What Is Stock-for-Stock?

Stock-for-stock is a type of compensation deal between two companies in which stock is partly used toward the cost of acquisition. A set number of shares of one company are swapped with the shares of another as a way of covering costs. Stock swaps also occur in employee stock compensation programs, in which employees exchange stock that has already vested so as to receive more stock options.

Key Takeaways

  • Stock-for-stock is a type of transaction in which one company's stock is swapped for that of another company, usually as part of a merger deal. 
  • This kind of deal is used as a way for the acquiring company to cover the costs of the acquisition.
  • A stock-for-stock exchange also occurs in employee stock option compensation plans, when employees exchange mature stock for stock options. 

Understanding Stock-for-Stock

In the context of mergers and acquisitions, stock-for-stock refers to the exchange of an acquiring company's stock for the stock of the acquired company at a predetermined rate. Usually, only a portion of a merger is completed with a stock-for-stock transaction, with the rest of the expenses being covered with cash or other payment methods.

For example, in order to satisfy the expenses of an acquisition, an acquiring company may use a combination of two for three stock-for-stock exchanges with shareholders of the target company and a tender offer of cash.

Stock-for-Stock and Employee Stock Option Plans

Stock-for-stock is also a method of satisfying the option price in an employee stock option compensation plan. Under these compensation programs, employees are granted stock options but must pay the company the option price before they are given the grant. By exchanging mature stock (stock that has been held for a required holding period), the grantee can receive their options without having to pay for them. After a given time period, grantees are given back the stock they used to pay for their options.

Where possible, grantees often take advantage of a stock-for-stock exchange, as they usually increase a grantee's ownership position and require no cash outlay. Non-employee shareholders argue that stock-for-stock option price satisfaction adds to the already high expense of granting employees options, as the employees end up not having to pay the option price, which can add up to be a significant amount of cash if all employees granted options take advantage of stock-for-stock exercises.

Special Considerations

When an executive is granted either an incentive stock option (ISO), or a non-qualified stock option (NSO), that employee must actually obtain the shares that underlie the option in order to make the option have any value.

Both non-qualified stock options and incentive stock options are typically granted under the condition that the executive is forbidden from selling them or giving them away because they are mandated to exchange the options for stock. These terms are written into an executive’s contract.

Stock-for-Stock Example

Companies involved in stock-for-stock mergers enter an agreement to exchange shares based on a set ratio. If company ABC and company XYZ agree to a 1-for-2 stock merger, XYZ shareholders will receive one ABC share for every two shares they presently hold.

Consequently, XYZ shares will cease trading and the number of outstanding ABC shares will increase following the completion of the merger. The post-merger ABC share price depends on the market's assessment of the future earnings prospects for the newly merged entity.