Stock Options Vs. RSUs

Companies often offer their executive team stock options and RSUs as part of the compensation package.

Executive man and woman on a downtown roof image by Scott Griessel from Fotolia.com

How to motivate employees is a key concern for businesses. There is, of course, the time-honored enticement of higher salaries for performance superior to those of other employees. The drawback is that offering higher salaries increases the direct cost of doing business because it increases payroll costs. Another way companies motivate employees is to offer stock options and restricted stock units (or RSUs), thereby giving employees a direct stake in the company’s fortunes.

Payment in Stocks

As an alternative form of payment, some companies offer employees the option of owning stock in the company. The better the company performs, the higher the price of its stock and the better off financially are its employees. Offering stock to employees can motivate them to perform better, benefiting the company and its employees. On the other hand, there is a downside for employees in that there is no guarantee that the company will show positive performance. If a company underperforms, the share price may well go down and employees who opted to receive stock as a form of payment may do worse than those who opted for higher pay.

Stock Options

With stock options, you can buy company stock in the future at the price that was current when you received the stock option. For example, if your company gave you a stock option last year when the price was $100 per share and the price is currently $300 per share, you would pay only $100 per share to purchase the stock. Employers typically require that you continue to work for the company for a significant period before you are eligible to exercise your options. The expectation is that the stock price will increase so that you can earn the difference between the prices. Alternatively, you can hold on to the shares if you believe the stock price will continue to increase. But if you don’t exercise your option before a predetermined future date, your stock options may expire. Similarly, if you leave the company before exercising your stock options, you will likely lose your rights to them.

Restricted Stock Units

Restricted stock units are another form of compensation that may involve the transfer of stocks. Companies, particularly start-ups, often offer executives a percentage of their salaries in RSUs, often as an incentive for increasing the company's stock value. The employer grants the stock to you at no cost or very little cost, sometimes as low as a penny per share. With an RSU, your employer promises to pay you with shares or the cash value of the shares if you meet certain conditions, often including a vesting period with the company. RSUs are valued through the number of shares within the unit and the stock price at the time of the grant. They also come with a required holding time, and often you must meet certain performance goals. As with stock options, you may forfeit your right to exercise an RSU if you leave the company.

Comparison

The main difference between an RSU and a stock option is that the former may result in a direct cash outlay, whereas, in the latter case, you get shares. Of course, if you have a stock option you can choose to turn the stock into cash when you receive the option. If you have an RSU, depending on the agreement, you may not be able to receive stock, as the company may restrict you to receiving cash. The choice between receiving money or stocks may belong only to your company. While you may not have to pay out any money for an RSU grant, you'll need to pay income tax on its fair market value. Since you are restricted from selling the RSU stock for a certain period, you may wish for the stock option, which requires no income tax until you sell.

Photo Credits

  • Executive man and woman on a downtown roof image by Scott Griessel from Fotolia.com

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