If I’m understanding correctly, a company at any given time has a fixed number of shares that split the ownership of that company, thus if a CEO is paid with shares someone else must be giving up their shares.
In: Economics
the board can issue more shares,
the share holders vote on the compensation package and if they say yes the board creates more shares and then gives those shares to CEO.
the board can also create shares as a fund rising effort and a few other reasons.
Usually a company has a a bunch of their own stock, otherwise they’ll have to buy them from the market. Another option is to issue new shares, but that’s usually quite excessive.
When a company is setup, various allocations of stock are made. One of those allocations is usually a pool of stocks for incentives for various employees (usually high level). Almost at any time, the company can also issue new stocks which dilute the existing stock values. That has the obvious drawback of lowering the stock price. There’s also many other games that can be played with stock types that is probably way beyond an ELI5 answer.
The short answer is you’re right. Issuing more stocks dilutes the value of current stocks. But, the company may have already set aside (i.e. the company still owns) a set of stock for the purpose of employee incentives.
The company can issue new shares with the approval of the board (and by extension, the approval of the shareholders). This is just like issuing new shares to raise capital.
Yes, this dilutes the shares of the existing shareholders, but this would be the same as if the company paid the CEO out of its bank account, which would decrease the company’s assets by that much and thereby make the company that much less valuable. In other words, either way it’s eating in the value of a share.
So it has to be reasonable, but most of the time the board is convinced that compensation is a worthwhile exchange.
Note this is not unique to CEOs, but the same goes when the company wants to award any employee equity, e.g., granting employees RSUs or ISOs as part of their compensation package.
If a company has 100 shares outstanding and is worth $200, then grants the CEO 1 share of stock compensation, it now has 101 shares outstanding but is still worth $200.
All else equal, the value per share goes from $2 to $1.98.
(the other answers saying the company owns or purchases the shares, or has some set aside are either not ELI5 or blatantly incorrect. The company will get board approval to grant employee stock options from time to time, but until they are issued to employees, they are not owned by the company in any sense… they are just available to be granted. And when the company eventually runs out of these authorized shares, the board will approve a new authorization for more shares)
A company will often own many shares of its own stock for exactly this reason, re: to give to employees as bonuses, sometimes as a sign on bonus, sometimes as a performance bonus. It’s why you hear about companies doing stock buybacks as well when the company has cash reserves.
That’s the thing, it’s created out of nothing. If a company has 10 million shares and they give the CEO a bonus of 500,000 shares the company will either buy 500,000 shares on the open market to give to the CEO or they will just create 500,000 shares and now have 10.5 million shares.
To answer the question what prevents the company from printing money to pay executives, compensation plans need to be approved by the board of directors, and the board of directors can be sued if they are found to not have the shareholders best interest in mind.
Outside the scope of ELI5 but companies either leverage treasury stock or derivatives which would allow them to provide the shares if the stock grant is in the money on vesting date.
> where do those shares come from?
Usually, they dilute the other shares. Everyone else’s shares get less valuable.
If you found a company and have 1 of 3 shares, you can sell it for one-third ownership of the company. If the company compensates the CEO by paying him 50 shares, then you went from owning 33% to owning 1.9%
>a company at any given time has a fixed number of shares that split the ownership of that company
Eh, you used “fixed” and “At any given time”. Places they pay employees with stock don’t have a fixed number of shares. This year there’s a “fixed” number of 3 shares, but next year there will be 53. It’s not really fixed.
Long story short: The finance guys and lawyers will screw you over and steal the company. And this is a progressive better way of doing things that actually gets the CEO to care about the company and do their job.
The bottom line is that in almost all cases a company has not distributed all it’s shares. When a company is set up or funded, there is always pool of shares (maybe even 25% of the company) that is set aside for compensating regular employees and senior execs like CEOs for years to come.
Issuing more shares is a big deal and it doesn’t happen very often. Usually it happens when the company needs a new round of funding. Existing shareholders get screwed so it’s a big deal.
More commonly, if needed companies will do a stock buy back and hold those shares to distribute. But still that’s not super common.
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