Investopedia requires writers to use primary sources to support their work. These include white papers, government data, original reporting, and interviews with industry experts. As described, phantom shares are usually redeemed in cash—the payment being treated like a bonus. However, should the plan agreement allow it, the payment obligation may be satisfied by distributing actual stock to the employees. A phantom stock plan must be supported by more than a verbal commitment.

It requires a formal document that describes the plan terms and articles. It is basically offered as a bonus for staying with the company for a long time and the hard work that employee puts in.

Just like real stock, phantom stock is worth money, and its value increases and decreases just like normal stock. Employees get profit gained from a phantom stock plan after a time period is complete.

There are also multiple kinds of phantom stock plans to choose from, based on the preferences of the company, which usually varies on the vesting schedule.

Each phantom stock plan has an agreement that defines the vesting schedule of the plan. The agreement would outline each rule including the goals or tasks that a participant needs to accomplish before the shares can vest. It also defines these goals and what is given to the participants once they reach their goals. If there are any voting rights , those rights are also mentioned in the agreement It would also outline the rules of if the phantom stock can be converted to actual shares upon payout.

Offering employees with employee compensation in the form of equity can offer a lot of benefits. It also helps create loyal employees, as they feel invested in the firm, and may stay with the company longer to receive the full amount of phantom stock. Nonetheless with such incentives, phantom stock is great for certain situations, such as:.

The number of shares given to an employee is usually based on how senior they are in the organization and their performance. And even though they are promised money today, their benefits are long-term. As per the phantom stock plan, the company would pay out the benefits in two, three, or even five years, with some being subject to certain milestones as well. There are two kinds of phantom stock plans that are given as employee compensation. Each has been explained below:.