New trend in bonuses: 'Phantom stock'

NEW YORK (CNNMoney.com) -- The little-known practice of issuing so-called "phantom stock" might be the next big thing when it comes to employee pay.

As supernatural as it may sound, phantom stock is hardly a dark art carried out by some occult sect in the corporate world. Rather, it is simply a promise to pay an employee a bonus that is directly tied to the value of a company's stock, but without actually giving an individual shares.

Up until recently, issuance of phantom shares has been largely limited to privately-owned companies like family-owned businesses that didn't want to give employees actual ownership stakes.

But experts say many big publicly-traded firms are taking a closer look at phantom shares as well.

Phantom stock issued to employees at power company Duke Energy (DUK, Fortune 500), for example, converts into actual shares over a certain number of years.

"The whole point is to retain top employees and develop and retain talent," said Tom Williams, a spokesperson for the Charlotte, N.C.-based firm.

And last year, the troubled insurance giant AIG (AIG, Fortune 500) flirted with the notion of paying its top 100 highest-paid employees with stock units that were pegged to several of its subsidiaries, rather than its publicly-traded shares. The company eventually decided against doing so, but is now giving employees the option of taking securities that are tied to stock and debt.

Compensation experts said two factors have fueled the shift to phantom stock. For starters, companies have come under increased pressure not to dilute existing shareholders. By paying employees with actual stock, firms have to issue new shares, lowering their value as a result.

Research has also shown that employees who are rewarded with actual shares tend to sell it shortly after they take hold of them. Companies, as a result, have less of a need to pay employees with stock if their workers aren't holding on to the shares.

"If they are going to do that, you might as well give them cash instead of equity," said Steve Slutsky, an executive compensation consultant for PricewaterhouseCoopers.

For now though, experts said only a minority of big public companies are issuing phantom stock. Many publicly-traded firms have avoided it for a variety of reasons - the potential for accounting headaches as well as the possibility that the company could be on the hook for a major cash payout if its stock enjoys a big run-up.

Another reason that the practice hasn't really taken off is because companies fear employees will be confused about what exactly they are getting, said Corey Rosen, executive director for the National Center for Employee Ownership, an Oakland, Calif.-based non-profit.

"If you give an employee shares usually there is the connotation of owning a piece of the company," he said. "If you give equivalent shares, you have to make more of an effort to explain why that is."

Still, some experts believe even more companies will start issuing phantom stock, especially financial services companies. In fact, Bank of America (BAC, Fortune 500) doled out phantom stock for its executives as far back as 2006.

Irv Becker, national practice leader for executive compensation at the consulting firm Hay Group, predicts that more banks will follow BofA's lead. He noted that banks have issued a large amount of new stock in order to raise capital after the financial crisis erupted in 2007.

As a result, institutional investors and proxy advisors alike are watching closely to make sure existing shareholders aren't diluted any further, Becker said.