Corporates are increasingly choosing to reward their management teams with equity awards or stock options. Especially for hi-potential employees who have made significant contributions to the business or have the potential to help move the company forward. Equity rewards or stock options can take various forms like equity stock options, stock appreciation rights (SARs) or restricted stock units (RSUs). Each of these are linked to company’s stock prices but could be difference in some form.
Stock option
Stock options present a right to purchase company stock at a set price for a specific period. These rights are subject to a waiting period (also called a vesting period), an exercise (purchase) period, and an expiration date. Stocks can be purchased during the exercise period at the price specified (exercise price) when the options were granted (grant price), assuming the stock’s fair market value is not below the grant price. This purchase is called ‘exercising your stock options’. If you do not exercise your stock options before the expiration date, you loose the right to purchase the stock at the grant price.
Stock appreciation rights (SARs)
Stock appreciation right (SARs) entitles you to receive cash equal to any gain in the value of your company stock over a set period of time. The gain in calculated on the increase in value of a set of number of shares as allotted to you. With SARs, you do not have to purchase the stock. You must however, exercise your SARs (i.e. you request the transaction to receive your payout during the exercise period). Similar to stock options, if you do not exercise your SARs before the expiration period, you will loose your rights to receive any payout.
Restricted stock units (RSUs)
Restricted stock unit (RSUs) is an unsecured promise from your company to deliver company stocks at a future date. RSUs are not actual shares of the company; and therefore they do not carry any voting rights or provide dividend. Similar to stock options and SARs, RSUs are also subject to employment and vesting criteria. In this case, the vesting period if also referred as restriction period, as the RSUs may not be sold, pledged, transferred or assigned during this period. Unlike stock options, with RSU’s you do not need to purchase these shares. You receive the shares when the restriction period ends and the vesting conditions are met. If the vesting conditions are not met, RSUs may be forfeited.
The bottom line
Stock options, SARs, RSUs are great means for companies to provide incentives to employees in the form of ownership company’s interest. Though very similar in nature and purpose, there is slights difference in the mechanics of each. While stock options and RSUs both provide you with rights on the stock upon exercising the right, you end up paying the exercise price for stock options. SARs on the other hand, provide you with cash, the quantum of which is linked to the company’s stock performance.