Stock dilution occurs when a company issues additional shares of restricted stock. Dilution results in changes to factors such as share price, ownership percentage, earnings per share and company voting rights. Determining the point at which employee stocks dilute the overall stock pool depends upon the type of employee stock in question. Dilution as a result of employee stocks may occur upon granting, exercising or vesting.
Stock Options Dilution
Employers provide employees the opportunity to purchase company stock with stock options. When a company grants stock options, it reserves a certain number of stocks for a set period. Employees can purchase, or exercise, these stocks between vesting and expiration if they choose. Vesting constitutes the point at which an employee may purchase granted stock options. Dilution with stock options occurs upon exercising because previous to exercising, no one owns these shares. Ownership and share value dynamics only change when new owners enter the fray.
Restricted Stock Dilution
Restricted stocks constitute a form of bonus. When granting restricted stock, employers promise to provide a certain number of shares to an employee as a gift at a set future date. The delivery of the stock occurs at vesting. Unlike stock options, employees need not purchase restricted stocks. Dilution occurs with restricted stocks upon granting. When employers grant restricted shares, those shares technically belong to the employee, even though employees can only access them upon vesting. Therefore, the employee owns these stocks, and becomes part owner of the company, upon granting, thus causing dilution.
Dilution only occurs occasionally with phantom stocks. Phantom stocks comprise a promise, like restricted stocks. Employers pledge to pay a bonus equal to a certain number of shares at a future date. Usually, the company simply pays this value as a cash bonus -- in such cases, the shares providing the value of phantom stock bonuses never exist, hence the name. However, as in the case of Duke Energy pointed out by CNN Money, phantom stocks sometimes convert to real stocks upon vesting. When this happens, dilution occurs upon vesting.
Restricted vs. Options Dilution
Writing on the website of law firm Morgan Miller Blair, attorney Steven R. Harmon asserts that restricted stock causes less dilution than stock options. This occurs because companies must issue more shares when creating options than when creating restricted stocks of equal value. Due to this fact, Harmon argues that restricted stock proves more attractive to companies by helping maintain a higher per-share price and return average.
- McDonough School of Business Georgetown; Dilution in Employee Stock Option Value; James N Bodurtha; 2002
- National Center for Employee Ownership: Stock Options, Restricted Stock, Phantom Stock
- CNN Money; Phantom Stock May Be the Next Big Thing; David Ellis; 2010
- Morgan Miller Blain; Compensating Employees with Restricted Stock; Steven R Harmon; 2003
- “Wiley Guide to Fair Value Under IFRS”; James P Catty; 2010
- My Stock Options; Restricted Stock and Restricted Stock Units; Bruce Brumberg
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