Stock-Based Compensation: Options, RSUs and Expense

Introduction

In its fiscal year to January 2026, Salesforce recognized $3.5 billion of stock-based compensation, equal to 8.5% of its $41.5 billion of revenue and 42% of its $8.3 billion of operating income. A further $6.0 billion of expense, on awards already granted, was still to be recognized over the next four years. Employees held 26 million unvested restricted stock units (RSUs) and 6 million options, and the company spent $12.6 billion that year buying back shares, partly to offset the dilution those awards create.

For many technology and life sciences companies, equity awards are one of the largest costs of the business. The accounting turns them into an expense that looks like any other, spread over the years in which employees earn them, but with no cash leaving the company. How that expense moves through the three statements, including the tax deduction at vesting or exercise and the cash paid for employees' withholding taxes, is traced in stock-based compensation on the three statements. The measurement and spreading of the cost, though, decide how large that expense is in any year, and the disclosures show how much of it is already committed.

Companies use a handful of instruments, often in combination:

Restricted stock unit

A promise to deliver a specified number of shares, or occasionally their cash value, once vesting conditions are met, usually continued employment over several years. Equity-settled RSUs are measured at the grant-date fair value of the shares and expensed over the vesting period; they are the most common form of equity award at large US companies.

Restricted stock units have largely replaced options at large companies: they keep value even if the share price falls, so fewer shares are needed for the same award value. Salesforce still grants both. The tax treatment of each type, including why incentive stock options generally produce no deduction, is covered in the tax effects of stock-based compensation.

Under Accounting Standards Codification (ASC) 718, an equity-classified award is measured once, at its fair value on the grant date, and that amount does not change afterwards however the share price moves. For a restricted stock unit, fair value is essentially the share price on the grant date, reduced if the holder does not receive dividends during vesting. For an option, fair value has to be estimated with a model, most often Black-Scholes, using six inputs: the share price, the exercise price, the expected term, expected volatility, the risk-free interest rate and expected dividends.

Grant-date fair value

The value of an equity award on the date the company and the employee agree its terms, measured under ASC 718 using the share price and, for options, an option pricing model. For equity-classified awards it fixes the total compensation cost to be recognized, which is not remeasured for later changes in the share price.

Salesforce's assumptions for options granted in fiscal 2026 were volatility of 36%, an expected life of 4.2 years and a risk-free rate of 4.0%, giving a weighted-average fair value of $92.06 per option. The assumptions matter: a longer expected life or higher volatility raises the value of each option, and therefore the expense, while the company's estimate of when employees will exercise is based on its own history. Awards with a market condition, such as a target for total shareholder return relative to peers, are valued with a Monte Carlo simulation that builds the probability of hitting the target into the grant-date fair value.

Employee Stock Purchase Plans

Many companies run an employee stock purchase plan (ESPP) that lets employees buy shares through payroll deductions at a discount, often 15%, sometimes with a look-back that sets the price at the lower of the share price at the start and the end of the offering period. Salesforce's plan offers a 15% discount. A plan this generous is compensatory under ASC 718: the discount and the value of the look-back are measured with an option pricing model and expensed over the offering period, which is why the expense line includes ESPP costs alongside RSUs and options.

Why the Expense Does Not Track the Share Price

Because the cost is fixed at grant, the expense in any year reflects the share prices at which past awards were granted, not today's. A company whose shares have doubled since its awards were granted will report an expense far below the value employees actually receive; one whose shares have halved will report an expense above it. The gap reappears at vesting or exercise, when the tax deduction is measured at the share price then, and in dilution, which depends on how many shares the awards turn into. Since Accounting Standards Update (ASU) 2016-09, the tax effect of a deduction above the book expense, an excess tax benefit, and of one below it, a tax deficiency, runs through income tax expense, so a rising share price lowers a company's effective tax rate in the years its awards vest.

The grant-date fair value is recognized over the requisite service period, usually the vesting period. Awards can vest all at once at the end, called cliff vesting, or in instalments, called graded vesting. For graded awards with only a service condition, US generally accepted accounting principles (GAAP) let companies choose between recognizing the cost straight line over the whole period and treating each instalment as a separate award recognized over its own period, which front-loads the expense. Under either method, the cumulative expense must at least equal the value of the portion already vested, as PwC's guide to awards with graded vesting explains.

Consider an award worth $400 at grant that vests 25% a year over four years:

Graded attribution doubles the first-year expense. A company that grants awards every year has many overlapping awards at different stages, so the difference shrinks in steady state, but it matters for a fast-growing company or a large one-time grant, such as a founder award or a retention grant after an acquisition.

Forfeitures

Employees who leave before vesting forfeit their unvested awards, and the expense already recognized on them is reversed. Companies choose an accounting policy: estimate forfeitures up front and recognize expense only for awards expected to vest, adjusting as actual forfeitures differ, or recognize forfeitures as they occur. Salesforce estimates forfeitures from its historical rates. The choice affects timing, not the total, but it makes comparisons across companies slightly less exact.

