What are Stock Appreciation Rights?

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.

Stock Appreciation Rights

Stock appreciation rights are a corporate method used by companies to reward their employees when the company reaches a specific performance goal. These stock appreciation rights are directly linked to the performance of the company stock. If employees are given the stock appreciation rights, it is profitable for them if the stock price rises, similar to an Employee Stock Option.. However, stock appreciation rights do not come with the exercise price payable by employees but provide them with an increase as stocks or cash.

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

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.

Advantages and disadvantages of stock appreciation rights

Stock appreciation rights provide cash benefits to the employees if the stock appreciates. As the stock price is directly related to how the company performs, the stock appreciation rights can prove to be a motivating factor for the employees to work hard and push the company towards performing better. Furthermore, stock appreciation rights also allow for better employee retention as there is a vested period where the employees tend to stay with the company to exercise the stock appreciation rights.

A major disadvantage with stock appreciation rights is if the price of the stock depreciates. If it does, the employee will have to incur losses if the stock appreciation rights are exercised. This can also result in demotivating the employees and increasing employee turnover.

Stock appreciation rights are one of the most effective ways for companies to ensure their employees are valued and motivated to do well for the company. As it comes with both the option of the cash reward or bonus stocks, it is a flexible and profitable way for employees to get rewarded for the hard work they have done. However, as stock appreciation rights can sometimes be loss-making, employees should always exercise caution while leveraging these rights.