Compensation Strategies: Phantom Stock

Attracting, retaining, and motivating quality employees is one of the biggest challenges for a business today. Creative compensation techniques can be an effective way to motivate employees, improve performance, and enhance teamwork.

Equity-based compensation plans (e.g., stock options, stock bonuses) are attractive because they permit employees to share in the company’s success and encourage long-term thinking. But these plans have a number of drawbacks, including the risks and costs involved with stock ownership and the dilution of the owners’ interests.

A “phantom stock” plan may offer the best of both worlds. Such a plan can motivate employees to work toward the company’s long-term success but avoids the disadvantages of actual stock transfers.

In a phantom stock plan, employee accounts are established and credited with hypothetical shares of the company’s stock. The value of the phantom stock mirrors the value of the company’s stock, and the growth in value of an employee’s phantom stock account is paid at a specified future date, such as retirement, termination of employment, or a set number of years. Some phantom stock plans even credit employee accounts with dividends attributable to the phantom shares. If the plan is properly structured, employees will not be taxed until the amounts in their accounts are distributed.