Stock Appreciation Rights
A stock appreciation right is a method that companies can use to give their executives and other employees a bonus if the company performs well financially. The bonus payment is equal to the appreciation in the company stock between the time of the grant price of the SARs and the exercise date of the right.
Like non-qualified stock options and incentive stock options, stock appreciation rights allow employees to participate in the upside potential of the company via an appreciating stock price. Additionally, they may be issued a grant date, a vesting date, and an expiration date.
Unlike their stock option cousins, stock appreciation rights do not require the employee to purchase the shares of the stock at exercise. Upon exercising the right, employees receive the value of any price increase that is greater than the grant price, often as cash (although some plans may allow for the employee to take the value as shares of company stock).
A key difference between an stock appreciation rights and stock options is that when you exercise an SAR, the proceeds are often paid out in cash. On the other hand, when exercising a stock option, proceeds are often paid out in employee stock. This difference in payment may have a material impact on diversification and concentration risk as they pertain to a personal financial plan.
How Does a Stock Appreciation Right Work?
Stock appreciation rights are granted as part of a compensation package. Upon receipt, they are often issued with key dates and figures:
Grant Price – This is the price that is used to determine if the shares will have value in the future. If the stock price is above the grant price, the right is “in the money.” If the stock price is below the grant price, the right is worthless.
Vesting Date – This is the day upon which the employee can exercise the stock appreciation right. Prior to this date, any in-the-money value cannot be captured. After vesting, the employee can then exercise the right and capture the gain, if they so choose.
Expiration Date – This is the last day upon which an employee can exercise their stock appreciation right, or they risk losing the right. For stock with a share price below the grant price, shares will likely expire as worthless. For stock with a share price that exceeds the grant price, exercising will likely make sense.
Using a hypothetical example, we can explore the details of a stock appreciation right:
Grant date – January 1, 2014
Grant price – $10
Number of shares – 1,000
Vesting date – January 1, 2017
Expiration date – December 31, 2023
Continuing our example, let’s assume that the share price on January 1, 2017 is $25. In this example, the in-the-money value of the shares is as follows:
($25 – $10) * 1,000 = $15,000