What Is Overhang?
Overhang measures the potential dilution of stock shares due to possible awards of stock-based compensation. Represented as a percentage, it is calculated by adding stock options already granted with those remaining to be granted and dividing by the total shares outstanding.
Key Takeaways
- Overhang quantifies potential dilution experienced by common shareholders as a result of stock-based compensation awards.
- It is represented as a percentage: (stock options granted + remaining options) / total shares outstanding.
- More broadly, overhang can signify the downward pressure from large blocks of shares that may be sold.
- Higher overhang numbers reflect greater risk potential for shareholders.
- Calculated by dividing total existing and future option issues by total stock outstanding.
Understanding Overhang
Though there’s no specific threshold for harmful overhang levels, higher percentages generally poses greater risks. Options overhang lowers post a public offering as outstanding shares increase. High options overhang necessitates substantial growth and profits to offset dilution’s negative impact on earnings per share (EPS) and investor returns.
Such scenarios can prompt managers to tend toward riskier strategies, curb dividends, or increase debt, enhancing stock price volatility. Conversely, firms with high employee stock ownership often demonstrate superior financial performance, with higher dividends and lower volatility.
How to Calculate Overhang
To calculate options overhang, sum up existing and future option issues, then divide by the total number of outstanding stocks. For instance, if a company has issued 50,000 options and plans for 50,000 additional, with 1 million shares outstanding, the overhang is (50,000 + 50,000) / 1,000,000 = 10%.
Broadly, market overhang can describe situations where investors hesitate due to future uncertainties about assets.
Special Considerations
A 2020 study by executive compensation consultant F.W. Cook \u0026 Co. highlighted that small-cap companies tend to grant a higher percentage of stock options to executives compared to large-cap companies. Technology sectors show the lowest and retail & industrial sectors the highest awards share to senior management.
Given an options overhang’s potential to negatively affect stock prices, management often designs HR strategies to mitigate effects. Performance-based options represent a significant strategy because they have lower chances of being exercised compared to traditional stock options not tied to performance.
What Is the Definition of Overhang?
Broadly, market overhang refers to scenarios where customers or investors defer purchasing due to uncertainty around future events, leading to hesitancy in buying certain products or stocks.
What Is Stock Overhang?
Stock overhang arises when a small number of shareholders hold large stock blocks, increasing the risk of a price drop if they decide to sell substantially. Common in scenarios with substantial employee compensation stocks, it also pertains to stocks held by institutional investors.
What Is Bearish Overhang?
Bearish overhang occurs when buyers hesitate due to a large asset block whose sale could depress prices. Though typically referring to stock shares, it can also apply to commodities. For example, sanctions debates affecting U.S.-Iran oil trade have been associated with a potential bearish overhang from Iranian oil sale discussions.
What Is Risk Overhang?
In insurance, risk overhang indicates situations where past transaction exposures limit an insurer’s present opportunities, often forcing lucrative opportunity pass-ups due to undue risk accommodation.
Related Terms: dilution, stock options, EPS, volatility.
References
- F.W. Cook. “2020 Aggregate Share-Based Compensation”, Page 4.
- Yahoo News. “There’s a ‘Major Bearish Overhang’ on Oil Markets, Analyst Says”.
