Stock Appreciation Rights (SARs) are a type of equity compensation that companies grant to employees, particularly executives and key staff, to motivate and reward them by sharing in the company’s stock price appreciation. Unlike stock options, SARs do not require employees to purchase shares; instead, they receive a payment equal to the difference between the stock price at grant and the price when the SARs are exercised.
How SARs Work
SARs typically have four stages:
- Grant Date: The company grants the employee a certain number of SARs with an assigned base price, usually the fair market value of the stock at that time.
- Vesting Period: SARs generally vest over time, often several years, encouraging employee retention. Employees must wait until vesting to exercise them.
- Exercise Window: After vested, employees can choose to exercise their SARs within a certain period.
- Payout: Upon exercise, the employee receives the gain—calculated as the difference between the current stock price and the base price—paid either as cash, company shares, or a combination depending on the company’s plan.
Example
Suppose Sarah receives 1,000 SARs with a base price of $25 per share. After three years, the stock price rises to $40. Exercising her SARs yields a $15,000 gain (1,000 SARs x $15 appreciation). Depending on her company’s rules, Sarah could receive this as cash or shares valued at $15,000.
SARs vs. Stock Options
Unlike stock options, which require an upfront purchase at a set strike price, SARs provide the value of appreciation without any cash outlay. SARs also tend to cause less dilution because they may be cash-settled and do not necessarily involve issuing new shares.
| Feature | Stock Appreciation Rights (SARs) | Stock Options |
|---|---|---|
| Mechanism | Pay the increase in stock value; no purchase required | Right to buy stock at strike price (may require cash payment) |
| Upfront Cost | None | Must pay strike price to exercise |
| Dilution | Generally less (or none if cash-settled) | More due to issuance of new shares |
| Taxation | Taxed as ordinary income at exercise | Taxation varies; may have preferential treatment for ISOs |
Eligibility and Use
SARs are especially common in startups and private companies where direct stock ownership may be complex. They are also appealing to employees who prefer cash gains without investing money upfront.
Taxation of SARs
When exercised, SARs are generally taxed as ordinary income on the amount of the appreciation. Your employer typically withholds income tax, Social Security, and Medicare taxes. Unlike some stock options, there is no tax event upon grant or vesting.
Common Misconceptions
- SARs do not confer stock ownership or shareholder rights.
- Vesting schedules govern when SARs can be exercised.
- The payment method varies; understanding whether the payout is cash or stock is crucial.
- SARs have expiration dates; unexercised SARs after expiration are forfeited.
FAQs
Do I have to pay to exercise SARs? No, they provide gains without requiring you to buy shares.
What if the stock price falls? If the stock price is below the base price, SARs have no value upon exercise.
Can I sell SARs? Typically no; SARs are non-transferable.
Do SARs dilute shareholders? Cash-settled SARs don’t dilute; share-settled SARs cause less dilution than options.
SARs are a strategic employee incentive that allows participation in company growth without requiring capital investment or stock ownership risks.
For more on equity compensation, consider reading about Common Stock and Security.
References
- Internal Revenue Service. “IRS Notice 2005-43.” https://www.irs.gov/pub/irs-drop/n-05-43.pdf
- Internal Revenue Service. “IRS Notice 2005-68.” https://www.irs.gov/pub/irs-drop/n-05-68.pdf
- Kiplinger. “Stock Appreciation Rights.” https://www.kiplinger.com/retirement/employee-benefits/603098/stock-appreciation-rights
- Investopedia. “Stock Appreciation Right (SAR): Definition, How It Works, and Tax.” https://www.investopedia.com/terms/s/stockappreciationright.asp