Types of stock based compensation

Types of Stock-Based Compensation:  The term “stock-based compensation” is a wide term which embraces the compensation of an employee in stocks options, stock appreciation rights and other stock-based related awards.

Broadly, stock-based compensation can be classified into two follows:

  1. Restricted stock plan: The most traditional type of restricted stock awards involves the grant of stock of the company, with vesting based solely on completion of a specified period of service. Restricted stock may provide that the vesting of the shares will be contingent on the achievement of performance goals, or the achievement of performance goals, or the achievement of performance and service requirements. Stocks units are a type of stock based award that is closely related to restricted stock. Vesting restrictions may apply to stock unit awards. However the grant of stock does not reflect current ownership of shares, but rather the right to receive delivery of shares of stock at a later date. Typically, the share units will accrue dividends during any deferral period, which may be credited to the employee’s account as additional stock units, or may be paid in cash. Another type of award that is related to restricted stock is performance share or performance unit award. These awards provide the opportunity to receive stock, or designated money based on the value of stock, subject to the achievement of performance or other objectives.

Merits:

  • There is no dilution of the issued share capital as no share is transferred on exercise of the option.
  • Work efforts is aligned to organizational growth  and progress.
  • Minimal administration cost.
  • Tax rebate benefits to the organization.

Demerits:

  • Cash flow cost is involved.
  • Bonus at hand of the employee is chargeable to income tax.

 

  1. Employee stock purchase plan: An employee stock purchase plan is a stock purchase warrant granted by a company to its employee in exchange for services. It is a plan permits purchase of company compensates the employee with option to purchase the stocks of the company. The main reason for granting employee stock option is that they are a means of tying compensation to the stock price, which is a measure of company performance, and are one of the ways of preventing or minimizing the agency problem. Generally, these p[purchase are paid preventing or minimizing the agency problem. Generally these purchases are paid for by the employee with money obtained through payroll deductions. At the end of the period the accumulated sums are applied to purchase company stock. At the end of the period, the accumulated sums are applied to purchase company stock. Typically, no brokerage fee is charged on the purchase. Often, the plan permits the purchase to be made at a discount from the fair market value of the stock.

Merit:

  • Ownership in the fortune of the organization through instant stock purchase.
  • Encourage for improving individual, group and organizational performance.
  • Deferred compensation which is likely to yield higher return with increasing organizational performance.

Demerits:

  • Widening of the share capital of the origination.
  • Expiry date.
  • Cash flows over time.
  • Subject to stock market fluctuations and risks.

A typically stock option plan will encompass the following components:

  • Eligibility terms.
  • Number of options.
  • Exercise price.
  • Grant date.                

However, irrespective of type of stock-based compensation, stock potions re frequently used when expected agency costs are high and when monitoring is difficult or costly. Demsetz and Lehn suggest that the optimal level of employee incentive is dependent on the company’s factor inputs and product markets. If the optimal company size is large, then the cost of fixed proportionate equity ownership is, correspondingly greater in large companies. Moreover, large companies are expected to require talented employee who demand higher compensation.

Core and Guay argue that the incentive alignment motivation for stock options is weaker in the case of lower level employees, since these individuals are expected to have less influence in the stock price through actions. However, Core and Guay say that a company grants stock options to lower level employees to retain and attract certain types of employees, and to serve as a substitute for retain and attract certain types of employees, and to serve as a substitute for cash compensation. The retention motive is highlighted by the fact that stock options typically include ve4sting restrictions, that is, stock options become vested overtime, which suggest that this type of compensation may bond employees to the company over an extended period of time. Moreover, requiring employees to hold stock options may serve to attract certain types of employees, such as individuals with lower degrees of risk aversion. Liquidity constraints may also be related to the use of stock options, that is implying a substitution effect between stock options and cash compensation. Since granting stock options does not involve outflows of cash, companies with cash flow constraints are expected to make use of stock options.

HR-Professionals 12 Compensation 12

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