The concept of Stock Appreciation Rights

Stock Appreciation Rights (SARs) are rewards in the form of appreciation rights to employees at the discretion of their employer. These are either cash-settled or equity-settled rewards to the identified employees provided as per the contractual terms of the respective employee after a date when the rights are exercised by such employees.

The Securities and Exchange Board of India (SEBI) defines SARs in the SEBI (Share Based Employee Benefits) Regulations, 2014, to mean:

A right given to a SAR  grantee entitling him to receive appreciation for a specified number of shares of the company where the settlement of such appreciation may be made by way of cash payment or shares of the company.

Let us understand this concept in the context of private limited companies with an example: say Company ABC selects employee ‘X’, ‘Y’ and ‘Z’ to be rewarded with SARs. The granting, vesting and exercising of SARs for all the 3 employees can be governed either by a plan framed by ABC or the terms of such granting, vesting and exercising may vary for each employee and shall be governed contractually. (Typically, an employee receives ‘pqr’ units which represent ‘mno’ number of shares. For simplicity we assume that one unit is equal to one share.) But X, Y, and Z are not allotted any shares in the beginning. Here, it would also be pertinent to note the concept of a strike price at the time of granting of the SARs, which is the base price of the share in ABC. (For the purposes of this example, let us assume Rs.10 is the strike price.)

Supposing ABC follows the concept of cash-settled rewards, at the time of exercise if the individual share price were Rs. 20, each employee would receive Rs. 10 on each unit, i.e., the spread (sometimes, when the company feels generous, then the employee receives even the entire market value). Or, if the company were to reward in stocks, then each of the employees would need to pay only the spread as the stock price.

This form of incentive is highly advantageous to an employer (particularly for start-ups) as on one hand, there is no dilution to its capital structure, while on the other, the employer is also able to delay the payment of the employee ‘bonus’. A company need only make a provision in its P&L account each year, depending on how the price of shares vary each year. Obviously, this is not the best of models for companies that are not cash rich.

Versus ESOPs (Employee Stock Option Plans)

Employees’ stock option is defined in the Companies Act, 2013, to mean an option given to

the directors, officers or employees of a company or of its holding company or subsidiary company or companies, if any, which gives such directors, officers or employees, the benefit or right to purchase, or to subscribe for, the shares of the company at a future date at a pre-determined price.

The law relating to issue stock options is governed by Section 62(1)(b) if the new Companies Act and by Rule 12 of the Companies (Share Capital and Debentures) Rules, 2014. It may be interesting to note is that while the section provide that private limited companies require only an ordinary resolution, the rules relating to ESOPs require a special resolution in a general meeting.

Interested readers may also refer to earlier articles posted on this blog that covers the concept of ESOPs.