capitalization involves multiplying the number of shares
outstanding by the observed market price. Since restricted
stockshouldhavelowervalues,themarketcapitalizationwill
beoverstatedforcompanieswithsignificantrestrictedstock
overhang.Asanexample,considerthefirmwith 80 million
regularsharesand 20 millionrestrictedshares,andassume
that the stock price is $10.15 (for the traded shares).
Multiplying the market price ($10.15) by the number of
shares outstanding (100 million) will generate a market
capitalization of $1.015 billion. In reality, though, the 20
millionrestrictedshareswouldhavetradedatadiscount(if
theyhadtraded)andthecumulativemarketcapwouldhave
been lower (say $1 billion).
Notwithstandingthisproblem,restrictedstockislesslikelyto
skew relative valuations than employee options, because
restrictedstockoverhangstendtobesmall(relativetooption
overhangs)andtheilliquiditydiscountissmall(againrelative
to the variability in option values).
CONCLUSION
The use of equity as employee compensation is not new.
Firmshavealwaysusedequitygrantsassweetenersnotonly
to attract managers but also to make them think like
stockholders.In thepast two decades, thefloodgates have
opened on equity compensation, especially at technology
firms. At many of these firms, managers were rewarded
primarilythroughoptions,aidedbythelaxaccountingandtax
treatment of these grants (by not expensing them until
exercise).Inthepastfewyears,theawarenessofemployee
optionshasbeenraisedbytwodevelopments.Thefirstisthe
recognition that some managers were receiving wildly