[1] They are not required to pay the (options') exercise price, but just receive the amount of the increase in cash or stock.
SARs typically provide the employee with a cash payment based on the increase in the value of a stated number of shares over a specific period of time.
Some phantom plans condition the receipt of the award on meeting certain objectives, such as sales, profits, or other targets.
If it is in real funds set aside for this purpose, the company will be putting after-tax dollars aside and not in the business.
Finally, if phantom stock or SARs are intended to benefit most or all employees and defer some or all payment until termination or later, they may be considered de facto “ERISA plans.” ERISA (the Employee Retirement Income Security Act of 1974) is the federal law that governs retirement plans.
Similarly, if there is an explicit or implied reduction in compensation to get the phantom stock, there could be securities issues involved, most likely anti-fraud disclosure requirements.
Moreover, the regulatory issues are gray areas; it could be that a company could use a broad-based plan that pays over longer periods or at departure and not ever be challenged.
It is expected that hedge fund and private equity fund managers will begin to more frequently use SARs in order to circumvent IRS code 457A while maintaining proper alignment of long term incentives for employee and investors.