| Incentive Mechanisms that do not Transfer Stock | | | | non-economic rights that come with an ownership |
| Ownership. | | | | interest. |
| Sharing ownership of a small company with the | | | | Under a phantom stock plan, an employee's bonus is |
| employees can create numerous conflicts. It is often | | | | immediately converted to phantom shares of stock. |
| wise to look to other incentive mechanisms that | | | | The phantom shares track the value of the underlying |
| reward employees for increasing company profit | | | | stock. The value of the phantom shares will increase |
| without sharing ownership. Two such alternatives are | | | | each time there is an increase in the value of the |
| profit sharing plans and phantom stock plans. | | | | underlying stock. At the time of distribution, the |
| Profit Sharing Plan. | | | | employee will receive cash equal to the liquidated |
| A profit sharing plan is one that provides annual | | | | value of the shares in his account. If the underlying |
| employer contributions (which may be zero), and | | | | stock is not traded on an established market, the value |
| allocation to employee's accounts according to a | | | | can be determined through a pre-arranged formula. |
| formula. The amount of the employer's contribution | | | | For example, assume GM's employee would receive a |
| may be specified by a formula or left to the | | | | bonus of $10,000 in year one. The value of GM shares |
| employer's discretion (possibly within specified limits). | | | | is $100 per share. Under a phantom stock plan, |
| A profit sharing plan can be a "qualified plan." A | | | | employee would receive 100 phantom shares in year |
| qualified plan offers tax advantage in that contributions | | | | one (i.e. $10,000 bonus / $100 per share). The plan |
| to the plan are currently deductible by the employer. | | | | would require distribution to the employee in a later |
| The employee's tax obligation is deferred, however, | | | | year (e.g. year five). If the value of the shares was |
| until funds are distributed from the plan to the | | | | $200 in year five at the time of distribution, employee |
| employee. To qualify, the plan must meet numerous | | | | would receive $20,000. |
| requirements. There can be no discrimination in | | | | Generally, a phantom stock plan will be a deferred |
| coverage or vesting. There are also disclosure and | | | | compensation plan. This means that the employee |
| reporting requirements. | | | | would not be taxed until he actually receives a cash |
| Contributions to a non-qualified plan are currently | | | | distribution. Assuming this is an "unqualified" plan, the |
| deductible by the employer and currently included in the | | | | employer does not receive a deduction until there is an |
| employee's income. The employee, however, can | | | | actual distribution to the employee. |
| have immediate access to the funds. | | | | Employers can receive a current deduction even |
| Phantom Stock Plan. | | | | though the employee's tax obligation is deferred if the |
| Phantom stock plans are designed to give the | | | | plan is qualified. To be qualified, the plan must comply |
| employee the same economic result as ownership of | | | | with numerous requirements. These requirements |
| company stock. The employee, however, does not | | | | relate to who must be covered, when are benefits |
| actually have an ownership interest or the | | | | vested, funding, reporting and disclosure obligations. |