Stock Appreciation Rights
Stock appreciation rights (SARs) are a way to give an executive a stake in a company's growth (as reflected in its stock price) without actually having to invest in the company's stock. A SAR provides an executive with a cash bonus measured by appreciation in the value of company stock from the time the rights are granted over a set or determinable period of time. In addition to appreciation rights, which may not be realized for some time, the executive may be awarded further payments equal to the amount of dividends paid on the stock.
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Example
Acme Gadgets Corp. (Acme) provides a SAR to one of its executives, Wile E. Canid. The SAR is granted in 2009 and specifies a period of five years. When the SAR is granted, Acme stock has a fair market value of $25 per share. At the end of the five-year period in 2014, Acme stock has a value of $50 per share. Canid will then be entitled to a payment of $25, which represents the increase in value of Acme stock during the SAR's five-year period.
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Using SARs provides a lot of flexibility in stock-based deferred compensation plans. Using SARs eliminates one of the major problems associated with stock options and stock purchase plans, which is that the executive must actually spend money or otherwise commit to acquiring the company's stock. Although there is some poetic justice in an executive's financial fate being tied to that of the company the executive helps run, executives do not want to end up in the hole financially when they are trying to maximize their compensation.
A company can also issue SARs in conjunction with other kinds of stock options, like nonqualified stock options. Using SARs together with nonqualified stock options is particularly easy because the tax consequences in either case are generally the same. Also under this scenario, the options complement each other so that the exercise of one option cancels the other option. For example, an executive purchasing company stock would cancel the need to exercise SARs.
Tax consequences. Payments related to SARs are includible in the executive's gross income, and therefore taxed, when paid. At the same time, the employer may take a corresponding business deduction.
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