Phantom Stock : It is an employee benefit plan that gives the selected employees, many of the benefits of stock ownership without actually giving them any company stock. That’s why, also referred to as "Shadow Stocks." The employees are not allotted actual shares, but are issued Options with underlying shares in it, the value of which increases over a period of time and that can be converted into a predetermined cash amount, depending upon the terms of the Stock Option Plan, without any actual allotment of shares. The payment terms may depend upon tenure of employment, performance, appraisal criterion, meeting the targets etc., or any combination of them as well.

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For any Organization-be it a Start up or a long existing one, the buzz word these days is
“Employee Retention”. High employee turnover keeps the CEOs/ HR Heads on their toes
and they keep wondering how to Award, Reward and Retain their human asset.
In such a scenario, Employee Stock Option Plan (ESOP) have emerged as a handy tool
for employee retention. ESOP give the
employee a right to buy a specific number
of company's shares at a fixed price within
a certain period of time. Employees who is
granted stock options expect to gain by
disposing off their shares at a higher price
than at what they were granted.
ESOP inculcates a feeling of being the
“Owner” and the Employees tend to
perform better, thus leading to the
Organisation’s betterment as well as the
Employee enrichment. ESOP, thus, align the Promoters’ wishlist with the employee interest.
ESOPs can even be granted to the employees of the Company’s holding/ subsidiary
companies as well.
ESOP can be of varied types and forms - Employee Stock Purchase Scheme (ESPS),
Restricted Stocks Units (RSUs), Performance Shares, Stock Appreciation Rights
(SAR) including Phantom Stocks etc.
While all others are comparatively traditional methods of ESOP, Phantom Stocks have
surfaced as an interesting and contemporary variation of ESOP. Phantom Stocks are also
referred to as “Shadow Stocks”. As the name depicts, these are the Stocks that are not
for real, they are like a shadow. The employee is granted the Options, to be redeemed into
cash, as per the Scheme, without creating any impact on the Company’s share capital or the
voting percentages.
Phantom Stocks provide a cash or stock bonus based on the value of a stated number of
shares, to be paid at the end of a specified period(s).

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These are favored by closely held or family-owned companies who intend to incentivize their
human assets without sharing their equity. Under Phantom stocks, employees get to share
the growth, without an actual ownership stake in the company.
Definition- Phantom Stocks
As mentioned above, it is an employee benefit plan that gives the selected employees,
many of the benefits of stock ownership without actually giving them any company stock.
That’s why, also referred to as "Shadow Stocks." The employees are not allotted actual
shares, but are issued Options with underlying shares in it, the value of which increases
over a period of time and that can be converted into a pre determined cash amount,
depending upon the terms of the Stock Option Plan, without any actual allotment of shares.
The payment terms may depend upon tenure of employment, performance, appraisal
criterion, meeting the targets etc., or any combination of them as well.
Key Features of Phantom Stocks
As mentioned above, Phantom Stocks mirror some of the attributes of actual stock
ownership without giving away any portion of the Company. Some of the pertinent benefits
are:
1. No dilution: The Promoters need not worry about control and dilution of their voting
rights. Thus, Phantom Stocks turn out to be a better option for unlisted companies as no
actual shares are issued.
2. Well laid Plan: The terms of encashment are well laid in the Stock Options Plan. Even
in case of termination of employment/ death/ disability of the employee, the encashment
can happen, depending upon the provisions in the Plan, as approved by the Board and
informed to the Employees through the Scheme.
3. Tax implications: Phantom Stock benefits are paid out as ordinary income and taxed as
such for the employee, thus serving as a deductible expense for the employer. Since no
capital gains are involved, this leads to simplified taxation regime for the employees as
well.
4. Impact on Company’s earnings: In a listed entity, another major advantage of a
Phantom Stock Plan is that it helps in reduction of share price dilution to some extent, as
accounting rules and applicable laws require amortization of fair value of the

