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Understanding Phantom Share Option Plans

Reading time: 11 mins

Phantom Share Plans (PSS), also known as shadow equity plans or phantom stock plans, are designed to replicate the benefits of share ownership without granting actual equity to employees.

it is is a way of rewarding and retaining employees without giving them actual shares in the company. Instead, they receive “phantom” or “shadow” shares that track the value of the real shares and pay out cash bonuses based on the company’s performance.

In this article, we will explain what a PSS is, how it works, and what are its advantages and disadvantages.

What is a PSS?

A PSS is a type of employee benefit plan that gives selected employees (usually senior management) many of the benefits of stock ownership without actually giving them any company stock . Employees do not have voting or ownership rights in the company. However, they can still benefit from the company’s share price or dividends increasing.

A PSS is also known as a synthetic equity plan because it simulates stock ownership without actually providing it. A company can design a PSS in different ways, depending on its objectives and preferences. There are two main types of PSS:

  • Appreciation only plans: These plans only pay out if the company’s share price increases from the date the plan is given. For example, if an employee receives 100 phantom shares at $10 each and the share price rises to $15 after three years, the employee will receive a cash bonus of $500 ($5 x 100).
  • Full Value plans: These plans pay out both the value of the underlying stock and any appreciation. For example, if an employee receives 100 phantom shares at $10 each and the share price rises to $15 after three years, the employee will receive a cash bonus of $1,500 ($15 x 100).


Both types of plans are like regular nonqualified deferred compensation plans. They can be unfair because they might only be offered to some employees. There is a risk that employees could lose their benefits if they leave the company early or don’t meet certain goals. The employees recognize income for tax purposes when they receive the cash bonus, and the employer can deduct the amount as an expense.

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How does a PSS work?

A PSS gives eligible employees phantom shares based on criteria like their job, time at the company, performance, or contributions. The plan design can determine whether the number of phantom shares granted is fixed or variable. The phantom shares are usually subject to a vesting schedule, meaning that they become payable only after a certain period of time or upon meeting certain conditions.

Phantom shares are valued based on the company’s actual share price. This price can be found from public sources for listed companies. For unlisted companies, the price is determined through private valuations. Phantom shares’ value can change because of dividends, splits, mergers, or other company actions affecting the real share price.

The payout of the phantom shares is usually affected by events, such as:

  • The employee reaching a certain age or retirement;
  • The employee leaving the company for any reason;
  • The company is terminating the employee for cause;
  • The company is being sold or going public.
  • The company achieving certain financial or operational goals.


The payout options include a lump sum or installments, depending on the plan design. The payout can also be subject to certain limitations or clawbacks, such as:

  • The employee having to repay some or all of the bonus if they compete with the company or breach their confidentiality or non-solicitation obligations;
  • The company will reduce or forfeit the bonus if its performance declines or falls below a certain threshold.
  • The company caps the bonus at a certain amount or percentage of the employee’s salary.

Advantages of PSS

For employers:

  •  A PSS can help retain key employees by aligning their goals with the company’s and recognizing their contributions to its success. Understanding what motivates employees and offering incentives that are meaningful to them can achieve this. By creating a supportive and rewarding work environment, employees are more likely to stay with the company long-term. This can lead to increased productivity and overall success for the organization.
  •  A PSS can avoid diluting the equity of existing shareholders by not issuing actual shares to employees.
  •  A PSS is easier to change and personalize than an ESS. This is because it doesn’t need to adhere to complex laws and regulations.
  •  A PSS can save money and taxes compared to an ESS. This is because it doesn’t involve issuing shares, paying dividends, or dealing with capital gains tax.

