Do you ever wonder if people consider the acronyms they are making when they name things? Of course sometimes the name pre-dates the widespread use of acronyms. Look at the Bank of Montreal who have had to very thoroughly and carefully blast into our consciousness that their acronym is BMO. That’s because if you shortened their name the way it should be condensed, it’s synonymous with something that no right-thinking bank wants you to imagine when you think of them. So whoever named Stock Appreciation Rights better have done it before 2002. That’s when Sudden Acute Respiratory Syndrome began killing people. Thankfully right now the only SARs I have to worry about are a fancy type of stock option but they still need me to make an important financial decision.
The Creation of Stock Appreciation Rights
Corporations, governments and regulatory agencies love tinkering with mechanisms to reward “executives” and even lesser mortals like us regular employees. They are searching for some way to provide a carrot to their business leaders. They want to reward those people if the work they do and the decisions they make enhance the company’s earnings and position in the industry.
One common way to do that in the olden days of the game was to provide Stock Options. Then, for a variety of reasons, those fell out of favour.
Next up to bat was Stock Appreciation Rights or SARs.
What are Stock Appreciation Rights, SARs?
SARs are a bit different than Stock Options but are not totally unique.
Like an option, an appreciation right is usually awarded one year but cannot be exercised right away. Often the person receiving the SARs has to wait one or more years before they can use the award to make money. A grant of SARs may even be awarded where a fraction of the total units vests each year over 2-5 years.
Also like options, usually workers lose their SARs if they quit or are fired for cause before they can use them.
The value of a SAR unit is based on the value of a single share of stock in a specified company. This is similar to a stock option but it’s handled differently.
Unlike stock options, no real shares are involved in a SARs bonus. The employee cannot buy shares or sell shares. The stock market is not suddenly flooded with shares when an employee sells their SARs.
Instead, an employee receives a cash payment equal to the number of SAR units times the increase in price between the deemed price of the stock on the day the SAR was awarded and the actual price of the stock on the day the SAR was exercised. The cash is fully taxable.
For example, Ms. Syed may be awarded 1000 SARs as part of her annual compensation review in February 28, 2013. The SARs may be awarded with a price of $10 per unit. They may vest, so she can use them, on December 31, 2014. They may expire December 31, 2017.
If the price of shares in Ms. Syed’s company increases to $13 in March, 2015, she may decide to exercise all of her stock appreciation rights. If she does, she will receive 1000 x ($13-10) = $3000 before tax.
Are SARs an Appropriate Way to Reward Good Performance?
If the company is doing well, in theory its stock price will go up making SARs more valuable. If the company does poorly and the stock price plummets the value of the SARs will also drop. Still in theory this is where the SAR is supposed to provide incentive for the worker to do a great job. If they exceed work expectations, then the company as a whole should prosper, and the share price should rise, and the bonus they will earn by exercising their stock appreciation rights should increase.
There’s a lot of “theory” in that paragraph.
In reality, of course, many companies prosper or founder based on factors which are totally beyond the control of the company or its employees.
- A gold mining company, for example, cannot control whether a huge new easily-accessible source of gold is suddenly found and brought into the market by a competitor diluting the price of gold.
- A newspaper company can do little to prevent its market from shifting from reading newspapers to watching cute kitten videos on YouTube.
- A company selling luxury dog-treats can’t control the international economy that can cost its buyers their jobs and their ability to spend thousands of dollars on their pets.
SARs have actually fallen out of favour with many companies. That doesn’t mean there aren’t some rights still hanging around waiting to be executed though. I know because I still have some.
Related Reading
- Part 2: I Know Market Timing is for Suckers, so Why Am I Trying to Time the Market?
Join In
Have you ever been issued SARs? Did the value of your company promptly sink beneath the waves leaving you with a negative bonus? Please share your sad experiences with a sympathetic listener (or make me wildly jealous by explaining how your company’s value actually increased!) by contributing a comment.