Understanding Stock Splits: A Guide for Employees with Equity Compensation

Stock splits are a corporate action where a company divides its existing shares into a larger number of shares. Think of it like cutting a pizza into more slices – you still have the same amount of pizza (the company's total value), but it's distributed across more pieces.

Key Concepts:

• The Core Idea: A stock split doesn't change the overall value of the company or your proportional ownership. It simply changes the number of shares outstanding and, consequently, the price per share.

• Proportionality is Key: Everyone holding shares of the company receives the same proportion of new shares relative to their existing holdings. If you own 100 shares before a 2-for-1 split, you'll own 200 shares afterward.

• Price Adjustment: Because the same overall value is now divided across more shares, the price per share is reduced proportionally. In a 2-for-1 split, the price is roughly halved.

Why Do Companies Do Stock Splits?

There are several reasons why a company might decide to split its stock:

1. Increase Affordability and Attract More Investors:

   • Example: A company's stock has soared to $1,000 per share. This high price may deter individual investors with smaller budgets. A 5-for-1 split would bring the price down to around $200 per share, making it more accessible to a wider range of investors.

   • Impact on Employees: This can lead to increased trading volume and potentially greater liquidity of your shares when you eventually sell them.

2. Boost Trading Volume and Liquidity:

   • Example: When shares are priced very high, they tend to have lower trading volumes. Lowering the price can encourage more frequent buying and selling, making the market more liquid.

   • Impact on Employees: Higher trading volume can make it easier and faster for you to sell your shares when you choose to.

3. Psychological Effect:

   • Example: A lower price may appear more appealing to some investors, even though the underlying value is unchanged.

   • Impact on Employees: This perceived increase in attractiveness could potentially boost the company's overall stock price, although this isn't guaranteed.

4. Avoid Looking "Expensive":

   • Example: A very high stock price can sometimes be interpreted as "too expensive," even for companies with excellent fundamentals.

   • Impact on Employees: Again, this can help maintain or boost overall company value.

Common Stock Split Ratios:

Stock splits are often expressed as ratios. Here are some common examples:

• 2-for-1 Split: For every 1 share you own, you receive 1 additional share.

• 3-for-1 Split: For every 1 share you own, you receive 2 additional shares.

• 5-for-1 Split: For every 1 share you own, you receive 4 additional shares.

How Stock Splits Affect Your Equity Compensation:

Now, let's get to the important part: how stock splits affect your various equity grants:

1. Stock Options:

   • Impact: The number of stock options you own will increase proportionally with the split. Your exercise price (the price you pay to buy the stock) will be reduced proportionally.

   • Example: You hold 100 options at an exercise price of $50. After a 2-for-1 split, you'll have 200 options at an exercise price of $25.

   • Key Takeaway: Your overall economic potential from the options remains the same – a split doesn't change how much you stand to gain.

2. Restricted Stock Units (RSUs):

   • Impact: The number of RSUs you own will increase proportionally with the split. You don't pay to acquire them (they vest over time), so there's no exercise price to adjust.

   • Example: You have 500 unvested RSUs. After a 3-for-1 split, you'll have 1,500 unvested RSUs.

   • Key Takeaway: The value of your RSUs remains the same. You still receive the same total value in company stock when they vest.

3. Employee Stock Purchase Plans (ESPP):

   • Impact: The impact on an ESPP depends on its specifics, but generally, the number of shares you can purchase will increase proportionally. The purchase price per share will decrease proportionally.

   • Example: If you purchase shares under an ESPP at a 15% discount and a 2-for-1 split occurs, you will be able to purchase twice as many shares at half of the adjusted price.

   • Key Takeaway: Just like with other equity, the total value of your ESPP potential doesn't change.

Example Scenario:

Let's say you have:

• 100 stock options with an exercise price of $100

• 200 RSUs that haven't vested yet

• The company announces a 4-for-1 stock split.

After the Split:

• Stock Options: You will now have 400 stock options with an adjusted exercise price of $25
  

• RSUs: You will now have 800 RSUs
  

• Total Value: Your overall value has not changed - just the distribution among more shares.

Important Notes for Employees:

• Read the Fine Print: Your equity grant documents should outline how stock splits are handled. Familiarize yourself with these details.

• Consult a Financial Advisor: If you have questions about how stock splits affect your specific situation, seek professional advice.

• Don't Panic or Get Overly Excited: Stock splits are a common occurrence. Don't make rash decisions based solely on the split. Focus on the long-term potential of your company.

• Monitor Your Brokerage Account: Your brokerage account should automatically reflect the split. If it doesn't, contact your broker.

Stock splits are essentially a "cosmetic" change that does not directly alter the underlying value of your equity compensation. They can be a positive signal, making the stock more accessible and potentially boosting trading volume. However, employees should understand that their proportional ownership and the total value of their equity remain the same. By understanding the mechanics of stock splits and how they affect your grants, you can make informed decisions about your equity compensation and continue to benefit from your company's growth. Don't hesitate to ask your HR department or consult with a financial advisor if you have any concerns or questions.