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Equity Alternatives: Phantom Stock, SARs, Restricted Stock, Performance Awards, and More, 22nd Ed.

A detailed guide to equity compensation alternatives.

By Joseph S. Adams, Barbara Baksa, Daniel D. Coleman, Daniel Janich, Blair Jones, Scott Rodrick, Corey Rosen, Martin Staubus, and Dan Walter

Format

Description

For many companies, stock options, ESPPs, or ESOPs are not the only stock plans to consider. Instead, restricted stock awards, restricted stock units, phantom stock, stock appreciation rights (SARs), performance awards, and/or direct stock purchases are an essential part of their compensation strategies. The book includes eight chapters on what the plan alternatives are, how they work, how to combine them, and the legal and accounting issues they raise. The authors include leading authorities from law firms, other consulting firms, NASPP, the Beyster Institute, and the NCEO.

In the 22nd edition, which went to press in early 2025, chapter 3 was revised and updated, the years in chapter 6’s examples were incremented by 1, and COLA updates were made in chapter 7.

Table of Contents

Introduction
Basic Issues in Plan Design
Phantom Stock and Stock Appreciation Rights
Restricted Stock Awards, Units, and Purchases
Performance Award Plans
Selling Stock Directly to Employees in a Closely Held Company
Accounting Issues
ESOPs, ESPPs, 401(k) Plans, and Stock Options: When the Old Standbys Still Make Sense
A Tiered Approach to Equity Design with Multiple Equity Compensation Vehicles
About the Authors
About the NCEO

Excerpts

From Chapter 3, "Restricted Stock Awards, Units, and Purchases"

The process of earning the restricted shares is commonly referred to as “vesting.” Generally, a vesting schedule provides that, at the completion of designated intervals, or the satisfaction of established performance criteria, a predetermined percentage or ratio of the restricted shares are earned and thereafter may be transferred by the employee. These interim dates are called “vesting dates.” Vesting is typically measured from the date the restricted stock is granted, but it can be measured from any date the company deems appropriate (such as an employee’s hire date).

Companies adopt a vesting schedule that best suits the incentive or other objectives of their restricted stock plan. Most restricted stock plans provide for annual vesting schedules; that is, the restricted shares vest in equal annual installments over a period of several years (typically, three, four, or five years). In some instances, monthly or quarterly vesting schedules are used, but because the administrative process of assessing and collecting the taxes that become due as the shares vest can be burdensome, companies may want to avoid vesting schedules where the shares vest in frequent intervals. Where restricted stock or units are offered at no cost to employees, frequent and/or short-term vesting can be viewed negatively from a corporate governance perspective. A recent survey conducted by the National Association of Stock Plan Professionals (NASPP) and Deloitte Tax found the following practices with respect to vesting of service-based restricted stock and unit awards at public companies:

  • Nearly 90% of survey respondents report that new-hire and ongoing awards vest on a graded, incremental schedule, rather than all at once on a “cliff” schedule. Graded vesting is slightly less common for retention awards (only 75% of respondents).
  • Among companies that report using graded vesting, annual vesting increments are most common (approximately 70% of respondents that use graded vesting). Quarterly vesting increments (with or without a one-year cliff period) are used by just over 25% of respondents that have graded vesting, mostly technology companies.
  • Most companies vest awards over a three-year schedule (58% of respondents for new-hire grants, 62% for ongoing grants, and 55% for retention grants). Four-year vesting is also common (34% of respondents for new-hire grants, 32% for ongoing grants, and 26% for retention grants).

Vesting demarcates the period of time over which the award recipient must perform services to earn the award and provides an incentive for award recipients to continue working for the company. When deciding on a service-based vesting schedule, companies should consider the following factors:

  • Over what period is it reasonable for the award to be earned, and over what period is the award intended to serve as compensation?
  • Will the number of shares or units vesting in each vesting increment be meaningful to award recipients, such that each vesting increment provides an incentive for continued employment?
  • Will the periods of time over which awards vest feel achievable to the award recipients? A disadvantage of cliff vesting over a period of several years is that the ultimate vesting date may seem so distant to award recipients that it causes the award to lose its motivational impact.
  • What vesting schedules are common among the company’s peers, particularly those with whom the company competes for talent?

Where the number of shares or units earned on each vesting date is very small, e.g., less than five, this could make it difficult for employees to sell or tender shares to cover the tax withholding due at that time (and the number of shares employees are left with after covering their taxes may be so few as to be demotivational). This is one reason awards typically do not vest any more frequently than annually.

Under the ISS Equity Plan Scorecard (EPSC), points are awarded to plans that prohibit any portion of awards from vesting in less than one year, provided this prohibition applies to at least 95% of all awards granted under the plan. Another factor under the EPSC awards points to a plan if awards issued to the CEO do not fully vest in less than three years (partial vesting in less than three years is permissible).

Restricted awards can also vest upon the achievement of specified company performance goals (such as earnings per share, revenue, or profitability targets) or based on work unit, individual, departmental, or divisional performance goals. Where restricted awards are performance-based, the awards are most commonly issued in the form of restricted stock units. Because restricted stock purchases and restricted stock awards involve issuing the stock at grant and would require cancellation of the issued stock in the event that the performance goals are not achieved, it is administratively burdensome to attach performance-based vesting to these arrangements.