Equity Compensation - Explained
What is Equity Compensation?
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Table of ContentsWhat is Equity Compensation?How is Equity Compensation Used?Common Types of Equity CompensationExamples of Equity CompensationAcademic Research on Equity Compensation
What is Equity Compensation?
Equity compensation is a non-monetary pay that is related with the ownership in the organization. Employees can receive this compensation in the form of options, performance shares, and restricted stock. It further enables employees to have a sense of ownership and belongingness towards the company, thereby reducing the employee turnover. Also, employees receive a share of the company's profits by investing in shares.
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How is Equity Compensation Used?
Several public and private companies, especially the budding ones, widely use equity compensation approach. Firms, who have just started, may not have adequate funds, or may seek to make investments for the company's growth. Therefore, they may choose the strategy of equity compensation for tempting prospective employees. Earlier, technology-based organizations, irrespective of their size and experience, used equity compensation for offering rewards to their employees.
Common Types of Equity Compensation
Organizations providing equity compensation to employees can offer stock options to their employees. Stock options give them the right to buy the company's shares at a given price, which is also known as the exercise price. Such incentives allow employees to have control over these shares after having worked for the firm for a set time period. At the time option vests, employees have the right to either sell or transfer the shares.
This policy motivates employees to build long-term relationships with the company. However, such options have a maturity date. Employees who have the option to vest cannot enjoy similar privileges as stockholders of the company. The vested options carry dissimilar tax liabilities as compared to the ones that are not. Thats why it is important for employees to check what kind of tax laws are applicable in particular situations. Equity compensation has many forms like non-qualified stock options, and incentive stock options.
Only the employees of a company can benefit from incentive stock options. These options offer exclusive tax benefits. If an employee owns a non-qualified option, they are not supposed to mention the time they obtain the option, or they exercise it. Restricted stocks ask for the fulfillment of a vesting tenure. One can do it in one go after a given time period. Or, one can do vesting in bits and pieces in a given number of years, or as per the requirements of the management.
RSUs have same properties, except the company agrees to make payment for shares on the basis of a vesting timeline. While it offers benefits to the organization, employees don't receive any privileges related to the company's ownership until they earn and receive shares. Employees receive performance shares when they achieve specific milestones. Such determinants include earnings per share (EPS), and return on equity (ROE), etc. Generally, performance shares have a maturity of many years.
Examples of Equity Compensation
For example, the equity compensation of the professional platform, LinkedIn, increased from $319.3 million in 2014 to $510.3 million in 2015, showcasing a revenue of over 17%. The company's restricted stock units comprised of $460 million of the total share amount.
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