Phantom Stock is on the rise. Or, at least the interest in Phantom Stock is on the rise. Over the past five or six years, I have had increasing numbers of executives and consultants ask me about these compensation programs. The context is usually, “I want to reward people for the growth in the company, but I don't want to give up any ownership.” What is phantom stock? That’s the fun part, because it means different things to different people. The most common form of phantom stock looks exactly like restricted stock units. Restricted Stock Units (RSUs) look almost exactly like restricted stock. Restricted Stock, in the world of equity compensation (as opposed to pre-IPO securities law, or post-IPO securities law…which each have their own additional definitions) is compensation delivered in the form of real shares of stock. This stock is then subject to vesting criteria which must be met before the stock is held “free and clear” by the employee.
RSUs are structured similarly, but the actual stock isn't issued until the vesting occurs. Because of this, RSUs are a great vehicle for performance-based vesting. Let’s get back to Phantom Stock Awards. In their most common form, these look and act exactly like RSUs. In fact, there is little reason to have two names.
However, Phantom Stock can also take other more creative forms. Instead of linking directly to the stock price, plans may be structured to deliver cash in other ways. For instance, an award with an original cash value set at the time of the award and growth in value based on the growth in the value of one area or subsidiary of the business. Essentially, Phantom Stock can be built as units that have a size and value equivalent to whatever you want to measure. Potential growth in these awards can then be defined by a formula. The final value is usually delivered in cash, but may also be delivered in company stock.
Wow, that was sort of boring. So why even cover this? Because interest in Phantom Stock is growing and most don't even know what it is or how it works.
What is driving the growth of Phantom Stock?
Companies are staying private longer. This means that giving real stock or even stock options that are then exercised for stock, results in longer-term owner-employee relationships than many can effectively manage.
Companies with no prospect of an IPO are still hoping that their executives will somehow get IPO-like money. Phantom Stock is so flexible that it can be leveraged to deliver almost anything. Even though that leverage may scare away potential suitors.
Companies are afraid of dilution. For many owners, stock dilution has become a bigger fear than value dilution. This is probably a misplaced fear for most.
Stock options and other common equity compensation tools have become tarnished in perception and sometimes in reality. But, it is better to call Phantom Stock in its most common structure RSUs.
When an executive or board member tells you they think Phantom Stock sounds like a great idea, ask a lot of questions before doing research. The name is more of a term of art than a term of compensation. And, by finding out what they think it is and why they believe it will work, will make you look far smarter than simply agreeing. If this issue has come up at your company in the past few years, please share your experiences in the comments.