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Stock Appreciation Rights (SARs) are a type of employee compensation linked to the performance of the company’s stock, without requiring the employee to own actual shares of stock. They offer an incentive in the form of potential financial gain that corresponds to the increase in the company’s stock price over a set period.

Here’s how SARs typically work:

  1. Grant Date: The date when the SARs are awarded to an employee.
  2. Vesting Period: Employees are often required to remain with the company for a certain period before they can exercise their SARs, similar to stock options.
  3. Exercise Price: SARs are assigned a base price which is often the company’s stock price on the grant date.
  4. Strike or Exercise Event: This is when the employee exercises their SARs after the vesting period has passed and the SARs are “in the money” (meaning the current stock price is higher than the base price).
  5. Payment: When exercised, the employee is entitled to receive the appreciation of the stock – the increase in the stock value above the base price. This payment can be made in cash, equivalent shares of stock, or a combination thereof, depending on the specific plan’s rules.
  6. Taxation: The benefit the employee receives from SARs is typically subject to ordinary income tax at the time of exercise. The company may also receive a tax deduction for the compensation expense.

The advantage of SARs for employees is that they can benefit from the increase in stock price without having to purchase the stock or pay taxes on it until the rights are exercised. For the employer, SARs can be a way to incentivize employees to contribute to the company’s success without diluting the share capital, as would happen with stock options or direct stock grants.

Additionally, SARs are flexible and can be structured in various ways to align with company goals and employee retention strategies. They are a popular tool among non-public companies that want to give employees a stake in potential financial success without the complexities of stock ownership or until a public market for the stock exists.