How to Find Compensation Expense for Stock Options

Public companies often compensate employees in part by giving them stock options. This form of employee compensation conserves cash, improves retention and aligns employees’ interests with the interests of their employers. However, stock option compensation also dilutes ownership of existing shareholders. Investors considering purchasing shares of a public company can find information about stock option compensation in the cash flow statement.

For help managing your money, including figuring out what to do with stock options, consider working with a financial advisor.

Stock Option Compensation Basics

Non-cash compensation in the form of stock options is particularly attractive to young companies that have limited cash and need to attract talented employees. It allows them to create appealing compensation packages for in-demand workers while conserving cash, improving retention and incentivizing performance.

Making owners out of employees helps align their interests with those of the company and its investors since options will be worth more when exercised if the company’s share price increases, and vice versa. Options can also motivate workers to put in more effort. Sometimes options are handed out in exchange for reaching performance benchmarks or achieving specific goals.

Investors need to know when companies they invest in are using employee stock option compensation. The main reason is that granting options to employees increases the number of shares. When options are eventually exercised and shares are distributed to employees, it dilutes the ownership of existing shareholders. Issuing more shares reduces earnings per share (EPS), an important determinant of the stock’s value and price.

Types of Stock-Based Compensation

Employees are granted the right to purchase company shares at a predetermined price (exercise price) within a specified time frame. Stock options are often vested over time, incentivizing employees to stay with the company and work towards increasing its stock value. If the stock price rises above the exercise price, employees can profit from the difference.

Restricted stock units (RSUs): RSUs are grants of company shares that vest over time or upon meeting specific performance criteria. Employees receive the shares outright once they vest, making this a straightforward and popular form of compensation. Unlike stock options, RSUs retain value even if the stock price decreases, offering more downside protection.

Performance shares/performance stock units (PSUs): These are similar to RSUs but vest only if specific performance metrics, such as revenue growth or earnings targets, are achieved. PSUs motivate employees to focus on achieving strategic company goals, aligning rewards with corporate success. If performance targets are not met, employees may receive fewer shares or none at all.

Employee stock purchase plans (ESPPs): ESPPs allow employees to purchase company shares at a discounted price, often through payroll deductions over a set period. These plans provide employees an accessible way to invest in the company’s future and potentially benefit from stock price appreciation. The discount and tax advantages make ESPPs an attractive option for employees.

Incentive stock options (ISOs) and non-qualified stock options (NSOs): ISOs and NSOs are subcategories of stock options, with ISOs offering favorable tax treatment under specific conditions. ISOs are generally reserved for employees, while NSOs can be granted to non-employees such as consultants. ISOs can result in significant tax savings if the shares are held for a requisite period, but they also come with strict eligibility requirements.

Phantom stock and stock appreciation rights (SARs): Phantom stock provides cash payments linked to the value of the company’s stock, without issuing actual shares. Similarly, SARs give employees the right to receive the appreciation in stock value over a set time. These methods are often used by private companies to offer equity-like benefits without diluting ownership.

Stock-based compensation comes in various forms, each tailored to meet specific company goals and employee needs. Whether through direct ownership, performance-linked incentives, or cash-based equity alternatives, these tools empower employees to share in a company’s success. By understanding and strategically implementing these types, companies can create a robust compensation framework that fosters alignment and long-term growth.

Finding Stock Option Compensation Expense

Public companies list expenses for employee stock options in several documents. They are included in the detailed 10-K forms submitted to the Securities and Exchange Commission every year. They should also appear in the annual reports, which are shorter and more slickly produced information packages created to give to investors.

Figures for stock-based compensation should appear in the income statement and in the cash flow statement. In the income statement, employee stock options are used to calculate gross profit or operating profit. In the cash flow statement, stock option expense appears under the cash from operations heading.

Like depreciation and amortization, stock-based compensation is a non-cash expense. Therefore, like depreciation and amortization, the value of stock options can be added to cash from net income to produce the figure for cash from operations.

Calculating Stock Option Compensation Expense

To calculate total stock compensation expense, multiply the number of stock options that have been granted by the fair market value on the date of the grant. To determine how much stock compensation expense to record for each annual period, divide the total stock compensation expense figure by the number of years required for vesting.

For example, granting 10,000 options to shares on a date when the fair market value of the options is $12 each makes a total stock compensation expense $120,000. If the vesting period is three years, then $120,000 is divided by three to indicate that $40,000 of stock compensation expense should be recorded every year.

Bottom Line

Many public companies use stock options to attract, retain and incentivize employees. While compensating employees with options conserves essential cash, it can also dilute ownership and affect the value of holdings by existing shareholders. That makes employee stock compensation expense useful information for investors who are deciding whether or not to purchase shares of a company. Employee stock compensation expense can be found in the income statement and in the cash flow statement of a company’s annual report or 10-K.

Financial Planning Tips

Consider talking to a financial advisor before investing in a company that uses employee stock compensation. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
Even if you do receive stock options, you’ll likely still be earning some cash. Make sure you put some of it into a retirement account like a 401(k) or an individualized retirement account.