“Shadow stock” can refer to a publicly traded stock that gains value when a similar new stock trends higher, or to a phantom stock plan where employees receive compensation based on rising stock values without receiving shares in the company. This is used as an incentive for employees to increase the company’s value. Payments are deferred to encourage longevity of employment.
The term “shadow stock” is used in different ways in the financial world. It can refer to a publicly traded stock that gains in value when a newly listed stock in a similar industry begins to trend higher, or the stock in what’s known as a phantom stock plan. In a phantom stock plan, people receive compensation based on rising stock values without receiving shares in the company.
In the first sense, a classic example of a shadow stock might be a stock in an automobile company that has been traded on the market and has a history. When a new car company goes public, the shares of the first car company become hidden shares. New companies tend to experience high trading volume when they go public, increasing their value, and hidden stocks often rise in value along with them. Eventually, the market and values will stabilize.
In the sense of a phantom stock plan, shadow stocks are a somewhat complicated concept. Employees in such plans receive a set number of shares of “phantom shares.” These are not actual shares and the employee has no shares in the company. When the value of the company’s stock increases, the employee receives compensation based on the number of shares of shadow stock received. In other words, it is as if the company had stocks that generated returns.
Giving employees shares of a company, fake or otherwise, is used as an incentive to provide them with a boost to help the company succeed. It is in the best interest of the employee to do things that increase the value of the shares and therefore increase compensation. In the case of phantom shares, companies can use this technique if they are not publicly traded so they can provide performance-based compensation without losing shares and publicly traded companies can also offer shadow shares to employees .
Generally, cash payments to which employees are entitled from a shadow share program are deferred. This is designed to encourage longevity of employment. Employees cannot be offered shares immediately and the number of phantom shares provided will increase over time. Payments may not start for several years, giving employees a reason to stay with the company so they can collect their cash bonuses. For tax purposes, money from a phantom stock program is treated as earned income.
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