An equity-settled award is measured once, at grant-date fair value, and that measurement is never revisited. The number of awards expected to vest gets trued up, but the price does not. Whatever happens to the share price afterwards, the total charge is fixed on day one.
How is a cash-settled award expensed?
A cash-settled award works the opposite way. A stock appreciation right pays the holder the increase in the share price above a strike, in cash. Phantom stock pays the value of a notional share. Neither delivers equity, so neither creates equity. What it creates is a liability, and a liability is remeasured to fair value at every reporting date until it is settled, with every remeasurement running through profit or loss.
The cumulative expense at any date is therefore the current fair value of the award times the fraction of the vesting period elapsed, and the period's expense is whatever makes the liability correct. In effect, it's a mark to market on the company's own share price, booked inside employee costs.
Advertisement
Worked example: cash-settled vs equity-settled awards
Blue Ridge Analytics granted 200,000 units of each design on the same day, at the same $40 strike, with the same three-year cliff. The option's grant-date fair value was $12.00, so the equity-settled charge is $800,000 a year for three years, and only a change in the number expected to vest could move it. The rights are remeasured.
| Year | Share price | Fair value per unit | Liability | Cash-settled expense | Equity-settled expense |
|---|---|---|---|---|---|
| 1 | $52.00 | $15.00 | $1,000,000 | $1,000,000 | $800,000 |
| 2 | $44.00 | $9.00 | $1,200,000 | $200,000 | $800,000 |
| 3 | $62.00 | $22.00 | $4,400,000 | $3,200,000 | $800,000 |
Year three's charge is sixteen times year two's and four times the equity-settled charge beside it, on awards granted the same morning to the same people for the same work. The driver is a share price that rose from $44.00 to $62.00, which is good news for owners arriving as an expense.
At settlement the arithmetic closes. Blue Ridge settles in year four at a share price of $71.00, paying intrinsic value of $31.00 a unit, or $6,200,000 in cash, with a final remeasurement charge of $1,800,000. Cumulative expense across all four years is $6,200,000, the same as the cash paid. For a cash-settled award the lifetime charge always equals the settlement cash, and that's the check to run on any liability roll-forward you're handed.
The comparison with the equity-settled twin is the part to carry. That award cost $2,400,000 of expense in total, brought $8,000,000 of cash in when the options were exercised, and delivered 200,000 new shares. On a $55.00 average price, and ignoring unrecognised compensation cost, the treasury-stock method treats $8,000,000 of assumed proceeds as buying back 145,455 shares, so 54,545 incremental shares join the diluted count. The cash-settled award produced $6,200,000 of expense against the other design's $2,400,000, took $6,200,000 out of the door instead of bringing $8,000,000 in, and diluted nobody. A $14,200,000 cash swing, and it is invisible in any comparison that stops at reported earnings.
Practical notes on settlement choices and net settlement
Three practical notes. Awards with a choice of settlement are compound instruments, and the accounting depends on who holds the choice, so read the plan document and not just the headline. Many Indian and American plans net-settle for tax, withholding shares to fund the employee's tax liability, and under both rulebooks that feature does not by itself make the award cash-settled as long as the withholding stays within the maximum statutory rate. The shares withheld are treated as a repurchase and never as a liability. And a cash-settled plan is popular for the very reason it's expensive to report. It rewards employees without diluting a promoter's stake, which is a governance fact worth knowing before you read the expense line as carelessness.