Performance and Market Conditions

Awards that vest only if targets are met follow two different rules. For a performance condition, such as a revenue or earnings target, the company recognizes expense only if achieving the target is probable, adjusts the expense as its assessment changes, and reverses it if the target is missed. For a market condition, such as a share price or total shareholder return target, the probability of achievement is already built into the grant-date fair value, so the expense is recognized as long as the employee provides the service, even if the target is never met. Salesforce's performance-based units with market conditions are valued with a Monte Carlo model and expensed on a graded basis.

Modifications and Liability Awards

If a company changes an award's terms, for example by repricing underwater options or extending their term, it recognizes the incremental fair value created by the change on top of the original grant-date value. Suppose options granted with a fair value of $30 each are deep underwater and worth $8 just before the company cuts their exercise price, after which they are worth $20. The company keeps recognizing the original $30 over the remaining vesting period and adds the $12 increase, the value transferred to employees by the repricing, either at once for vested options or over the remaining vesting period for unvested ones. Awards that will be settled in cash, such as cash-settled stock appreciation rights, or that employees can require the company to settle in cash, are liabilities instead of equity. They are remeasured at fair value at every reporting date until settlement, so their expense moves with the share price, much like the liability-classified warrants described in warrants: equity or liability classification.

Awards in Acquisitions

When a buyer replaces the target's employee awards with its own, the fair value of the replacement awards is split. The portion attributable to service employees provided before the deal is part of the purchase price, and so adds to the goodwill recorded in the acquisition; the portion attributable to service after the deal is post-combination compensation expense, recognized over the remaining vesting period. Acceleration depends on who decides it: awards that vest automatically on a change of control under their original terms count as fully earned before the deal and stay in the purchase price, while vesting the buyer chooses to accelerate is expensed at once, as PwC's guide to exchanging employee awards in a business combination sets out. Large acquisitions of companies with heavy equity compensation can therefore raise the buyer's stock compensation expense for several years, as covered in acquisitions on the three statements.

The stock compensation note contains most of what an analyst needs. Salesforce's fiscal 2026 annual report discloses:

Burn Rate, Overhang and the Expense Pipeline

From these figures, bankers calculate a few standard measures. The burn rate, awards granted in a year as a share of shares outstanding, was about 1.7% for Salesforce, 16 million units against 950 million weighted-average shares. Overhang, outstanding awards plus shares available for future grant as a share of shares outstanding, shows how much potential dilution is already authorized: Salesforce's 32 million outstanding options and units plus 88 million shares available under its equity plans come to about 13% of its weighted-average share count, before shares reserved for its purchase plan. And unrecognized expense divided by annual expense, about 1.7 years for Salesforce, shows how long the existing pipeline of cost will last before new grants are needed to sustain it.

A high burn rate is not necessarily a problem if buybacks offset it, but it means the company must keep spending cash to hold its share count steady. A large overhang means shareholders have already approved substantial future dilution, which proxy advisers and investors watch closely when companies ask for new share authorizations.

Stock compensation is non-cash in the narrow sense that no cash leaves the company when the expense is recognized. It is not free. Employees accept equity in place of cash salary, and existing shareholders bear the cost through dilution, or through the cash the company spends buying back shares to prevent it. Salesforce's $351 million of payments in fiscal 2026 for employees' taxes on net share settlement is the most direct cash cost: the company kept back shares from vesting awards and paid their value to the tax authorities in cash, so part of each award was settled in cash rather than new shares. That cash is part of the same award value already in the expense, not a cost on top of it. Its buybacks are the largest indirect cost.

The debate over which approach to use, and how to forecast future grants, is covered in the stock-based compensation add-back debate. For comparisons between companies, the ratio of stock compensation to revenue is a useful first measure, and it varies widely by industry: equity awards are a large share of pay at software and internet companies and a small one at most industrial and consumer businesses.

When a model does forecast the dilution, a simple approach converts each year's projected stock compensation expense into new shares at the projected share price. A company expected to expense $500 of stock compensation next year, with shares trading at $50, will issue roughly 10 new shares; if it has 1,000 shares outstanding, that is about 1% dilution a year, which compounds over a long forecast unless buybacks offset it.

Stock Compensation in Credit Agreements

Lenders usually take the opposite view to equity investors. Credit agreements generally define EBITDA to add back non-cash compensation, because the expense does not consume cash that could service debt, and leverage covenants are measured on that basis. For a credit analyst, the relevant cash costs are the taxes paid on net share settlement and any buybacks the company is committed to, both of which compete with debt service for the same cash.

The dilution itself shows up in the share count. Diluted earnings per share includes unvested awards and in-the-money options under the treasury stock method, as covered in earnings per share: basic vs diluted, and the net effect of buybacks against new grants determines whether shares outstanding actually fall, as discussed in share repurchases and treasury stock accounting. Salesforce's weighted-average basic share count fell from 962 million to 950 million in fiscal 2026, after $12.6 billion of buybacks, a reduction of about 1%.

Stock-based compensation sits at the intersection of accounting, tax and capital structure. The accounting measures a cost at the grant date and spreads it over service; the tax system deducts a different amount at vesting; and the shares that result dilute every owner. Bankers who read all three, rather than only the line on the income statement, get the most accurate picture of what employees really cost the shareholders.