Also known as restricted securities, restricted stock refers to unregistered shares, the ownership of which cannot be transferred until some conditions are fulfilled. These are commonly awarded to corporate affiliates such as executives and directors. Usually, the conditions include continuous employment for a predefined period, the fulfilment of pre-set performance objectives and earning per share (EPS) goals.
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Features of Restricted Stock
Following are the key features of restricted securities –
- Restricted stocks are commonly awarded to employees in reputed and established companies to keep them motivated.
- These shares have their own vested date and milestone. Some conditions have to be met before the actual transfer of ownership of such shares take place.
- Conditions are attached to these shares to avoid untimely selling which might be troublesome for the company.
- The issue of restricted shares is the most common form of employee compensation in specific corporations.
Restricted stock is often issued to directors and senior executives following important corporate events or mergers. Occasionally, these shares might become unrestricted if another corporation acquires a company, and the executive is laid off in the process.
Types of Restricted Stock
There are two variations of restricted stocks, and they are as follows –
- Restricted stock unit
Restricted stock unit or RSU is a promise made to an employee by the company to grant them shares at a predetermined future date. Holders of RSUs do not enjoy voting rights as these are not actual stocks. An employee must exercise RSUs to get the right to these stocks.
- Restricted stocks award
Restricted stock awards mostly share similar features with RSUs. A company usually issues these stocks to the employees as a reward. Employees who are granted such stocks are able to enjoy voting rights with immediate effect. Unlike RSUs, The cash value of restricted stock awards cannot be redeemed by the employees.
Employee stock options are a type of incentive compensation which gives an employee the right to purchase shares of the company at a predetermined price within a specific timeframe. Unlike restricted securities, these are mostly issued in start-up companies rather than well-established corporations to keep their employees motivated.
Difference between Restricted Stock and Stock Options
The differences between restricted shares and stock options are given below –
|Point of Difference||Restricted Stock||Stock Options|
|Value||These stocks are a form of employee compensation and thus possess some value, unlike stock options.||When the market price of a stock is below the strike price during the exercise period, it becomes worthless.|
|Tax treatment||Restricted stocks are taxed once the ownership is transferred to the employee. The taxable value depends on the market price of a stock.||Employee stock options are of two types, and they are taxed differently.|
|Motivating tool||When employees are awarded restricted stocks, they become motivated to achieve long term goals set by the company.||Stock options make the employees focus more on short term goals that can increase the market price of the stock for short term gains.|
Advantages of Restricted Stocks
Here are some of the advantages of restricted stocks –
- Provides motivation: Usually, companies grant restricted stock to an employee, but the ownership of such stock is transferred only after the fulfilment of certain performance-related targets. Hence, these serve as an effective motivating tool. This proves to be equally beneficial for companies as the ownership will be transferred only after successful completion of the predetermined objectives.
- Voting rights and dividends: After the conclusion of the vesting period, restricted shares become regular shares. Hence, employees can be entitled to dividends and also enjoy voting rights. But, this is only possible if the issuing company chooses to do so.
- Better than stock options: Stock options require significantly more number of shares to offer benefits that are at par with restricted stocks.
- Absolute value: Restricted stock retains its value even if the market price falls or doesn’t move after the date of grant. Hence, these do not pose much risk.
Disadvantages of Restricted Stocks
Some of the demerits of restricted securities are given below –
- Excess tax: Employees may be required to pay additional taxes even if the market price of the stock falls.
- Issuance of fewer shares: In contrast to stock options, they possess absolute value. Hence companies choose to issue fewer shares.
- Payment of taxes: All employees need to pay off the outstanding tax at the time of exercise. There’s no option of deferral until sale.
- Vesting requirements: Employees are not entitled to the immediate possession of the stock; certain vesting conditions need to be fulfilled first.
Both restricted stock and restricted options serve as extremely useful forms of compensation for employees. The circumstances surrounding both the company and employee should be taken into account when deciding which is better.