Is Phantom Stock Better than Real Stock?

What do I mean by better?  Phantom stock better aligns with shareholder goals.  Wait! How can a cash-based plan (such as phantom stock) align better than actual stock? Shareholders hold actual stock. If employees own actual stock don’t we have perfect alignment? Typically not.

Phantom stock has advantages over real stock in non-public companies.

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First of all most companies don’t usually grant stock, they grant stock options. Stock options pay off if the value of the stock increases but they don’t result in a reduction of value if the stock declines in value (from the initial strike price). Shareholders have an interest in preserving value, not just in increasing value. Thus, if the officers of a company own options they are not perfectly aligned with shareholders who, obviously, own actual stock. Shareholders are thinking “preserve and grow.” Managers are thinking “grow!”

Secondly, in a public environment stock prices are influenced by more than actual performance. They are influenced by what the market believes about future performance. If I own stock in your company I of course want people to believe the future value will be higher (especially if I want to sell the stock soon). However, over time, actual performance will tell the tale.

The Phantom Stock Workbook

A phantom stock plan (properly designed) would not normally tie to market performance. It would tie to true performance indicators (typically some kind of profit multiple). Thus, true growth in profits over time would result in value for the phantom stock unit-holders.

By the way, it’s fine to structure the phantom stock as an “appreciation” plan (like with stock options) as long as it’s tied to true profit growth. Again, those results must be real, not just anticipated. That said, a “best practice” model would include both full-value phantom stock and appreciation rights held in a well-balanced structure.

Unfortunately, the accounting rules generally favor options over phantom stock rights. But, in my book, alignment trumps accounting any day.

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