Examining Phantom Stock

As the construction industry’s most precious resource — people — becomes scarcer by the day, it is time for construction executives to think outside the box and consider new ways to attract and retain key people. One of those vehicles is the concept of phantom stock, a unique method to engage key personnel and to vest them in the long-term profitability and health of the construction company.

Phantom stock is a contract between a company and recipients of phantom shares, who are chosen at management’s discretion but are usually (as noted above) key personnel. The agreement gives participants the right to a cash payment at a future date or in association with a defined future event (e.g. if the company sells). The value of the phantom units, and their growth, is pinned to the market value of an equivalent number of shares of the company’s stock. In other words, if the company does well and the value rises, so does the future payout. The opposite holds true in periods of decline.

There are two types of phantom stock plans your company can provide: full and appreciation. Under both plans, a participant’s phantom stock base is assigned a value based on the number of units awarded and the company’s equity at that date. As time goes on and the value of the company grows, so does the employees’ phantom stock value.

The difference between the two plans is clear when it comes time to pay out the accumulated balance. Under the full plan, the construction company is paying exactly that: the full value, including the starting equity base, which generally is not attributed to the employees’ efforts. The appreciation method, on the other hand, pays out the growth between the equity base and the value of the shares on the payout date.

To illustrate, assume that on Jan. 1, a construction company issued 10 phantom stock units to Carl with a starting value of $100 each, for a total value of $1,000. Over time, the value of the 10 units will grow to $1,000 each, for a total value of $10,000. Under a full plan, Carl would walk away with $10,000. Under the appreciation methodology, he would earn $9,000.

One item to note in both scenarios is that the employee does not invest any of his or her own capital into the construction company or take any risk outside of performing his or her role at an optimal level.

There are a number of benefits to the construction company in researching, designing and implementing a phantom stock plan.

Better Alignment of Organizational & Employee Interests 

Stock-based compensation plans are a great tool to align the financial interests of the organization and employees. Phantom stock is no different. When management can understand what wealth looks like over time to key personnel, they can design a plan to achieve that, assuming financial metrics are met. For the construction company, project performance should increase proportionately to the level of engagement of the project people. Given the financial motivation, employees will be more inclined to make sure projects finish on time and on budget — if not better. 

Furthermore, think of the efficiency and productivity an organization can achieve if everyone agrees on what success looks like and everyone benefits financially from it. Company executives can build a financial model to strengthen this alignment and keep everyone’s goals in clear sight. The model can be shared with the phantom stock owners to show him or her how the strategic growth of the company will directly impact their financial situation over time to achieve their personal wealth goals.

Powerful Retention Tool 

It is no secret that money is a powerful motivator, and a phantom stock plan will provide a financial reason for employees to stay. As with most incentive-based compensation/reward plans, however, the company needs to implement a vesting mechanism to ensure that if the value of the phantom stock dips, participants do not “cash out” and run to a competitor. In other words, the plan should be designed that none of the phantom stock value is earned until a certain age or years of service mark is reached.

Exclusive Perk for Future Leaders

Perhaps more important than everything previously outlined, keep in mind that a phantom stock plan is not for everyone. This type of plan should be designated for the key people that the company cannot risk losing to a competitor. While other types of incentives and short-term compensation plans can and will be used for everyone else, phantom stock plans are designed to retain and reward the construction company’s future C-suite team.

While the concepts and core values of phantom stock sound good, it must not be a surefire solution, or else more companies would be using this tool. There are some important considerations to be made before entering into a phantom stock plan, including:

• Tax treatment isn’t a phantom — While the company will be entitled to a tax deduction at the time the payment is made (i.e. after fully vesting), the employee, who hasn’t received real equity within the company, is paying tax on the payment at an ordinary rate, which is higher than capital rates. This needs to be a consideration for both parties during the modeling process.
• It only works when it works — In other words, this isn’t real equity for the employees. They haven’t invested their own capital within the company, and if there are shifts or changes that may not align with an individual’s personal ideals and goals, it is certainly easier to leave unvested phantom equity behind than attempting to pull real equity out.

The construction industry is a dynamic, growing field that is constantly in flux. The way we build has changed, and so must the way we attract and retain talent. So be open to new ideas for retaining your future leaders. The next great executive of your company may be on the jobsite or in the office right now, and with the proper training and incentives you can cultivate that individual straight up to the boardroom.