How equity-settled stock-based compensation should be reflected in free cash flow analysis remains the subject of ongoing debate. There are two distinct questions: whether an effective cash cost exists when no shares are repurchased to offset dilution, and whether that cost should be measured at grant date or vesting date.
Both questions have direct implications for free cash flow, DCF valuation and comparisons between companies with different repurchase policies. We have previously argued that an effective operating cash outflow should be recognised at grant date. In this article we address the arguments raised against that view.
We have explained in earlier articles why the value of equity granted to employees represents a valid operating expense, and why it should also be treated as an effective operating cash outflow in free cash flow calculations, even though no cash changes hands – most recently in ‘AI Hyperscalers: Capital expenditure and free cash flow’. In essence, we argue that a non-cash grant of equity to employees should be regarded as an (effective) employee compensation operating cash outflow, offset by an (effective) financing cash inflow. We think that the effective operating cash outflow should be included in free cash flow measures.
Our focus in this article is on two specific challenges to our approach: whether any effective cash cost exists in the absence of an offsetting share repurchase, and whether grant date or vesting date is the appropriate measurement point.
Is there a cash cost without a buyback?
Some recent commentary1For example, these articles in the Wall Street Journal and Harvard Business Review. has argued that the cash flow impact of SBC depends on whether the company repurchases shares to offset the dilutive effect of grants. Under this view, the cost to shareholders is either the cash spent on repurchases (if dilution is offset) or the dilution itself (if not). Where no repurchase takes place there is, according to this view, no cash cost to include in free cash flow – and, in some versions of this argument, no basis for an expense in profit and loss either.
The logic behind this view rests on treating the SBC cost as taking one of two forms: either explicit cash from buybacks that eliminates dilution, or the dilution that remains because no cash was spent. Since the two are presented as alternatives, recognising both an expense and a dilution is characterised as double counting.
Recognising expense and dilution together is not double counting
This argument was addressed extensively during the original development of IFRS 2 and its US GAAP equivalent, and we find it no more persuasive today. The error lies in treating the operating and financing effects of SBC as mutually exclusive, when in fact they are not.
Every operating transaction produces two effects: an operating cost and a financing consequence. When a company pays employees in cash, the expense is clear and the financing consequence is reduced cash or increased debt, affecting future interest expense. Both effects are captured in financial analysis without any suggestion of double counting. SBC is no different. The operating effect is the value transferred to employees at grant. The financing consequence is either dilution that remains (if no buyback occurs) or the explicit cash cost of eliminating that dilution (if a buyback does occur). Either way, both effects are present, and neither cancels the other.
A comparison illustrates this point. Suppose a company pays employees $80 in cash and grants them equity worth $20, with no share repurchase. Compare this with a company that pays employees $100 in cash and requires them to use $20 to purchase newly issued shares. Economically these transactions are identical, and in both cases the total employment cost is $100. In the second, it is evident that the share issuance is a separate, financing transaction and has no bearing on the measurement of the employment cost. The same logic must apply to the first. The $20 equity grant is an employment cost – not dilution instead of a cost, but an employment cost that produces dilution as its financing consequence.
If the “no cost without buyback” argument is accepted, companies would have a perverse incentive to avoid share repurchases in order to avoid recognising an SBC expense. Large technology companies, which typically grant significant equity compensation, would report substantially higher free cash flow simply by electing not to repurchase – not because their compensation costs had fallen, but because they had chosen to leave the dilution in place. This cannot be the right basis for free cash flow analysis.
Buyback policy should not affect free cash flow
A comparison of Meta and Amazon illustrates why the alternative view creates a serious analytical problem.
Meta repurchases shares at or around vesting date. In 2025, the grant-date SBC expense was approximately $20.4bn, while the actual cash cost of repurchasing shares to offset dilution was approximately $44.6bn – the difference reflecting the increase in Meta’s share price between the original grants and the subsequent repurchases. Amazon, by contrast, does not repurchase shares to offset its SBC dilution at all. A company that conducted buybacks closer to grant date would incur a different cash cost again.
