The overlooked expense – stock based compensation

The slowing global macro backdrop is feeding through to the performance of a range of businesses.

by Michael Bray

Senior Research Analyst

Understanding Finance

Even the technology sector, which has seen an impressive performance over the past decade, is feeling the effects leading many technology companies to pivot away from a pure sales growth focus towards cost cutting in order to preserve profits. One of the biggest expenses for tech companies has been stock based compensation (SBC). That is the share options which companies give to employees as part of their remuneration package in order to attract talent, in what is a competitive industry.

Tech companies have historically been sneaky in stating that SBC is not an underlying cost for their business and does not impact cash flow, but in reality that is not the case. If a company grants SBC this dilutes existing shareholders by increasing the number of shares. If a company offsets this dilution through share buy-backs then this is a cash outflow from the business, meaning less cash available to shareholders.

When times were good, many investors were willing to overlook the impact of SBC, but this is now changing, with more scrutiny being placed on this expense. The question is how will tech companies respond? Share prices in the sector have fallen substantially over the year meaning share options are now less valuable. As compensation, employees may demand more share options or higher base pay. Companies will however need to balance such demands against investors’ justified concerns; we expect this to be a key theme to watch out for in 2023.

Managing your wealth

Managing your wealth

Understanding Finance

Helping clients understand what we do is key to building relationships. To explain some of the industry jargon that creeps into our world, we’ve pulled together a section of our site to help.

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Winter Issue Forty One