Equity comp induces a desirable correlation between stock price and employee retention
The primary reason for big, public tech companies (ie: Apple, Google, Facebook, Amazon, etc.) to offer equity-based compensation packages is that it induces a desirable correlation between stock price and employee retention.
A lot of this is in the upside: if the stock price grows tremendously, employees will become incredibly unlikely to leave.
Consider for example, a senior SWE joining Apple in early 2019, getting an offer of 300k, at a 50-50 cash-RSU split. The stock then triples by early 2021, doubling the employee’s pay to 600k, at no cost to Apple.
Now the employee will have an incredibly hard time leaving Apple, unless they’re willing to take a paycut, as competing employers are unlikely to match this appreciated pay. Additionally, stock price growth implies revenue growth and the associated desire for future headcount growth. The company has an extra strong desire to hire and also keep around older employees to help provide the scaffolding of institutional knowledge for new hires.
In the opposite case, with say, Snapchat stock falling 10x from mid 2021 to mid 2022, employees are particularly likely to leave due to the effective drop in pay, and this is desirable. Cutting pay is hard, and so are layoffs, but Snap gets an automatic force encouraging elective downsizing, where they can offer bonuses to the select employees they really care about retaining.
The flip side: equity comp is a free* long horizon option
Let’s look at the same effect, but from an employee’s perspective.
Should a rational employee prefer 150k in cash + 150k in stock over 300k in cash? Yes - they should, since equity comp is a free call option on the company’s stock. There are three key assumptions here: a) the company is publicly traded, b) they can choose to not exercise the option by finding a new job paying them a comparable amount of money, c) they’re willing to switch companies or not based on how the option performs.
If Snapchat stock goes down, they can choose to not exercise (ie: leave), and if Apple stock goes up they can exercise (ie: stay).
Ben Kuhn has a good post on this in the context of early stage startups. He estimates startup equity as worth 30-100% more than face value, due to the fact that the employer commits to continue to sell equity if the employee stays, but the employee has the option to stop buying it by leaving. For big companies, this is weaker, since they have less volatility, and the volatility between various big tech companies is more correlated. Yet, I still think this exists, and can somewhat motivate a rational employee to prefer stock.
CMM & other reasons
The above is my best thesis as to why publicly traded tech companies use stock-based compensation. But, it’s theoretical and not supported by data. Change my mind.
Here are some other commonly cited reasons. They may be true, but focus more on other aspects of employee relations, instead of viewing employees as rational counterparties.
- Stock-based compensation aligns incentives
I buy this for C-suite executives, but not as much for lowly engineers. An individual employee has minimal impact on the stock price, and ought to know this. I don’t think employees work harder due to stock-based compensation.
- Stock-based compensation is one component of fostering company belonging
The company believe that it’s able to foster a strong sense of belonging, almost akin to patriotism. Employees wholeheartedly believe in the mission and that the company is a force for good in the world. Equity compensation says give yourself to us wholly, and if we succeed you’ll be very well off.
I kinda buy that this works - but unless it’s coupled with strong short-term equity growth, I don’t see why this works on employees if they’re rational actors. But maybe they’re not!. This feels particularly weak in the modern world that’s more short-term and tech-cynical (see: the weekly “Google is no longer Googly” post.
- Stock-based compensation helps with liquidity
It’s cheaper for a company to give stock-based compensation in situations where its hard to access capital. But, it’s not really relevant here since big tech is flush with cash.
- Stock-based compensation successfully leverages employee irrationalities
Employees have seen people get rich by holding onto stock, they’ve done the math of “If I invested $1,000 in Apple in 1990 I wouldn’t need to work right now”. The company knows that enough employees will be sufficiently irrationally motivated by stock to save them X% on employee compensation. So, the employer plays into this story and reaps the benefits.