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Phantom Trick: Get Your Employees to Act Like Owners

May 2, 2011 3 Min Read

Almost every business owner wonders at some point how he or she can inspire employees to act like owners. The easy answer is to treat them like owners.

During the height of the Internet bubble, companies seemed to hand out stock options like candy. The widespread issuance of options, coupled with the rapid rise in equity valuations, ultimately resulted in massive payouts to employees at the expense of shareholders. This misalignment, as well as subsequent changes in accounting rules requiring the expensing of stock options, led to a dramatic reduction in the issuance of stock-based compensation instruments to employees. This truly was an unfortunate outcome because an effective compensation program should include some form of long-term compensation that motivates employees to create lasting business value. The reality is that a properly structured equity-based compensation program can align the interests of both owners and employees as well as avoid unwanted charges to the income statement.

One of the most common ways to accomplish these objectives is a phantom stock program. Under a typical phantom stock program, a company grants an employee the right to receive future compensation equal to the increase in the equity value of the company, but only upon the occurrence of a triggering event and the achievement of specified service conditions. For instance, if a business strategy centers on creating value for owners through the sale of the company to a strategic acquirer, the company could grant units under a phantom stock program that would entitle an employee to receive payments based upon appreciation in the equity value of the company from the date of grant through the date of sale of the company.

Additionally, to ensure that only employees who provide services up to the date of sale receive payments under the plan, a phantom stock program can include provisions requiring active employment at the date of the transaction. The issuance of awards under this type of program also often serves as a retention tool for key employees, mitigating the risk of damage to the equity value of the business because of the departure of key employees. Finally, in many cases, there are no income statement charges until the event that triggers payment becomes probable. Accordingly, in this hypothetical scenario, the company now has an employee whose compensation is directly correlated with the interests of the owner, without the income statement volatility that could create problems with other contractual arrangements such as loan covenants.

While there may never be a silver bullet that motivates all employees, a properly designed phantom stock program just might be the tool your business needs to get your key employees focused on the most important goal—building long-term shareholder value.

Christopher F. Meshginpoosh can be reached at Email or 215.441.4600.

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