Contingent Shares

Definition

Contingent shares are shares of stock that are issued based on the occurrence of specific events or conditions, such as meeting performance targets or completion of a merger. These shares can potentially dilute existing shareholders' equity if the conditions are met, impacting earnings per share calculations.

5 Must Know Facts For Your Next Test

1. Contingent shares are often linked to specific performance metrics that must be met before they are issued, such as revenue targets or market conditions.
2. When calculating diluted EPS, companies must consider the potential impact of contingent shares as they can increase the total number of shares outstanding.
3. The issuance of contingent shares can affect stockholder control and may lead to changes in dividend policies if significant dilution occurs.
4. Contingent shares can serve as an incentive for management and employees to drive performance since they will only benefit from the shares if the company meets its goals.
5. Companies must disclose the existence of contingent shares in their financial statements to provide transparency regarding potential dilution risks.

Review Questions

• How do contingent shares influence a company's diluted EPS calculation?
  • Contingent shares impact a company's diluted EPS calculation by increasing the denominator in the EPS formula if the conditions for issuance are met. This means that when calculating diluted EPS, companies must include the potential additional shares from contingent stock that could be issued in the future. This can lead to a lower diluted EPS figure compared to basic EPS, reflecting the potential dilution of existing shareholders' equity.
• Discuss how the issuance of contingent shares can serve as an incentive mechanism for employee performance.
  • The issuance of contingent shares acts as a motivational tool for employees by tying their compensation directly to the company's performance. When employees know that their stock options or performance shares will only vest upon achieving specific targets, they are likely to work harder to meet those objectives. This alignment between employee interests and company goals encourages a culture of accountability and drives overall performance, ultimately benefiting both employees and shareholders.
• Evaluate the potential risks associated with contingent shares in relation to shareholder equity and company valuation.
  • Contingent shares pose potential risks to shareholder equity and company valuation by introducing uncertainty regarding future ownership structures. If contingent shares are issued, they can dilute existing shareholders' ownership percentage and influence decisions on dividends and governance. Moreover, if too many contingent shares become activated due to easy performance metrics or ambitious targets, it might suggest overvaluation of management's capabilities. Thus, careful consideration is needed when designing such incentive programs to balance motivating employees while protecting shareholder interests.

Related terms

Diluted Earnings Per Share (EPS): A measure of a company's earnings per share that accounts for all potential shares that could be created through convertible securities, options, and contingent shares.

Stock Options: Contracts that give employees the right to purchase shares at a predetermined price, often used as part of compensation packages and can lead to dilution if exercised.

Performance Shares: Shares granted to employees based on meeting specific performance goals, which may also be considered contingent shares since they depend on achieving those goals.