What are Stock Appreciation Rights?

Last Updated: 4 Feb 2025

The greatest resource for a company is its employees. You can start a company with very little capital. However, to see it succeed, you have to rely a great deal on the employees and their hard work. Take the example of any big company that is enjoying success today. You will realize that they invest heavily in their employees

India is witnessing a heavy surge in new startups. With over 50,000 startups, India is among the countries with the highest number of startups that are garnering billions of dollars in funding. With such high volumes of new companies, the employment spectrum has become fast-paced, meaning that these companies require skilled employees in high numbers. As a result, companies are facing employee retention problems. If an employee finds a company that can offer them better benefits, they consider leaving the current one, which becomes a problem for the company to find a quick, equally skilled replacement.

One of the most widely used ways companies use to retain employees is by offering them ESOPs or Stock Appreciation Rights. This blog details everything you need to know about stocks appreciation rights.

How do stock appreciation rights work?

The stock appreciation rights work on the principle of providing employees with the difference between the base price and the current market of the company stocks in cash. The base price is at which the stocks were initially offered to the employees by the company. Although almost all companies provide this benefit in cash, some may offer bonus shares as stock appreciation rights. In both situations, the employees are given an option to choose between the two. If they think the price of the stocks may go higher in the future, they may opt for bonus shares instead of a cash reward.

Employees can only exercise the stock appreciation rights after the shares have vested. The vesting period is the minimum period employees must hold the stocks before they can exercise the stock appreciation rights. Generally, employers offer stock appreciation rights along with stock options. The process called tandem stock appreciation rights, allows employees to cover the expenses related to the purchase of options and the resulting tax arising due to exercising the stock appreciation rights.

All the stock appreciation rights come with transferable rights, allowing employees to transfer their stock appreciation rights to other employees. However, these rights may come with clawback clauses. These clauses list down the rules and regulations an employee must follow to exercise the stock appreciation rights. For example, in its clawback clause, a company can reclaim the stock appreciation rights from employees if they leave the company and start working with the company’s direct competitor.

A practical example of stock appreciation rights

Here is a practical example for a better understanding of stock appreciation rights.

Suppose you join a company that has the benefit of stock appreciation rights. You are given 100 shares with a base price of Rs 50. The vesting period is two years, after which you can exercise the stock appreciation rights. Let’s say after two years, the price of the company stock appreciates to Rs 150. Now, you can exercise the stock appreciation rights in cash or stock. If in cash, you will receive a cash amount of ((Rs 150- Rs 50)x100)= Rs 10,000. However, if you prefer to have the stock appreciation rights in stock, you will receive (Rs 10,000/150)= 66 more shares.

Types of Stock Appreciation Rights

Stock Appreciation Rights (SARs) can be categorized into different types based on how they are structured and implemented within a company. Now that we have understood what is stock appreciation rights, it is time to understand the types of them:-

1)Stand-alone SARs: These are issued independently of other stock options. Employees receive the benefit of the appreciation in the stock price, paid in cash or shares, without the need to exercise any stock options. This type allows employees to benefit directly from the increase in stock value without requiring upfront investment or the need to purchase shares.

2)Tandem SARs: Issued alongside stock options, tandem SARs give employees a choice between exercising the stock option or the SAR. If the stock option is exercised, the SAR is forfeited, and vice versa. This flexibility allows employees to select the option that provides the maximum benefit based on the stock’s performance and their financial goals.

Advantages and disadvantages of stock appreciation rights

Advantages

1. No Initial Investment Required: One significant advantage of stock appreciation rights is that employees do not need to invest any of their own money to benefit from the appreciation in stock price. This makes SARs an attractive form of compensation for employees.
2. Alignment with Company Objectives: SARs align employees’ interests with those of the company and its shareholders. Since employees benefit when the stock price rises, they are motivated to contribute to the company’s success and work towards increasing its value.
3. Flexibility: SARs offer flexibility in terms of payout. They can be settled in cash or company shares, depending on the terms of the plan and the employee’s preference. This flexibility makes SARs a versatile tool for compensation.
4. Retention Tool: SARs can serve as a powerful employee retention tool. Since employees typically receive SARs after a vesting period, they are encouraged to stay with the company to benefit fully from the appreciation rights.

Disadvantages

1. Complexity: What are stock appreciation rights? While the concept might seem simple, the implementation and administration can be complex. Companies need robust systems to track SARs, calculate payouts, and ensure compliance with regulatory requirements.
2. Tax Implications: SARs can have unfavorable tax consequences for employees. Depending on the jurisdiction, the payout from SARs may be taxed as ordinary income, which could result in a significant tax liability. Employees need to understand the tax implications before exercising their rights.
3. Potential for Reduced Motivation: If the company’s stock price does not perform well, employees may receive little to no benefit from their SARs. This can lead to reduced motivation and dissatisfaction. Companies need to balance SARs with other forms of compensation to keep employees motivated.
4. Market Risk: The value of SARs is tied to the company’s stock price, which can be influenced by market conditions and external factors beyond the company’s control. This introduces an element of uncertainty and risk for employees.

Frequently Asked Questions

Q1. What are the examples of stock appreciation rights?

Suppose you get 100 shares of your company at a base price of Rs 10. After the vesting period, you can exercise the stock appreciation rights and get a cash reward based on the difference between the base and the current stock price.

Q2. Are stock appreciation rights equity?

The stock appreciation rights come in two forms: Cash and Equity. Equity, in this case, is given in the form of bonus shares.

Q3. Are stock appreciation rights like securities?

No, stock appreciation rights are not securities as they do not require the employees to hold any contract or asset.

Q4. How do employees receive stock appreciation rights?

Employees receive stock appreciation rights as part of their compensation package, allowing them to benefit from the stock’s price appreciation without purchasing the stock itself.

Q5. How stock appreciation rights are handled when a firm is purchased?

When a firm is purchased, stock appreciation rights are typically settled in cash or converted into equivalent rights in the acquiring company’s stock, depending on the acquisition terms.