Publicly traded corporations often award company shares to their employees as part of the compensation package. However, the employee must work a certain number of years before she can sell these shares. Understanding the rights and restrictions associated with these unvested shares is important if you own such stock.
Definition
In finance, vesting refers to the transfer of full ownership of a financial instrument. If a company has set aside a certain amount of stock for you, but stipulates that certain conditions have to be met before these stocks are assigned to you, such shares are considered unvested. Until the shares vest, you cannot sell or transfer them to another party. You also can't use the voting rights that come with stock ownership if the stock has not yet vested. In other words, you have nothing but a promise of future transfer of shares if they are still unvested.
Vesting Process
In most cases, a predetermined amount of time must pass for the shares to vest. An executive, for example, may be promised 100,000 of his company's own shares that will be awarded to him in two years. The two-year period is referred to as the vesting period. Less frequently, the vesting process might be contingent on meeting performance targets. The executive may be given shares only if the company's net profit reaches a particular target, for example, or if the stock price of the company exceeds a threshold by a certain date.
Rationale
There are several reasons companies award restricted shares that vest over a period of time. Since the employee must be employed at the company until the vesting period, such shares typically encourage loyalty. The employees also have a reason to work harder until the end of the vesting period. The better the company performs, the higher the stock price and the more their shares will be worth. On the other hand, if employees are given shares right away, they may immediately sell them and therefore no longer stand to gain from the company's improved performance. Finally, the company can delay the expense by awarding restricted shares because such shares need only be issued at the end of the vesting period.
Departure Before Vesting
If an employee voluntarily leaves the company before the shares vest, she typically loses all rights and privileges associated with the unvested shares. What happens when the employee is laid off depends on the employment contract and company rules. In most cases, if employees pass away their unvested shares are inherited by their descendants. When a company wants to recruit a talented worker from a rival where the employee still has unvested stock, the recruiting company might provide cash equal to the market value of the unvested stock or offer a competing stock award program with a similar vesting period.
References
Writer Bio
Hunkar Ozyasar is the former high-yield bond strategist for Deutsche Bank. He has been quoted in publications including "Financial Times" and the "Wall Street Journal." His book, "When Time Management Fails," is published in 12 countries while Ozyasar’s finance articles are featured on Nikkei, Japan’s premier financial news service. He holds a Master of Business Administration from Kellogg Graduate School.