Definition
Restricted stock, also known as restricted securities, are shares granted to employees that are subject to certain restrictions, such as a vesting period or performance milestones. Employees do not own these shares outright until they satisfy the specific conditions.
Key Features of Restricted Stock:
- Vesting Period: A time-based condition where the employee must stay with the company for a predetermined number of years.
- Performance Targets: Conditional ownership based on meeting individual or group performance goals.
- Transfer Restrictions: During the restriction period, the stock cannot be sold or transferred.
- Dividends and Voting Rights: Employees might have the right to dividends and voting rights during the vesting period.
Examples
- Time-Based Vesting: An employee receives 1,000 restricted shares, which vest entirely after five years of continuous employment. If the employee leaves the company before five years, they forfeit the shares.
- Performance-Based Vesting: A manager is awarded 500 restricted shares that vest if the company achieves a 10% growth in revenue over three years. If the target is met, the shares vest; if not, they are forfeited.
Frequently Asked Questions (FAQs)
What happens if an employee leaves the company before restricted stock vests?
If an employee leaves the company before the stock vests, they typically lose the shares. Each company’s policy and the specific terms of the restricted stock grant will dictate the exact rules.
Are restricted stocks taxed?
Restricted stocks are subject to taxation. The taxation event typically occurs when the shares vest, based on their fair market value at that time. Employees may also elect to be taxed at the grant time by filing an 83(b) election with the IRS.
Can restricted stock be sold or transferred?
Restricted stock cannot be sold or transferred until the vesting period or performance targets are met, and any other restrictions are lifted.
Do employees with restricted stock get dividends?
Employees may receive dividends on restricted stock even before it vests, depending on the terms of the equity award agreement.
How does restricted stock differ from stock options?
Restricted stock grants actual shares with restrictions, whereas stock options provide the right to purchase shares at a predetermined price after meeting certain conditions.
Related Terms
- Stock Options: A benefit in which the employee has the option to buy company stock at a future date at a preset price.
- Vesting Period: The time duration an employee must wait to gain access to benefits such as stock or retirement funds.
- Performance Targets: Specific goals that employees must meet to earn bonuses or the vesting of stock and other incentives.
- Share Incentive Scheme: A program designed to grant employees shares or share options as part of their compensation.
Online Resources
- Investopedia: Restricted Stock
- Financial Industry Regulatory Authority (FINRA) on Restricted Securities
Suggested Books for Further Studies
- “Equity Compensation Strategies for Executives and Employees” by Scott A. Fithian
- “Principles of Private Firm Valuation” by Stanley J. Feldman
- “Stock Options & Restricted Stock” by Corey Rosen
Accounting Basics: “Restricted Stock” Fundamentals Quiz
### What is Restricted Stock?
- [ ] Shares that can be freely sold upon grant.
- [x] Shares granted with conditions attached.
- [ ] Shares that are always free from any restrictions.
- [ ] Non-share-based bonuses.
> **Explanation**: Restricted stock refers to shares granted under specific conditions, such as a time-based vesting period or performance targets.
### How long must an employee typically wait for time-based restricted stock to vest?
- [x] A predetermined number of years.
- [ ] Until the end of the fiscal year.
- [ ] Immediately upon grant.
- [ ] There is no waiting period.
> **Explanation**: A vesting period is common, wherein the employee must work for the company for a set number of years to gain full ownership.
### Can restricted stocks be sold immediately after they are granted?
- [x] No, they are subject to restrictions.
- [ ] Yes, if conditions are met.
- [ ] Only if approved by the board.
- [ ] Upon achieving company revenue targets.
> **Explanation**: Restricted stocks cannot be sold immediately as they come with conditions that need to be fulfilled first.
### Who bears the right to dividends with restricted stock?
- [x] The employee, subject to the equity award agreement.
- [ ] Only vested stockholders.
- [ ] The company board.
- [ ] Not applicable to restricted stock.
> **Explanation**: Depending on the equity award agreement, employees might receive dividends on restricted stock even before it vests.
### How is restricted stock taxed?
- [ ] Not taxable.
- [x] Taxable typically when the stock vests.
- [ ] Only during the grant.
- [ ] Tax-exempt entirely.
> **Explanation**: Restricted stock is generally taxed when it vests, based on its fair market value at that time.
### What document, if filed, can allow taxed restricted stock at the time of grant?
- [ ] W-2 Form
- [ ] 1099-MISC
- [x] 83(b) election
- [ ] 1040 Form
> **Explanation**: Filing an 83(b) election allows employees to choose to be taxed at the time the restricted stock is granted rather than when it vests.
### What major distinction exists between restricted stock and stock options?
- [x] Restricted stock involves actual shares; stock options involve the option to buy shares later.
- [ ] Both include only voteless shares.
- [ ] Restricted stock is always performance-based.
- [ ] Stock options are tax-exempt.
> **Explanation**: Restricted stock constitutes actual shares (though with restrictions), while stock options give the right to purchase shares at a predetermined price later.
### What usually happens to unvested restricted stock if an employee leaves a company?
- [x] It is generally forfeited.
- [ ] It accelerates vesting.
- [ ] It is converted into cash.
- [ ] It remains with the employee.
> **Explanation**: Typically, unvested restricted stock is forfeited if an employee leaves the company before fulfilling the vesting requirements.
### In an equity compensation plan, what is a performance target?
- [ ] Expected market value of stock.
- [ ] Rule that defines expiry date of shares.
- [x] Company goals or milestones employees must achieve.
- [ ] Employee year-end bonus.
> **Explanation**: Performance targets are the company goals or milestones employees must meet to have their restricted stock vest.
### How do employees benefit most from the restricted stock?
- [ ] By immediate sale.
- [x] By holding vested shares which appreciate in value.
- [ ] By instant tax exemption.
- [ ] Permanent control over the shareholder company.
> **Explanation**: Employees benefit the most by holding onto the vested shares, especially if the company performs well and the stock appreciates in value.
Thank you for embarking on this journey through our comprehensive accounting lexicon and tackling our challenging sample exam quiz questions. Keep striving for excellence in your financial knowledge!
