Boards and compensation committees typically consider equity plans as part of compensation strategy: how to recruit, retain and align interests with shareholders. Yet their design can create two recurring costs for shareholders: stock-based compensation expense and dilution. For some companies, the potential shareholder value associated with reducing those costs can reach billions, depending on the plan structure and the valuation multiple the market applies.
That makes equity-plan design a fiduciary issue for the board and, specifically, the compensation committee. It raises a fundamental question for the board: Is the company costing its shareholders billions every year with the way it runs its employee equity plans?
Two costs, compounding quietly
Stock-based compensation can be one of the largest operating expenses on an income statement. It recurs, often grows and reduces reported earnings dollar for dollar. Consider a company with $500 million of annual stock-based compensation. At 5 percent annual growth, the expense rises to $525 million in year two and $551.25 million in year three, resulting in a cumulative charge of $1.57625 billion over just three years.
At the same time, when grants are settled with newly issued shares, they reduce the ownership percentage of existing shareholders. Our analysis at Carver Edison indicates that some public companies may carry as much as 6.7 times the dilution necessary to deliver the same grants.
Directors should examine whether the company can deliver the same equity awards with less expense and dilution while preserving grants, headcount and its compensation philosophy. Any unnecessary expense and dilution erode shareholder value.
How millions become billions
The effect is magnified because public companies are valued at a multiple of earnings. One way to estimate the potential shareholder value is to multiply annual stock-based compensation savings by the company’s price-to-earnings ratio.
Here is how that math could work with Cashless Equity™, which we developed at Carver Edison to deliver the same equity value to employees with less expense and dilution. Take a company with $100 million in annual stock-based compensation and a price-to-earnings multiple of 15. An 85 percent reduction in expense would lower the annual SBC to $15 million, allowing up to $85 million to flow to earnings. At 15 times earnings, the market could value that lift at $1.275 billion in the first year. If held flat, the same calculation produces $3.825 billion in shareholder value over three years. This is an illustrative estimate based on publicly available data. It is not financial advice. Outcomes are not guaranteed and vary based on company-specific factors and market conditions.
Yet the scale is precisely why the issue deserves board attention. Applied to some large-cap companies, the same methodology can produce estimates in the hundreds of billions for a single year and trillions over three years. Even if directors apply a substantial haircut to those figures, the potential value at stake is too large to leave unexamined.
The 90-day playbook
During days 1–30, the board should ask management to quantify the loss to shareholders, excess dilution and GAAP impact. During days 31–60, the board should review a business case based on the company’s grant schedule and plan structure. During days 61–90, management should finalize and implement the new structure under board oversight.
The questions for the board are straightforward: How much does the plan reduce reported earnings? How much does it dilute existing shareholders? Can the company provide employees with the same equity value through a different issuance mechanism that results in lower expense and dilution?
Equity plans deserve the same scrutiny as any other recurring cost that affects earnings and ownership. When the same employee award can be delivered with less expense and dilution, continuing to accept the higher cost is a board decision.
Certain statements describe potential outcomes of program design. These outcomes are not guaranteed and depend on company-specific factors, employee participation and market conditions.
