What does the term "stock-for-stock" mean?

By Rob Renaud AAA
A:

The term "stock-for-stock" is popularly used in two different contexts, and it regularly makes business news headlines in both.

"Stock-for-stock" most commonly appears in headlines in reference to the stock-for-stock merger. In this type of merger, the acquiring company trades shareholders of the target company a predetermined number of shares of its own stock for each share of the target company's stock. This type of merger is often said to be more efficient than traditional cash-for-stock mergers because the transaction costs involved are substantially lower and the stock-for-stock arrangement doesn't stretch the acquiring company's cash position quite as much.

In a merger funded entirely with cash, the acquiring company may have to go to the debt market to raise the cash to pay for the merger. Because large acquisitions are very expensive, acquiring companies often issue expensive equity and debt that they otherwise would not dream of issuing, such as short-term convertible notes or convertible preferred shares. Making a deal happen with stock can save time and money. Deals that are entirely funded with stock are known as "all-stock" deals. However, it is more common to see a combination tender offer and stock-for-stock deal than an all-stock deal.

You may also hear the term "stock-for-stock" used in the context of executive compensation, particularly in reference to employee stock option grants. Typically, executives are the only group of employees who are awarded so many stock options that they can't afford to use them all - this is one case in which an executive may receive a stock-for-stock award or exercise a grant by paying "stock-for-stock" .

When an executive is granted either a non-qualified stock option (NSO) or an incentive stock option (ISO), he or she actually needs to get the shares that underlie the option in order to make the option worth anything. Both non-qualified stock options and incentive stock options are usually granted under the condition that the executive cannot sell them or give them away - he or she must exchange the options for stock. These terms are written into executives' contracts to increase their share ownership.

Let's say an executive already owns 80,000 shares in the company for which she works, and the company awards her 50,000 ISOs at an exercise price of $5 per option. The executive must come up with $250,000 (50,000 x $5) in order to exercise the ISOs and get the underlying stocks (which we'll assume are currently trading at $12.50). In a stock-for-stock exercise, the grantee can transfer 20,000 shares of her already-owned stock to the company (20,000 x $12.50 = $250,000). Once the executive has met all required holding periods (usually one year), she can get the grant, and it will not have cost her interest payments, as it would have if she had taken out a loan from the bank to pay for the exercise.

To learn more about M&A, see our tutorial on The Basics Of Mergers And Acquisitions. For more on management compensation, check out Option Compensation - Part One and Option Compensation - Part Two.

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