In Part 1, we saw how Andrew Carnegie’s oversized bonuses helped prove one of capitalism’s primary principles: incentives shape behavior. Since then, compensation in privately held companies has evolved from straightforward salary-plus-bonus into purpose-built structures—deferred comp, SERPs, and other designs—that keep executives and owners chasing the same outcome. Part 2 moves the story into the world of “synthetic” equity: phantom stock and Stock Appreciation Rights (SARs) that share value growth without issuing real shares.
We’ll also look at Long-Term Incentive Plans (LTIPs) as a parallel path for rewarding multi-year performance. Different structures, same objective: keep key executives thinking like owners while you keep the ownership cap table exactly where you want it.
Phantom Stock & Stock Appreciation Rights (SARs)
Phantom stock plans and SARs are inventive ways to give employees a stake in your company’s success without issuing actual stock. You create an imaginary ledger of shares for an employee, and down the road, you pay them a bonus based on how those phantom shares performed. A SAR (Stock Appreciation Right) is a close cousin: it only pays the increase in value of a share over time. In other words, phantom stock can mimic full stock value (including the base price and growth), while a SAR strictly rewards growth.
How do these work? Say your company’s stock value is $50 today. You grant a key manager 1,000 phantom shares. Five years later, if those shares are valued at $80, the manager gets a cash bonus of 1,000 × $80 = $80,000 (under a full-value plan) or perhaps 1,000 × ($80–$50) = $30,000 (if it’s an appreciation-only plan). With a SAR, you’d typically just owe the $30,000 gain. No actual stock certificates change hands – it’s all on paper until the payout. That means no new shareholders to deal with and no dilution of your ownership.
Phantom Stock vs. Stock Appreciation Rights
From a business owner’s perspective, both shine when you want to share the company’s success without sharing ownership. This is a big deal if you’re a family business owner who wants to keep equity in family hands – phantom stock lets your key non-family execs feel like owners in the economic sense, so they’re motivated, yet you maintain full control.
These plans typically come with vesting schedules or “golden handcuffs”. For example, a phantom stock grant might vest only if an exec stays for five years and the company hits performance goals. Leave early or miss targets, and the payout vanishes. That keeps your talent in their seats and laser-focused on long-term wins, which is exactly what you want if your endgame is a lucrative sale or handing the business off to the next generation.
Of course, we can’t ignore taxes and costs. The tax-efficiency angle here is mainly about timing and deduction. As the employer, you get a tax deduction when you cut that bonus check at the end of the plan. The employee, on the other hand, defers their taxation until they receive the payout (which is taxed as ordinary income). There’s no capital gains treatment for the employee (since they didn’t actually own stock), but deferral itself can be valuable, especially if the payout coincides with a high-growth period of the company (and presumably a stronger ability to pay).
One note of caution: if your company’s value skyrockets (nice problem to have!), be ready for the cash obligation. Big phantom/SAR payouts can dent your cash flow if you haven’t planned ahead.
Long-Term Incentive Plans
Moving on from the stock-mimicking world of phantom shares, let’s talk about Long-Term Incentive Plans (LTIPs). An LTIP is a multi-year bonus program tied to your company’s big goals. You sit down with your executive team and say, “If we grow our revenue 50% over the next three years and increase our profit margin by 5 points, you’ll each earn a significant bonus (or equity award) at the end.” That’s a performance-based LTIP in action. It’s generally not about handing out rewards for one good quarter or a one-time win. Rather, it’s about incentivizing sustained, long-term performance that drives up shareholder value.
How LTIPs Work
Generally, you establish an LTIP by setting specific performance targets and a time horizon (usually 3 to 5 years is common). The targets can be financial metrics such as cumulative earnings, revenue growth, or return on equity. Alternatively, they can be about strategic milestones – e.g., expanding to 50 stores or successfully launching a new product line. Many companies use a mix of metrics to capture what “increased shareholder value” means for them. For instance, a plan might require hitting Total Shareholder Return (TSR) and Earnings Per Share goals, and maybe a customer growth number.
Establish performance metrics, targets, and time horizon (typically 3-5 years). Communicate plan details to key executives.
Begin measuring performance against established KPIs. Regular updates to participants on progress toward goals.
Ongoing performance tracking. Executives remain focused on long-term goals rather than short-term gains.
Final assessment of achievement against targets. Determination of payout amounts based on results.
Distribute earned rewards (cash, stock, or other compensation) based on achievement level. Potentially establish next LTIP cycle.
In practice, LTIPs can be paid in different ways. Public companies often use actual equity for LTIPs (like performance shares or stock options that vest based on the results). Private companies may instead use cash-based LTIPs or even phantom equity. The downside, of course, is that cash for bonuses must come from the company’s coffers, so you need to ensure the incentive is affordable based on your financial projections (again, modeling is key).
Let’s not forget tax and cost efficiency here as well. Typically, any payouts under an LTIP are tax-deductible to the company, since they’re compensation. The executives will pay income tax on cash bonuses or on the value of stock they receive (there are nuanced timing rules if stock is involved, but that’s beyond today’s scope). The real benefit, tax-wise, is that you’re timing these payouts to when performance has been achieved, meaning your company should have the profits or liquidity to justify the expense (and the tax deduction).
Conclusion & Call to Action
Executive compensation can be complex, but it’s also one of your most powerful levers as a business owner. The strategies we’ve covered – from Deferred Comp and SERPs in Part 1 to Phantom Stock, SARs, and LTIPs here in Part 2 – are all about aligning incentives with long-term outcomes. When your compensation plan is aligned with your vision of the future, amazing things can happen. You can motivate growth, retain the talent that fuels that growth, and simultaneously pave the way for your own financial freedom and legacy.
Are you confident that your company’s executive compensation plan is pulling its weight in your broader financial plan? Does it dovetail with your retirement timeline, your tax strategy, and the future you want for your family? If you’re hesitating, it’s probably time to get a second opinion. I’d be happy to review your situation and, if necessary, realign your plan to keep your best people laser-focused and ownership firmly in your own hands.
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