Stock Appreciation Rights - Financial Reporting and Analysis

Some firms grant key employees stock appreciation rightsinstead of stock options or in addition to stock options. Stock appreciation rights give the employee the right to receive compensation in cash or stock (or a combination of these) at some future date, based on the difference between the market price of the stock at the date of exercise over a pre-established price.

The accounting for stock appreciation rights directs that the compensation expense recognized each period be based on the difference between the quoted market value at the end of each period and the option price. This compensation expense is then reduced by previously recognized compensation expense on the stock appreciation right.

For example, assume that the option price is $10.00 and the market value is $15.00 at the end of the first period of the stock appreciation right. Compensation expense would be recognized at $5.00 ($15.00 – $10.00) per share included in the plan. If 100,000 shares are in the plan, then the expense to be charged to the income statement would be $500,000 ($5.00 100,000 shares).

If the market value is $12.00 at the end of the second period of the stock appreciation right, expenses are reduced by $3.00 per share. This is because the total compensation expense for the two years is $2.00 ($12.00 – $10.00). Since $5.00 of expense was recognized in the first year, $3.00 of negative compensation is considered in the second year in order to total $2.00 of expense. With 100,000 shares, the reduction to expenses in the second year would be $300,000 ($3.00 100,000 shares). Thus, stock appreciation rights can have a material influence on income, dictated by changing stock prices.

A company with outstanding stock appreciation rights describes them in a footnote to the financial statements. If the number of shares is known, a possible future influence on income can be computed, based on assumptions made regarding future market prices. For example, if the footnote discloses that the firm has 50,000 shares of stock appreciation rights outstanding, and the stock market price was $10.00 at the end of the year, the analyst can assume a market price at the end of next year and compute the compensation expense for next year.

With these facts and an assumed market price of $15.00 at the end of next year, the compensation expense for next year can be computed to be $250,000 [($15.00 – $10.00) 50,000 shares]. This potential charge to earnings should be considered as the stock is evaluated as a potential investment.

Stock appreciation rights tied to the future market price of the stock can represent a material potential drain on the company. Even a relatively small number of stock appreciation rights outstanding could be material. This should be considered by existing and potential stockholders. Some firms have placed limits on the potential appreciation in order to control the cost of appreciation rights.

Forbes reported the following in a May 17, 1999 article, “Safe Haven” :

“According to the Company’s latest filing with the SEC, both the Daimler-Benz and the Chrysler compensation systems disappeared when the merger was consummated. The Daimler bonus and the Chrysler option plan was replaced with performance-based stock appreciation rights.”

The General Electric Company 1998 annual report indicated that “at year-end 1998, there were 1.4 million SARs outstanding at an average exercise price of $22.14.” The General Electric Company stock price during 1998 ranged from a low of $69 to a high of $103 15/16.

Per note 8 of the Nike 1999 annual report, Nike has the potential for outstanding stock appreciation rights. Apparently stock appreciation rights were not outstanding as of May 31, 1999.

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