Dilution And Overhang

These are two key concepts related to stock options.
What is Dilution?
Stock options are the common currency of executive compensation, representing over half of total compensation for many top officers. However, every time you give a manager stock, you are taking some ownership away from the existing shareholder, that is, you are diluting the ownership.

How is Dilution Calculated?
Dilution is generally calculated as an annual measure of how much equity has been granted to management during a particular year as a percentage of common shares outstanding. This includes stock options, restricted stock, and any other form of compensation that uses shares. For example, if there were a million shares of stock outstanding, and ten thousand options were issued then the dilution would be 1% (10,000/1,000,000).

The dilution measure captures the "run-rate" of equity incentives (e.g., we are granting 2% of our shareholders equity to management every year, or diluting existing shareholder holdings by 2%).

What is Overhang?
Overhang is generally a more significant measure as it captures the total potential shareholder dilution from employee stock option programs rather than just the annual rate of dilution. To calculate overhang using the simplest definition, add the total employee stock options outstanding to the remaining pool of shares authorized for future employee equity grants and divide that total by the common shares outstanding. For example, if a company has 10,000 options outstanding, 5,000 authorized shares for future grants remaining, and total common stock outstanding of 100,000, then the overhang is (10,000 + 5,000) / 100,000 - or 15%.

Why Does it Matter?
Equity compensation, and stock options in particular, are sometimes talked about as if they are "free money"-the accounting treatment of options in the US encourages this view. However, equity compensation is a cost the shareholders must bear, just like any other means of compensation. Hence, shareholders and the board will watch dilution and overhang very closely.

What HR Needs to Know

Value Transfer that seeks to capture the economic value of share dilution rather than just the percentage of equity granted. Visit www.isstf.com for further assistance in such complex arenas.

The HR industry´s premier online community and resource for Human Resource professionals: HR, human resources, HR community, human resources community, HR best practices, best practices in human resources, online communities for HR, HR articles, HR news, human resources articles, human resources news, HR events, leadership, performance management, staffing and recruitment, benefits, compensation, staffing, recruitment, workforce acquisition, human capital management, HR management, human resources management, HR metrics and measurement, organizational development, executive coaching, HR law, employment law, labor relations, hiring employees, HR outsourcing, human resources outsourcing, training and development
hr.com. human resources management resources for hr professionals. | HR menus | HR events | HR Sitemap