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Compensation Cost (i.e. aggregate liabilities of the Company towards the Employees)
during the vesting period of the plan. Accordingly, the earnings of the Company
automatically get adjusted in tandem with the change in the Compensation Cost without
any dilution of actual stock ownership percentages.
5. Flexibility: The Companies have full flexibility in designing their Plans and can have
graded vesting schedules/ exercise periods/ pay out tranches etc.
6. Employee’s liability: Under a Phantom Stock Plan, the employee does not become a
shareholder and thus is not responsible for additional capital contributions and not
required to personally guarantee any liabilities of the Company.
7. Adjustment in Value: Phantom stock is treated in the same way as deferred cash
compensation as the value gets adjusted in tandem with the market value or fair value of
the shares.
8. Freedom from Market related worries: Even from the employees’ point of view, they
remain free of the worries arising on account of market fluctuations and as it does not
involve any cash outlays to purchase shares/ exercise the options.
Suitability
Phantoms can be issued in any kind of a Company-be it listed/ unlisted/ closely held, but
from the nature of the instrument, it becomes more suitable for the following types of
corporates:
1. They are more apt for cases, where in the Promoters intend to share the Company’s
growth with the employees, but without hampering their equity stake or relinquishing
their control in the Company.
2. Phantom Stocks also turn out to be a better option, in cases, where options are to be
granted to lower cadre employees, who might not appreciate a stock/ share as such,
but can surely understand the concept of getting hard cash after a pre determined
period.
3. In cases, wherein further allotment of equity shares is under litigations/ barred by any
Authority, even in such cases, Phantom Stocks stand out as a savior for the purpose
of employee retention.
4. Even in cases, wherein Companies do not intend to increase the Authorised Share
Capital and bear the Stamp Duty thereon, Phantoms are suitable.

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As per market reports, some of the Indian companies that have offered phantom stocks are
Bajaj Allianz, DLF, Birla Sunlife, Apollo Tyres, Cairn India, etc.
Vesting and Award Payment
Phantom shares may vest similar to other stock option plans over a 3-5 year period.
Vesting in private companies may be longer than what is typical in public companies. The
company has wide discretion over the vesting of phantom stock. However, unusually long
vesting periods may make the Plan non lucrative for the employees.
Awards are typically paid in cash upon exercise or maturity and may be in a lump sum or in
installment payments.
In the event of any Corporate Action that takes place during the currency of the Plan, the
Phantom stock options granted under the Plan are also accordingly revalued. Alternatively,
in case of Corporate Actions like Merger or Amalgamation, if required, the value to the
Employees may be ensured by re-shaping the existing Phantom Plan to a new plan such
as stock options or restricted stock in the new-fangled Company. Pre mature payments
may also be made upon early retirement, death, or permanent disability, depending upon
the provisions in the respective Stock Options Schemes.
Valuation
In any Stock Option Plan, the Valuation/ the accounting aspect of the same plays a very
crucial and also a very tricky part. In next few paragraphs, we have tried to explain and
exemplify the Valuation & Accounting aspects of a Phantom Stock Plan.
The value of phantom stocks is needed to be determined upon grant, during interim periods
and at the final payment date to facilitate the calculation of the award.
For Phantom Stocks, there are basically 2 types of Valuations:
(1) ESOP Valuation for Accounting: This Valuation is required to amortize the Employee
Compensation Cost during the vesting period. Accordingly, the compensation value is