For employees:

  •  A PSS can give employees a substantial bonus and make them feel like they own a part of the company’s success.
  •  A PSS can give employees more cash and security compared to an Employee Share Scheme (ESS). Employees do not have to wait for shares to be available, purchase them, sell them, or be concerned about market fluctuations.
  •  A PSS is simpler for employees. They don’t need to handle complex share agreements, valuation methods, or tax implications. This is unlike an ESS.
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Disadvantages of PSS

For employers:

  •  A PSS can strain a company financially. It requires large cash payments to employees at specific times, which can impact cash flow.
  •  A PSS can make a company owe taxes by deducting bonus payments as expenses and withholding taxes from employees.
  •  A PSS can cause employees to focus more on short-term gains than long-term sustainability and product quality. This can result in moral issues for the company.
  •  A PSS can cause a gap between employees and shareholders because employees have no say in the company’s decisions or governance.

For employees:

  •  A PSS can cause employees to owe taxes on bonus payments at their income tax rate. This rate may be higher than the capital gains tax rate for share schemes.
  •  A PSS can create a risk of forfeiture for the employees, as they may lose their benefits if they leave the company before vesting or fail to meet certain performance criteria .
  •  A PSS can create a lack of control for the employees, as they do not have any say over the valuation of the phantom shares or the timing or amount of the payout .

Key Takeaways

  • A PSS is a type of employee benefit plan that gives selected employees cash bonuses based on the value of the company’s shares without actually giving them any equity in the company.
  • A PSS can be a useful tool for employers who want to incentivize and retain their talent without diluting their ownership or dealing with complex legal and regulatory issues.
  • However, a PSS can have downsides like causing financial issues and tax problems for employers and employees. It may also impact how well employees connect with the company’s goals and beliefs.
  • Therefore, before implementing a PSS, employers should carefully consider their objectives, preferences, and constraints, and consult with their legal and financial advisors.

Frequently Asked Questions

What is a Corporate Share?

In Australian law, a share denotes ownership in a company’s equity. The Corporations Act 2001 mandates that proprietary companies have share capital and shareholders. Ordinary shares usually provide voting rights and dividends, while preference shares may offer fixed dividends and liquidation precedence.

Shares are transferable, subject to the company’s constitution and legal stipulations. Shareholders are not liable for company debts beyond unpaid share amounts. They influence company decisions through voting at meetings, with procedures detailed in the Corporations Act.

Here are some of the rights of a Shareholder:

  • Shareholders have the right to vote at company meetings on various issues, including the appointment and removal of directors.
  • Shareholders are entitled to receive a share of the company’s profits distributed as dividends, depending on the type of shares they hold.
  • Shareholders have the right to sell their shares, though there may be restrictions imposed by the company’s constitution.
  • Shareholders can participate in corporate actions offered by the company, such as rights issues, share buybacks, or dividends.
  • Shareholders are often entitled to receive information about the company, including financial statements and reports.

Yes, there are tax implications.

Phantom Share Schemes are taxed similarly to cash bonuses, with payments being considered part of the employee’s income for the pay cycle and taxed accordingly.

The taxation of a Phantom Share Scheme occurs when the benefits are paid out, either annually, upon dividend payments, or upon specific events like the company going public or being acquired. 

Employee Share Schemes (ESS) and Phantom Share Schemes (PSS) are two different ways to motivate employees in Australia. Each scheme has its own unique features and tax implications.

An Employee Share Scheme (ESS) gives employees real shares or options in the company. These may become available over time or based on performance. This helps align employee interests with the company’s growth and can offer tax benefits. The shares or options in an ESS can lead to direct ownership in the company, giving employees a stake in its success and possibly resulting in capital gains if the company’s value increases.

A PSS, or Share Appreciation Rights Plan, gives a cash bonus that imitates owning shares without actually giving ownership. Payments under a PSS are typically tied to the company’s share price or value and are taxed as ordinary income when they are made. While PSS can be simpler to administer and provide immediate financial rewards without diluting equity, they do not confer the same sense of ownership or long-term investment in the company as an ESS does.

About the Author

Angelie Opalla
Angelie joined Prosper Law in 2022 as a Senior Paralegal, assisting with legal documents. Admitted to the Philippine Bar in 2023, her experience spans across firms in the Philippines and the US.

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