practice area: Corporate and Commercial
date: February 19, 2024

Employees play a pivotal role in driving an organization’s growth.  Recent times have witnessed a surge in startups and a thriving e-commerce sector.  Consequently, this led to an increase in opportunities and an escalation in competition.  Given the fact that the talent pool to support the growth has been largely stagnant, companies have been forced to deal with a significant increase in employee attrition rates.  This, in turn, has led to companies to develop attractive remuneration packages and incentives, especially to key employees, to ensure long-term retention.  While the companies in the traditional space have found it easy to offer across the board increases to its workforce, others have been forced to innovate to come up with remuneration structures which are non-dilutive and also do not put undue pressure on company financials.  Equity linked incentives are one of the key components of these packages.  This article attempts to explain one such mechanism introduced recently known as stock appreciation rights (‘SARs‘), offering a contractual stake in the company without actual ownership transfer.

Understanding SARs

SARs are generally of two types – cash settled SARs and equity settled SARs. SARs which are settled by way of equity are known as equity settled SARs, whereas SARs where employees have a right to receive cash benefit on fulfilment of specific criteria are known as cash settled SARs. Unlike conventional employee equity plans, these mechanisms do not necessarily create new business partners but instead acknowledge and remunerate key contributors.

SARs grant the employees with rights associated to underlying equity shares, entitling them to settlement by way of cash or by way of equity shares, depending on the contractual arrangement between the employee and the company, contingent upon business performance. For instance, an employer might grant an employee 10,000 SARs with an initial value of INR 10 each, equivalent to its fair market value (though this amount is not actually paid by the employee to the Company and is only contractually recorded).  When the employee exercises their SARs (on occurrence of an exercise event), they receive a cash payment equal to the difference between the current market value of the share (i.e. on the date of exercise) and the fair market value at which the SARs were granted (which is, in effect, recovered by the Company for initially granting the SARs), or the equivalent amount of the equity shares.

Legal Background

Employee stock options (ESOPs) for unlisted companies are mainly governed by the Companies Act, 2013 (‘Act’), and in case of listed companies, by SEBI (Share Based Employee Benefits and Sweat Equity) Regulations, 2021 (‘SBEB & SE Regulations’).

In case of listed companies, SBEB & SE Regulations provides recognition and some clarity with respect to the issue of SARs. Regulation 2, sub regulation 2(qq) of SBEB & SE Regulations defines SARs as a right given to a SAR grantee entitling him to receive appreciation for a specified number of shares of the company where the settlement of such appreciation may be made by way of cash payment or equity shares of the company. For the purpose of SAR scheme, appreciation shall mean the difference between the market price of the share of a company on the date on which the employee exercises their right under the scheme or the date on which such SAR vests with the employee, as the case may be, and the SAR price (which is defined on the grant date of SAR).

Further SBEB & SE Regulations in its regulation 23(2), states that a company shall be free to implement cash settled or equity settled SAR scheme.  Provided that in case of equity settled SAR scheme, if the settlement results in fractional shares, then the consideration for fractional shares should be settled in cash. This was replicated based on the report of the expert group on SBEB Regulations and SEBI (issue of sweat equity) Regulations, 2002 [1] issued in July 2021 (‘Expert Group recommendations’), where the expert group recommended “….that if due to regulatory requirement, a company is unable to issue shares, there should be an option to settle in cash (assuming this is already contemplated under the plan previously approved by shareholders). If not covered in the plan, this settlement in cash option should be approved by the shareholders”.

However, it is pertinent to note that the explanation to Regulation 2, sub regulation 2(qq) provides that SAR shall not include any scheme which does not, directly, or indirectly, involve dealing in or subscribing to or purchasing, securities of the company. This is very similar to the position that SEBI took in the year 2015 in the informal guidance sought by Mindtree Ltd[2] and Saregama India Ltd[3].  Both these companies have issued a phantom stock scheme in which only notional SAR units were issued at a predetermined grant price and the grantees were entitled to receive cash payment for appreciation in the share price over the grant price.  This perspective of SEBI was seemingly rooted in the notion that such phantom stock scheme does not entail “dealing in or subscribing to or purchasing securities of the company, directly or indirectly.”

Further the discussion paper released by SEBI ‘Review of guidelines governing stock related employee benefit schemes’[4] recommended that the regulations should not cover the schemes involving ‘Phantom options which do not involve purchase or sale of Shares’ and/or ‘any other scheme where shares of the company are neither given to the employee nor acquired or sold by the Trust for the purposes of giving benefit to the employees by an employer company.’

Considering the discussion paper, SEBI’s informal guidance and the Expert Group recommendations, it will be safe to assume that SARs will fall under the purview of SEBI as long as the mode of settlement involves equity and not cash, and the permission to transact under the Regulation 23(2) would only be applicable in the case where the settlement of equity settled SAR scheme results in fractional shares.

In case of unlisted companies, regulations for ESOP have not recognized SARs yet. However, the Company Law Committee report of March 2022[5] (‘Report’) mentioned that ‘SARs lack recognition under the same and that this may lead to regulatory gaps and arbitrage’.  The Report recommends that section 62(1) of the Act should be amended to allow additional employee compensation schemes linked to the value of the share capital of a company.  The report further recommended that ‘the schemes that require the issue of further securities by the company, their issuance must be allowed only after approval of the shareholders through a special resolution.  The provisions should also allow an annual omnibus approval by the shareholders of the company to ensure that fresh approvals should not be required at the time of each allotment under such schemes.  However, where the settlement of such rights does not involve offer or conversion into securities, approval by shareholders need not be mandated’.

Unlike SBEB & SE Regulations, the intention appears that the Act should regulate both, cash settled and equity settled SARs.  However, in the absence of any amendment yet, the terms of issuance of SARs in unlisted companies is currently governed by contractual arrangement between a company and a grantee of SAR (which, as of today, could not only include employees, but also third-party advisors).

Conclusion: Balancing Act

Employee compensation by way of SARs has emerged as a strategic tool for companies seeking to retain top talent while safeguarding ownership stakes. Cash settled SARs allow companies to provide innovative compensation structures without restructuring the existing ownership.  In the present context, where retaining talent has become as crucial as preserving ownership integrity, this compensation form presents a harmonious middle ground. It facilitates a company to reward its employees while safeguarding its foundational ownership structure.

However, the current regulatory landscape for SARs requires amendments and comprehensive guidelines. Clear, inclusive regulations would offer guidance, ensure transparency, fairness, and compliance in implementing such equity-based incentive schemes for employees by companies.

Written By Nidhi Arora (Partner) and Kriti Mehrotra (Associate)

[1] Report of the expert group on SBEB Regulations and SEBI (issue of sweat equity) Regulations, 2002 (available at:    

[2] Informal Guidance by SEBI issued for Mindtree limited (available at:

[3] Informal Guidance by SEBI issued for Saregama India limited (available at:

[4] Discussion paper Review of guidelines governing stock related employee benefit schemes (available at:

[5] Company Law Committee Report 2022 (available at:

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