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required to be computed initially i.e. at the time of Grant and at the end of each
reporting year till the liability in respect of Phantom Stock gets settled.
This Valuation can be conducted by any Independent Valuer i.e. Chartered
Accountant/ Merchant Banker.
(2) Perquisite Valuation: This Valuation would be conducted at the time of Exercise of
Options by the Employee to know the value of the perquisite to be added in the
Employee’s salary for the month in which he makes the exercise of his option.
This Valuation can be done only by a SEBI Registered Merchant Banker.
Accounting Aspects
For accounting purposes, employee share-based payment plans are classified into the
following categories:
(a) Equity-settled: Under these plans, the employees receive shares.
(b) Cash-settled: Under these plans, the employees receive cash, based on the price (or
value) of the enterprise’s shares.
(c) Employee share-based payment plans with cash alternatives: Under these plans,
there is a choice available to settle the payment in cash or by issue of shares.
From the above, it can be inferred that the Phantom Stock is covered under the category of
Cash- settled plan. Accordingly, the liability under the Plan is required to be determined
initially and at each reporting year until settled at fair value by applying an option pricing
model.
The accounting treatment for phantom stock is outlined with the help of following example:
Suppose X Ltd grants 1 Lac options of face value of Rs. 10/- each under Phantom Stock
Options Plan and the said options are to vest in the following manner:
a. 1/3rd of Total Options to vest at the expiry of 3rd year from the date of Grant of Options

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b. 1/3rd of Total Options to vest at the expiry of 4th year from the date of Grant of Options
c. 1/3rd of Total Options to vest at the expiry of 5th year from the date of Grant of Options
Accounting Treatment at the end of First Year
Presuming Fair Value at the end of first Reporting Year: Rs. 10/- per share.
Provisions required to be made at the year-end:(No. of Options*Fair Value/Vesting
Period)
For 1st Grade Vesting: 111110
For 2nd Grade Vesting: 83332.5
For 3rd Grade Vesting: 66668
Expenses for the year 261110.5
Accounting Treatment at the end of Second Year
Presuming Fair Value at the end of second Reporting Year: Rs. 12/- per share.
Provisions required to be made at the year-end:
(No. of Options*Fair Value/Vesting Period)
For 1st Grade Vesting: 155554
For 2nd Grade Vesting: 116665.5
For 3rd Grade Vesting: 93335.2
Expenses for the year 365554.7
Accounting Treatment at the end of Third Year
Presuming Fair Value at the end of third Reporting Year: Rs. 13/- per share.
Provisions required to be made at the year-end:
(No. of Options*Fair Value/Vesting Period)
For 1st Grade Vesting: 166665
For 2nd Grade Vesting: 124998.75
For 3rd Grade Vesting: 100002
Expenses for the year 391665.75

8.
Accounting Treatment at the end of Fourth Year
Presuming Fair Value at the end of third Reporting Year: Rs. 14/- per share.
Provisions required to be made at the year-end:
(No. of Options*Fair Value/Vesting Period)
For 2nd Grade Vesting: 141665.25
For 3rd Grade Vesting: 113335.6
Expenses for the year 255000.85
Accounting Treatment at the end of Fifth Year
Presuming Fair Value at the end of third Reporting Year: Rs. 15/- per share.
No. of SARs expected to Vest: 1,00,000
Provisions required to be made at the year-end:
(No. of Options*Fair Value/Vesting Period)
For 3rd Grade Vesting: 126669.2
Expenses for the year 126669.2
Conclusion
As compared to a plain vanilla ESOP, Phantom Stocks come with a cherry as a topping.
With all the motivating factors, as contained in any other ESOP, Phantoms have an added
flavor of no equity dilution. However, as is said, nothing is perfect, one major drawback in
Phantom Stocks is that these plans do not extend ownership benefits and other benefits like
dividend, bonus, etc. to the Employees, which otherwise they would be entitled to in case of
other ESOP forms.

9.
Contact us:
An Online Venture of
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M: +91 9971673336 M: +91 9999702150
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Email: anjali@indiacp.com Email: simran@indiacp.com
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Disclaimer: -
The entire contents of this document have been developed on the basis of relevant statutory
provisions and the information available at the time of the preparation. Though the author has made
utmost efforts to provide authentic information however, assumes no responsibility for any errors
which despite all precautions, may be found herein. The material contained in this document does not
constitute/substitute professional advice that may be required before acting on any matter. The author
and the company expressly disclaim all and any liability to any person who has read this document,
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