In this series, we bust the jargon and explain a popular investing term or theme. Here it’s stock-based compensation.
What is this?
SBC stands for stock-based compensation (also known as share-based compensation). Companies wishing to win the loyalty of managers or workers will grant them stock options which can be exchanged for shares at a later date.
SBC is at the centre of controversy amid heightened scrutiny of executive pay after the collapse of lender Silicon Valley Bank, which sparked a global banking panic.
Some tech companies issued options at a time when their shares were soaring. Subsequently, however, their shares have fallen, meaning that SBC options are worth much less. This was the case, for example, at payments group Stripe which raised money last month to tackle the problem.
Meanwhile, some other companies have awarded workers their option packages at its original much higher value.
Winning loyalty: SBC stands for stock-based compensation (also known as share-based compensation)
How does that work?
Let’s say the employees were each entitled to receive 5,000 shares at $40 apiece. Instead they receive 20,000 shares at the current price of $10. This increase in the number of shares in issue leads to dilution for other shareholders as their share of the profits and dividends has been reduced.
Which companies favour SBC?
In Silicon Valley, restricted stock unit (RSUs) packages, where the beneficiaries need to meet certain goals, have been key to attracting talent. Often workers are drawn by the pledge that their options will pay out when the company makes its stock market debut. But SBC is not only popular among US tech firms. More established European and UK firms seeking to hire and retain the best people are setting up schemes.
Why not pay larger salaries?
The argument is that SBC aligns the interests of employees and managers with those of shareholders. If bosses and workers have a stake in the value of the company’s shares, they will strive even harder to boost sales and profits. SBC also helps companies to save money since their wage bills are a lot lower. Workers may be in line for bumper rewards in future. But, until that moment arrives, it could be argued that they are subsidising their cash-strapped employer.
Any other issues with SBC?
There is a hullabaloo over some companies’ failure to disclose SBC in their profit or earnings figures. As a form of compensation it should be considered an operating expense, although a number of businesses, like Salesforce, the software giant, do not see it this way.
Leading fund managers aren’t impressed. Warren Buffett of Berkshire Hathaway argues: ‘If options aren’t a form of compensation, what are they? If compensation isn’t an expense, what is it? And if expenses should not go into the calculation of earnings, where in the world should they go?’
Anybody else cross about this?
Terry Smith, manager of Fundsmith, has criticised Intuit, the accounting software group, for excluding SBC from its profits, saying that this practice makes it tricky to compare companies in the same field and is therefore misleading.
Microsoft does not exclude SBC, which is why Smith continues to hold shares in this tech titan and sold out of Intuit.
Private investors who also prefer transparency in accounting will almost certainly take the same view.
