May 23, 2024
Equity Usage: Focus on Stock-Based Compensation Expense
In a report analyzing equity compensation at software companies, Compensia discussed how investors now consider stock-based compensation (SBC) expense as a percentage of revenue as a critical data point (in addition to gross burn rate) to evaluate equity spend and measure the economic cost of equity compensation to the company’s shareholders — even though this contrasts with the common practice of adjusting earnings to exclude the impact of stock-based compensation.
But this new focus presents a difficulty for companies because “unlike burn rate, addressing high SBC/revenue ratios can take time given that a significant portion of stock-based compensation expense reflects that amortization of grants from prior years. Declining revenue growth also makes it difficult to manage SBC/revenue over a short-term time horizon.”
In light of this, Compensia encourages companies to evaluate their equity budgets taking into account gross burn rate and stock-based compensation expense. However, the report says this focus hasn’t carried forward to plan design.
Despite investors’ focus on managing equity usage, our research showed that the vast majority of executive compensation annual incentive plans do not use metrics that account for stock compensation expense.
Among public companies with full disclosure of annual incentive plan performance measurement, 98% do not account for stock-based compensation. They measure either profitability metrics adjusted to exclude stock compensation or measure only growth and/or cash flow.
Programming Note: Our blogs will be off on Monday for the holiday. We wish each of you an enjoyable Memorial Day weekend.
– Meredith Ervine