Difference Between Stock Options and Stock Appreciation Rights

Employee compensation is a key factor when it comes to recognizing talented employees and retaining them for a longer period. Compensation can be an attractive paycheck at the beginning, but through time, employees may seek other compensation as their needs change. There are multiple options that the working class looks for when applying for a new role. Post-Pandemic, the job offers around the global working system offer more flexibility. It is crucial to retain deserving talents, given the fact they have many doors open at a time.

Now, more employee benefits reward talents with not just money but also appreciation and ownership. Some of them are Stock Options, Stock Appreciation Rights (SARs), Phantom stock, ESOP, and ESPP.? We see that SARs and Employee Stock Options are recently gaining better reception from employees and employers worldwide. So, here is what you should know about what Stock options are and how they are different from Stock Appreciation Rights in their policies.

What are Stock Options?

A Stock Option is a type of employee benefit that offers the participant the right to purchase or sell company stocks at a set price on a specific date. ESOs (Employee Stock Options) are given by employers based on the employee's performance and experience. Here, the employee receives stock rights at an exercise price or strike price, the price at which the company allows the participant to purchase the stocks. They follow a vesting schedule to become eligible to exercise their rights over the shares. The schedule may expect them to wait for an average of 2 to 3 years to fully vest the shares.?

The options may either be ISOs (Incentive Stock Options) or NSOs (Non-qualified Stock Options) based on their taxation policies. The latter is taxable as ordinary income even if the employee has not sold the shares. The former makes the participant eligible to pay tax only upon the capital gains.?

Pros and Cons of Employee Stock Options

While Employee Stock Options are highly rewarding, they have their share of disadvantages to the employees and sometimes the employers. The following are the pros and cons of Stock Options.

• Stock options allow employees to have a sense of ownership which they can later translate into better productivity in the company's interest.
• Employers can effectively retain great talents for a longer time with stock options.
• Employee stocks grow when the business grows. This motivates the employees to give their best effort.
• Companies can save so much when rolling out such employee benefits as the cash equivalents may be difficult to afford.
• The valuation of stocks can be tricky because they are highly dependent on the company prospects and market trends.
• Since the company value depends on overall performance, a hardworking individual alone will not make much of a difference.
• Existing shareholders can find dilution in the long run, very expensive and complicated.

What are Stock Appreciation Rights?

SARs (Stock Appreciation Rights) are also an employee benefits strategy that allows employees to be eligible to receive cash equivalents of an increase in the stock price value of the company. They are mostly awarded along with stock options. This scenario is called Tandem SARs. These follow certain clawback provisions which allow the firm to take back the participants exercising rights if they do not adhere to company policies. The vesting schedule is similar to the one of Stock Options. Even the taxation policies are similar to the Non-qualified Stock Options.

Pros and Cons of SARs

Exercising SARs is usually considered risky even though they offer many benefits. When the company stocks do not increase in value, the purpose of these rights becomes invalid. But it is also crucial to remember it offers flexibility to the participants in choosing whether and when they have to exercise these rights.?

Difference between Stock Options and Stock Appreciation Rights

Although both Stock Appreciation Rights and Employee Stock Options are effective incentive strategies, they differ in the following terms.

• Stock Appreciation Rights do not require the employees to pay an exercise price during their issuance, while stock options demand a certain set price before getting access to the shares.
• SARs do not impose taxes on the employees while granted, whereas certain stock options are taxed on their strike price.
• The employees may receive the rewards as stocks or cash while exercising SARs whereas the stock options can reward them only as shares.?
• SARs can be offered to anyone, including consultants, advisors, and even part-time workers but Incentive Stock Options can only be offered to employees.
• Under certain conditions, the shares from stock options can be preserved even after the employee quits. Whereas the clawback provisions of SARs will not allow the employees the rights after they leave the company.

Summing up

Employee benefit strategy is an important aspect of a company's success in the long term. It requires careful planning and the ability to understand employee expectations and customize plans around them. At Eqvista, we have a panel of experts to draft effective strategies that suit your company policies. Be it the valuation of the company or allocating employee shares and anything in between, we have your needs covered. Get on a call with us to know more!