Stock Based Compensation - Corporate Finance Institute

Stock Based Compensation (also called Share-Based Compensation or Equity Compensation) is a way of paying employees, executives, ... Home›Resources›Knowledge›Accounting›StockBasedCompensation StockBasedCompensation Aformofequityremuneration(non-cash) Writtenby CFITeam UpdatedFebruary16,2022 WhatisStockBasedCompensation? StockBasedCompensation(alsocalledShare-BasedCompensationorEquityCompensation)isawayofpayingemployees,executives,anddirectorsofacompanywithequityinthebusiness.Itistypicallyusedtomotivateemployeesbeyondtheirregularcash-basedcompensation(salaryandbonus)andtoaligntheirinterestswiththoseofthecompany’sshareholders.Sharesissuedtoemployeesareusuallysubjecttoavestingperiodbeforetheyareearnedandcanbesold. TypesofEquityCompensation Compensationthat’sbasedontheequityofabusinesscantakeseveralforms. Commontypesofcompensationinclude: Shares RestrictedShareUnits(RSUs) StockOptions PhantomShares EmployeeStockOwnershipPlan(ESOP) HowitWorks Companiescompensatetheiremployeesbyissuingthemstockoptionsorrestrictedshares.Thesharestypicallyvestoverafewyears,meaning,theyarenotearnedbytheemployeeuntilaspecifiedperiodoftimehaspassed.Iftheemployeequitsthecompanybeforetheshareshavevested,theyforfeitthoseshares.Aslongastheemployeestayslongenoughwiththecompany,alloftheirshareswillvest.Theycanholdthesharesindefinitely,orsellthemtoconvertthemintocash. Stock-BasedCompensationExample Theeasiestwaytounderstandhowitworksiswithanexample.Let’slookatAmazon’s2017annualreportandexaminehowmuchtheypaidoutinequitytoemployees,directors,andexecutives,aswellashowtheyaccountedforitontheirfinancialstatements. Asyoucanseeinthecashflowstatementbelow,netincomemustbeadjustedbyaddingbackallnon-cashitems,includingstock-basedcompensation,toarriveatcashfromoperatingactivities. Source:amazon.com In2017,Amazonpaid$4.2billionofshare-basedcompensationtoitsemployees. Sincethecompanyhasapproximately560,000employees,thatworksouttoabout$7,500peremployeeonaverage. AdvantagesofStockBasedCompensation Therearemanyadvantagestothistypeofremuneration,including: Createsanincentiveforemployeestostaywiththecompany(theyhavetowaitforsharestovest) Alignstheinterestsofemployeesandshareholders–bothwanttoseethecompanyprosperandthesharepricerise Doesn’trequirecash DisadvantagesofShareBasedCompensation Challengesandissueswithequityremunerationinclude: Dilutestheownershipofexistingshareholders(byincreasingthenumberofsharesoutstanding) Maynotbeusefulforrecruitingorretainingemployeesifthesharepriceisdecreasing ImplicationsinFinancialModeling&Analysis Whenbuildingadiscountedcashflow(DCF)modeltovalueabusiness,it’simportanttofactorinsharecompensation.AsyousawintheexamplefromAmazonabove,theexpenseisaddedbacktoarriveatcashflow,sinceit’sanon-cashexpense. Whiletheexpensedoesnotrequireanycash,itdoeshaveacapitalstructureimpactonthebusiness,sincethenumberofsharesoutstandingincreases. Analystsneedtodecidehowtoaddressthisissue,andtherearetwocommonsolutions: Treattheexpenseasacashitem(don’tadditback). Additbackandincreasethenumberofsharesoutstandingbythenumberofsharesawardedtoemployees(bothvestedandnon-vested). AdditionalResources ThankyouforreadingCFI’sguidetoStockBasedCompensation. Tocontinuelearningandadvancingyourcareer,theseCFIresourceswillbehelpful: FinancialModelingGuide InvestmentBankingSalaryGuide FinancialAnalystSalaryGuide InvestmentBankingJobDescription Sharethisarticle GetCertifiedfor
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