What is a stock option SAR?

Stock options are a popular form of compensation for employees and executives in many companies. They offer the opportunity to participate in the growth and success of the company by allowing employees to purchase stock at a discounted price. One type of stock option is a Stock Appreciation Right (SAR), which is a way for employees to benefit from the appreciation of the company's stock without having to purchase the stock outright. In this article, we will discuss what a SAR is, how it works, and the benefits and drawbacks of using SARs as a form of compensation.

What is a Stock Appreciation Right (SAR)?

A Stock Appreciation Right (SAR) is a type of stock option that gives employees the right to receive cash or shares of stock based on the appreciation of the company's stock. Unlike traditional stock options, which require employees to purchase the stock at a set price (the strike price), SARs do not require employees to purchase the stock. Instead, employees are given the right to receive cash or shares of stock based on the difference between the strike price and the current market price of the stock.

How do SARs work?

When a company grants SARs to its employees, it sets a strike price, which is the price at which the stock can be purchased. The strike price is typically set at the market price of the stock at the time the SARs are granted. The company also sets a vesting period, which is the amount of time that the employee must work for the company before they can exercise their SARs.

Once the vesting period has expired, the employee can exercise their SARs. To do this, the employee must notify the company that they want to exercise their SARs and the company will pay them cash or shares of stock based on the difference between the strike price and the current market price of the stock. For example, if the strike price is $50 and the current market price is $100, the employee would receive cash or shares of stock worth $50 (the difference between the strike price and the current market price).

Benefits of SARs

There are several benefits to using SARs as a form of compensation:

1. Employee alignment: SARs align the interests of employees with those of the company by giving them a stake in the company's success.

2. Cost-effective: SARs are a cost-effective way to compensate employees because they do not require the employee to purchase the stock outright.

3. Flexibility: SARs give employees the flexibility to exercise their options at a time that is most advantageous to them.

4. Tax benefits: SARs may offer tax benefits to both the employee and the company.

Drawbacks of SARs

Despite the benefits, there are also drawbacks to using SARs as a form of compensation:

1. Limited upside potential: SARs have a limited upside potential because the employee can only receive cash or shares of stock based on the appreciation of the stock.

2. Vesting periods: SARs typically have vesting periods, which means that the employee must work for the company for a certain amount of time before they can exercise their SARs.

3. No ownership: SARs do not give employees ownership of the stock, which means they do not have voting rights or the ability to participate in shareholder meetings.

Conclusion

Stock Appreciation Rights (SARs) are a type of stock option that give employees the right to receive cash or shares of stock based on the appreciation of the company's stock. They are a cost-effective way to align the interests of employees with those of the company and offer flexibility and potential tax benefits.