Stock Compensation Expense, Cash Flows and Inflated Valuations
28 Pages Posted: 1 Jan 2020 Last revised: 12 May 2020
Date Written: December 12, 2019
This paper reviews the statement of cash flow implications of stock compensation expense and the effect it can have on valuations. The paper suggests that treating stock compensation as a non-cash item in the statement of cash flows can be misleading from internal decision making and external valuation perspectives. This is important given the increasing role of non-GAAP cash flow disclosures in financial reporting as well as their use internally by managers. It quantifies the potential size of the problem and suggests potential solutions including treating stock compensation expense as an operating cash outflow and a financing cash inflow and/or adding further descriptive disclosures to the financial statements. Finally, the paper also highlights a similar issue that occurs with the cash flow implications of finance leases.
Keywords: stock compensation, non-GAAP disclosures, Free cash flow, overvaluation
JEL Classification: M41, G02,G14,G11
Suggested Citation: Suggested Citation