Free cash flow should not vary with repurchase timing
Under the “actual cash cost only” view, these companies would report very different free cash flow effects from economically similar compensation arrangements. Meta’s free cash flow would reflect the $44.6bn vesting-date repurchase cost, Amazon’s would show no SBC-related cash outflow at all, and a company buying back at grant date would show a cost closer to $20.4bn. These differences would be driven not by the cost of compensating employees, but entirely by corporate treasury decisions about repurchase timing – decisions that are, in principle, value-neutral for the shareholder base as a whole2Buying shares in the market at the current market price is value neutral in that the consideration paid equals the value of the shares. Of course, if the share price differs from fundamental value, then there can be an apparent gain/loss for the group exiting their holdings and an equivalent loss/gain for the other equity investors. Nevertheless, for the ‘shareholder base as a whole’ the transaction is still value-neutral.. Free cash flow that varies systematically with repurchase timing complicates DCF valuation and is not a reliable basis for cross-company comparison.
Under the effective cash flow approach we advocate, the operating cost of SBC is recognised at the point value is transferred – at grant – and is consistent across companies regardless of subsequent repurchase decisions. For Meta, the relevant effective cash outflow is $20.4bn, not $44.6bn. The additional $24.2bn reflects a financing decision to delay repurchases, which resulted in buying back shares at a significantly higher price than the grant-date value. This is a consequence of trading in own shares at a timing disadvantage, not an incremental employment cost.
In practice, the SBC expense reported in profit and loss is recognised through amortisation over the vesting period rather than in full at grant. This means the reported figure in any given year reflects a blend of current and prior-year grants being amortised at their respective grant-date fair values, which will not exactly match the grant-date value of all new grants in that year alone. The profit and loss expense is also complicated by being trued-up to reflect actual rather than expected forfeitures. However, for practical purposes, using the reported SBC expense as a proxy for the effective cash outflow is a reasonable approach, and it is what we recommend in most circumstances3We think that the correct ‘effective’ cash flow to include in adjusted operating cash flow and in free cash flow metrics should be the grant-date value (after allowing for expected forfeits) of SBC granted in a period. However, because this figure is not separately disclosed, and because estimating it is challenging, we think the best approach is generally to use the reported expense for the period as a proxy. There is more explanation about this in our article ‘Forecasting sticky stock-based compensation’..
SBC in the Meta cash flow statement
Below is an extract from the Meta 2025 cash flow statement showing the operating and financing sections only.
Meta 2025 cash flow statement extracts
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Meta 2025 10k
The $20.4bn profit and loss expense in 2025 is added back in the operating cash flow section because it does not actually involve cash payments. Our approach is to augment cash flows with an effective operating cash outflow of the same $20.4bn, offset by an effective financing cash inflow for the issue of shares to employees. Employees have, in effect, purchased equity in Meta by providing employment services rather than an actual cash investment. Omitting this important non-cash transaction from cash flow analysis, we argue, leads to an incomplete result.
In the financing section, the cash payment to offset the dilution totals $44.6bn, made up of two amounts – $18.4bn and $26.2bn. The actual cost of repurchasing shares to offset those issued to employees4We assume all share repurchases by Meta relate to offsetting SBC dilution. Clearly this may not be the case and there is no requirement to disaggregate share repurchases. is $26.2bn. However, employees only receive a portion of the shares allocated to them because of withholding taxes (net settlement). To the extent income tax is due, companies usually sell the remaining shares granted and use the proceeds to settle income tax due on behalf of employees. Meta instead chooses to pay those taxes in cash, resulting in the outflow of $18.4bn. However, this does not alter our analysis. In substance, Meta is repurchasing the full number of shares granted to employees to fully offset dilution, it is just that this partly shows up as a tax paid amount. The presentation of this tax in the financing section by Meta is consistent with the underlying substance of the transaction.
Grant date or vesting date?
If the effective cash cost of SBC should be recognised in free cash flow metrics irrespective of whether buybacks occur (as we believe), the measurement question follows directly. Should the effective cash outflow reflect the fair value of equity at the date of grant, or the value that employees ultimately receive at vesting?
This was among the most contested questions in the original standard-setting debate. Both the IASB and FASB considered the vesting-date approach seriously, and it attracted significant support – including from the CFA Institute, which expressed a preference for vesting-date measurement in its response to the original proposals. Both standards ultimately adopted grant-date measurement, but the debate was genuine, and the arguments on both sides remain worth examining.
