The Real Cost of Free Shares: Why Stock Compensation Is Distorting Your Clients’ Books
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While “Big Tech“ companies like Netflix, Google, and Facebook report big earnings, there's a hidden cost buried in their books: stock-based employee pay. And the way it's reported could be hiding the real impact on shareholders. In short, these companies often rewards staff with stock options instead of high salaries. It keeps employees happy and cash flow strong. But under U.S. accounting rules (GAAP), the cost of these stock options is only recorded based on their estimated value at the time they are granted.
That sounds fair until you do the math. Take Netflix in 2019: employees exercised over 2.2 million stock options. The real market value of those shares was around $708 million. But the amount recorded in the income statement as compensation expense? Just $36 million. It resulted in a $672 million gap between what shareholders effectively gave up and what was shown in the books.
Impact on the Financial Statements
Using the Netflix case and the information above we can summarise the impact as follows:
Income Statement - Statement of
Only the fair value of the options at the grant date is expensed. For Netflix, this meant just $36 million in compensation expense for options that ultimately cost $708 million in shareholder value. The result? Significantly overstated profits. Investors may think the company is more efficient and profitable than it really is.
Cash Flow Statement
Because stock-based compensation is non-cash, it’s added back in operating cash flow. But Netflix didn’t buy shares from the open market to fulfil these stock options, it issued new shares. This dilutes existing shareholders without showing a real cash outflow, creating a misleading picture of cash efficiency.
Balance Sheet - Statement of Financial Position
The equity dilution doesn’t appear as a liability. In Netflix's case, issuing new shares to employees diluted the ownership pool but left no trace of this real cost on the balance sheet. This can inflate retained earnings and make the company appear financially healthier than it is.
What About IFRS?
IFRS 2: Share-based Payment, provides for similar manner of accounting in that equity-settled share-based payments are also measured at the fair value at grant date, not at exercise. However, IFRS places stronger emphasis on detailed disclosures, which include:
The nature and terms of share-based arrangements
The number and weighted average exercise prices of outstanding options
A reconciliation of outstanding options at the beginning and end of the period
The total expense recognised for the period, split into components.
Despite these detailed disclosures, the same fundamental limitation remains: the true cost to shareholders at the time of exercise is not reflected in the income statement. Like GAAP, IFRS captures only the estimated fair value upfront, not the actual dilution cost when shares are issued.
This means that even IFRS-compliant financials can understate the economic impact of stock-based pay, particularly in high-growth companies issuing large volumes of options.
Why This is Important
If you're advising clients on valuations, earnings, or investment decisions, understanding how stock-based compensation is reported (or under-reported) is key. Especially when dealing with fast-growing, equity-heavy tech firms. Ignoring this can lead to:
Overstated profits
Misleading earnings-per-share (EPS)
Underestimated cost of employee retention.
Bottom line
Always read the footnotes. The real cost of stock-based pay could be far higher than what’s reported in profit and loss, and that can distort every key financial metric.
Source article: Forbes
