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While stock awards have long been included in CEO and top executive compensation packages, the practice of offering lower-ranking employees some form of equity compensation has been in place at a number of companies for decades.
Some 28 million U. More recently, a specific type of equity compensation, restricted stock units RSUs , has been on the rise. Apple made headlines in when it announced grants of RSUs to its retail employees.
The practice of offering equity compensation to employees was popularized by Silicon Valley companies during the '90s tech boom.
At the time, fledgling tech companies that couldn't afford to pay large salaries sought to attract talent by offering stock options, according to Kaye Thomas, the author of "Consider Your Options. When some of those companies went on to see great success, employees found that exercising their stock options paid off handsomely, which prompted even greater interest in employee stock options. The practice has since spread beyond tech, with companies ranging from manufacturers to insurance firms offering stock awards to employees Indeed, like any other investment, stock awards come with risks.
If your company has granted you a stock award or you're considering a job that includes equity compensation, here are a few questions to consider:. Stock options and RSUs are among the most common types of equity compensation. An employee stock option is a contract that grants an employee the right to buy shares in his or her employer at a specific, fixed price, known as the exercise price, after a designated date. RSUs may have overtaken stock options in popularity in recent years.
A survey of more than stock award-granting companies by the National Association of Stock Plan Professionals NASPP and Deloitte Consulting found that time-vested RSUs had become more prevalent than options, with the latter experiencing a 31 percent decline in popularity in the last decade. Some employees may prefer RSUs to stock options because, in the case of options, an employee must spend his or her own money to buy the stock even if they ultimately sell it , while an RSU is granted to an employee without any investment on his or her part.
Therefore, a company must issue more stock options to equal the same value of fewer RSUs, so if a company goes the RSU route it can issue fewer shares than it would through options, resulting in less shareholder dilution.
Businesses, meanwhile, may prefer RSUs to options for reasons ranging from a accounting rule change that required companies to record options as expenses which forced them to deduct the value of the options from their profits to concerns about shareholder dilution from option grants. It's common for executives to receive performance-based equity awards , meaning that their stock options may only be exercised, or they only receive full ownership of their RSUs, once certain performance goals are met.
For rank-and-file employees, however, performance-based equity awards are more unusual. The NASPP survey found, for example, that just 9 percent of companies offered performance-based awards to salaried employees with positions below the rank of middle management, while 45 percent offered time-vested restricted stock to such employees. Companies can use awards that vest over a certain time period as an incentive to retain employees.
Vesting is contingent on an employee remaining with the company, with RSUs or options vesting gradually over time. Sometimes vesting doesn't begin until a person has been employed with his or her company for a year or more. For example, following the one-year anniversary of employment, the employee may see his or her stock award vesting on a monthly basis.
Sometimes, the timeline can be much longer. Consult your company's HR department to learn how your vesting schedule works. Generally speaking, portfolio diversification is a good way to mitigate investment risk. Longtime employees may accumulate large holdings of their employer's stock or stock options and if they don't sell at least some of their holdings after they vest—and diversify their portfolios through other investments—they could find themselves facing steep losses if the company's stock suddenly underperforms.
This problem is one that's also common among employees who accumulate company stock in their k accounts. Learn more about that here. You can learn more about concentration risk on the Financial Industry Regulatory Authority's " Concentrate on Concentration Risk " page. Both RSUs and stock options are subject to taxes, though in different ways. With RSUs, the tax situation is relatively simple: RSUs are taxed upon vesting. Non-qualified options are taxed when the employee exercises the options, while qualified or incentive options may be taxed when the employee actually sells the options, and may qualify for favorable tax treatment if certain conditions are met.
Consult a tax professional to learn more about how your company holdings will be taxed. Think rank-and-file employees always get paid in cash? If your company has granted you a stock award or you're considering a job that includes equity compensation, here are a few questions to consider: