Stock compensation faces scrutiny, and the cost-saving method for U.S. tech companies may be reduced by one

Zhitong Finance learned that US tech companies need to prepare to break free from their reliance on stock-based compensation in the new year. Startups, which are cash-strapped but firmly believe that valuations will rise, attract talent by paying salaries in stock; even mature tech giants find it difficult to pay solely in cash. However, by 2025, as scrutiny increases, the momentum to maintain this practice will weaken. The ultra-low interest rates and the post-pandemic period have reinforced this habit. In 2021, about 121 tech companies went public, the last time such a listing boom occurred was before the dot-com bubble. Many companies grew rapidly but were unprofitable; on the surface, it seems attractive to save cash on salaries by using overvalued equity. Given that the BVP Nasdaq Emerging Cloud Index doubled last year—this index tracks the valuations of cloud software companies—stocks appear to be a safe choice for employees. This trend has been led by more mature peers. Morgan Stanley analysts noted that among the companies in the Russell 3000 index, stock compensation grew by about 15% annually from 2006 to 2022, far exceeding the approximately 4% revenue growth during the same period. The $270 billion in compensation accounted for 8% of the total compensation for US publicly traded companies in 2022. This is not just the income of the bosses; 80% of equity compensation flows to those below the executives. The information technology sector has benefited the most from this practice. The motivation to offer generous packages to junior employees will decrease. Tech companies are not poaching all the talent they can find but are cutting costs. According to Forbes data, they have laid off over 500,000 employees since 2022. The leeway that management has with investors will also diminish. After a decade of growth, profitability is now being prioritized. In 2022, as global interest rates rose, the BVP Nasdaq Emerging Cloud Index was halved. The valuation gap between companies exceeding the Rule of 40 and those not meeting it is widening. The Rule of 40 is a metric that combines revenue growth and EBITDA margin to measure profitability expansion. Of course, companies may exclude stock compensation from adjusted earnings metrics. However, issuing stock is not without cost; it dilutes existing shareholders' equity and reduces earnings per share. Even the $300 billion industry giant Salesforce (CRM.US) had to assure investors in August that its capital return plan (i.e., buybacks) would "completely offset" the dilution caused by its stock plan. This is a twisted logic of saving first and then spending cash flow on compensation. In July of this year, the majority of Salesforce shareholders opposed a consultative vote on the compensation of CEO Marc Benioff and other executives. As inflation becomes tricky, central banks may slow down the pace of interest rate cuts, and tech companies will learn the wisdom of paying in cash