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What is a SAR?
sars work much like stock options. a
company grants an award, which provides an
individual with the ability to profit from the
gain made in the value of a set number of shares
over and above the price set in the award.
however, the holder of a sar receives no
benefit unless the underlying stock value ap-
preciates. so the value of a sar is a function
of corporate performance, giving the holder
an incentive to improve financial performance
with the expectation of a higher stock price,
which leads to creation of shareholder value.
as a result, investors and shareholders
begin to focus on the “value transfer” (the
amount of company market value granted to
individuals) rather than on the number or
dollar value of stock options granted. unlike
stock options, sars offer a solution to indi-
viduals where no cash is needed to acquire
shares under the award at exercise date, thus
making them more attractive than stock
options. depending on the plan’s design, the
gain is paid in stock or cash or a combina-
tion of both. however, the company does not
generate any cash flow from the exercise of
a sar compared to a stock option. for em-
ployees, the tax consequences of sars and
non-qualified stock options are the same.
upon exercise, stock-settled sars require
the use of fewer shares while delivering the
same economic value to individuals as stock
options. for example, a company will issue only
enough shares to cover the appreciation of the
stock price. because options require payment
of an exercise price, a company must issue more
shares to deliver the same net value.
Consider two companies, a and b, each
with a stock price of $10. say the companies
grant options at $10 and stock price appreci-
ates to $20. to receive $20 in net value, an
employee of Company a must exercise two
stock options having an aggregate exercise
price of $20, for which he will receive two
shares, having an aggregate value of $40, in re-
turn. to receive the same $20 in net value, the
employee of Company b exercises two sars
and receives one share of stock. if the sar is
settled in cash, no shares are issued.
When negotiating loan agreements that give
consideration to future financial results, such
as loan covenants, it is important to specify
the basis of accounting that will be employed
by using a “frozen gaaP” clause, wherein
the accounting principles employed at the
relationship’s start are consistent throughout
the term of the agreement.
typically, companies with significant
amounts of stock-based compensation use
ebitda, adjusted for stock-based compen-
sation expense (adjusted ebitda) to
evaluate the effectiveness of operational
strategies and evaluate its capacity to service
debt. further, adjusted ebitda should be
used to calculate various interest or debt-
service coverage ratios.
Companies should review their long-term
incentive plan’s design, taking into account their
specific business needs and characteristics by
identifying what’s right for the company, what’s
right for the plan participants, and what’s right
for the shareholders.
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