The case for grant date measurement
Under the grant-date approach, the SBC expense – and the corresponding effective cash outflow – is measured at the fair value of equity at the time of grant, adjusted for expected forfeitures. The rationale is that employees receive something of value at grant: from that date they are exposed to the equity risks and returns of the business, in much the same way as any other investor. Any change in value between grant and vesting accrues to them in their capacity as equity holders, not as employees providing services. The subsequent value change is therefore not an employment cost.
Under this framework, if RSUs with a grant-date value of $100 are worth $150 at vesting, the employment cost is $100. The additional $50 is a return on equity shared between the employee and other shareholders – not incremental compensation. Including it in the employment cost would, in effect, put a portion of the company’s own share price movement through the operating cost base, an outcome that is difficult to justify conceptually and that creates a problematic link between remuneration expense and market performance.
Grant-date fair value captures option time value automatically
For options, the grant-date approach carries a further practical advantage that we think is analytically significant. Fair value at grant – typically estimated using a model such as Black-Scholes – automatically captures the time value and asymmetric payoff structure of the instrument. An option holder benefits from appreciation above the exercise price but is not exposed to equivalent downside; this optionality has a quantifiable value that is fully embedded in the grant-date estimate.
Under a vesting-date approach, this time value would need to be handled differently in a forward-looking valuation model. By the point of vesting, an option has either moved into the money or lapsed worthless; the time value that existed throughout the holding period has been absorbed into intrinsic value or extinguished. Estimating the future employment cost of options under a vesting-date framework would therefore require either a range of share price scenarios or probability-weighted expected outcomes. This would introduce complexity that the grant-date method avoids entirely through a single fair value calculation at grant. This is especially relevant for free cash flow forecasts used in DCF valuation, where scenario analysis across options with different terms and exercise prices would introduce additional uncertainty that the grant-date approach avoids entirely.
The case for vesting date measurement
The vesting-date approach holds that the true cost of SBC is what employees actually receive. Only at vesting can employees sell their shares or exercise their options; it is also the point at which income tax typically falls due for the employee, and when the corporate tax deduction is usually obtained. There is a coherent argument for measuring the employment cost at the same point as the tax event. The deferred tax asymmetries that arise from grant-date measurement under both IFRS and US GAAP, and the difference in how the two frameworks handle them, illustrate the practical complications this creates; we discuss these in our article ‘Effective tax rates and stock-based compensation’.
The vesting-date approach is also consistent with how cash-settled SBC is already treated, where the liability is remeasured at each reporting date and settled at vesting-date value. Some have argued for consistency between cash and equity-settled instruments; the desire for alignment is understandable. However, the economic difference between the two forms is significant. Cash-settled plans create a real obligation that must be discharged in cash; equity-settled plans transfer an ownership interest to employees. We think this distinction is sufficient to justify different treatment, and we would not apply vesting-date measurement to equity-settled SBC solely for the sake of alignment with cash-settled plans.
These are genuine arguments, not errors. The vesting-date approach is a coherent alternative and, applied consistently, can produce equivalent results in valuation analysis. However, in our view, they do not outweigh the conceptual and practical case for grant-date measurement, particularly where options form a material part of compensation.
DCF valuation: Two approaches, same answer
Both a grant-date and a vesting-date framework for measuring the stock-based compensation expense and cash flow effect should produce the same equity value in a DCF model. The choice of measurement date affects the composition of free cash flow forecasts, the treatment of outstanding equity awards in the enterprise-to-equity bridge, and whether and how SBC is reflected in the discount rate – but with appropriate internal consistency, neither approach should arrive at a different conclusion about fundamental value.
Insights for investors
- The effective cash cost of equity-settled SBC should be included in free cash flow regardless of whether the company repurchases shares to offset dilution; a decision not to repurchase does not extinguish the operating cost.
- Using actual share buyback costs as the measure of SBC cash flow makes free cash flow dependent on share repurchase timing rather than the economics of compensation, undermining comparability between otherwise similar companies.
- The grant-date approach to measuring the SBC expense and effective cash flow is, in our view, preferable to the vesting-date alternative, but what matters most is consistent application.
- Where options form a material part of SBC, the grant-date approach has a significant analytical advantage: fair value at grant automatically captures the time value and asymmetric payoff of the option.
- Where companies exclude SBC from non-GAAP performance metrics, investors should restore it; it represents a genuine cost of employee compensation, and its recognition alongside the dilution effect captured in per-share metrics does not constitute double counting.