Phantom stock is an employee compensation tool giving employees access to stock ownership in the company without actually owning the stock. As with regular stock, the value of phantom stock rises and falls in value in line with the underlying stock. Recipients have the right to a cash payment at a predetermined time or triggered by a predetermined event. Anywhere from two to five years is a common time frame for a phantom stock payout arrangement.
The number of phantom shares given to an employee usually depends on that person’s value to the company similar to other incentive plans. The higher that employee is valued, the more shares of phantom stocks they are likely to receive. Payment is made by an amount tied to the market value of an equivalent number of shares of the firm’s stock. The payout therefore increases as the stock price rises, and decreases if the stock falls. All this happens without the recipient, or employee actually receiving any stock.
Phantom Stock Background
Companies use phantom stocks both as a motivational tool to encourage loyalty and increase productivity and as a way to reward employees, managers and even directors for service completed. Similar to other forms of stock-based compensation plans, phantom stock aligns the interests of the recipients and shareholders, thus reducing the agency problem. Staff turnover is also generally lower as loyalty to the firm is increased.
Especially for startups, phantom shares can also be used as a replacement for stock options. This provides prospective contributors to the success of the startup with a form of equity participation, thus benefitting from any success the firm may achieve. In the event of a takeover or merger, or even an IPO, phantom shares are still recognized by the acquirer and the holder is compensated accordingly.
Phantom Award Example
The following text is taken from the DEFA14A filing made by Willis Towers Watson (WLTW) on March 9, 2020 in relation to the proposed merger with AON (AON)
Section 4.3 WTW Phantom Stock Unit Awards. As of immediately prior to the Effective Time, by virtue of the occurrence of the Effective Time and without any action on the part of the holder thereof, each WTW Phantom Stock Unit Award that is outstanding immediately prior to the Effective Time shall be converted into an award (“Assumed Phantom Award”), with respect to a number of Aon Shares equal to the product obtained by multiplying (x) the total number of units granted under such WTW Phantom Stock Unit Award (including any corresponding dividend equivalent units) by (y) the Exchange Ratio. For each holder of a WTW Phantom Stock Unit Award, any fractional shares resulting from the conversion of his or her WTW Phantom Stock Unit Awards shall be aggregated and rounded down to the nearest whole share, such that Assumed Phantom Awards will not be subject to fractional shares and each holder is rounded with respect to no more than a single share. Except as otherwise provided in this Section 4.3, each Assumed Phantom Award shall continue to have, and shall be subject to, the same terms and conditions (including time vesting conditions, but excluding any performance-based vesting conditions) that applied to the underlying WTW Phantom Stock Unit Award immediately prior to the Effective Time, including accelerated vesting in connection with an involuntary termination of service, but excluding (x) the shares underlying the Assumed Phantom Awards, the type of property (i.e., shares or cash) payable upon settlement of the Assumed Phantom Awards (subject to the terms of the WTW Phantom Stock Unit Awards and applicable Law), the issuer thereof and the administrator of the WTW Equity Plan pursuant to which such WTW Phantom Stock&Unit Award was granted and (y) for terms rendered inoperative by reason of the transactions contemplated by this Agreement or for such other immaterial administrative or ministerial changes as in the reasonable and good faith determination of Aon are appropriate to effectuate the administration of the Assumed Phantom Awards; provided that, to the extent any Assumed Phantom Awards are settled in Aon Shares, Aon shall provide that participants shall be entitled to elect that any withholding tax obligations may be satisfied through a net settlement or a sell to cover arrangement.
In this document, it is clearly stated the actions and procedures that will be enacted with regards to the treatment of Phantom Stock Awards.
