What Are Stock Options?
A stock option grants the holder the right — but not the obligation — to buy a fixed number of company shares at a predetermined price (the “strike price” or “exercise price”) on or before a specified expiration date. The strike price is typically set to the closing market price on the grant date, so options begin life at zero intrinsic value. They make money only if the stock price rises above the strike during the exercise window.
A typical CEO option grant has a 10-year term with a four-year vesting schedule (often 25% per year, sometimes back-loaded). Once vested, the executive can exercise — pay the strike price, receive the shares, and either hold or sell. If the stock never rises above the strike, the option expires worthless. This binary outcome is what makes options leveraged: a 50% rise in the share price can produce a much larger percentage gain on the underlying option position.
Worked Example
Grant: A CEO receives 100,000 options with a strike price of $50 (the share price on grant day).
If the stock rises to $80 at exercise: profit = ($80 − $50) × 100,000 = $3,000,000
If the stock stays at $50: profit = $0 (options at-the-money, no incentive to exercise).
If the stock falls to $40: profit = $0 (options “underwater,” expire worthless).
What Are RSUs (Restricted Stock Units)?
A restricted stock unit is a contractual promise to deliver a specified number of shares at a future date, subject to a vesting schedule. Unlike options, RSUs always have value as long as the share price is positive — they are full shares, not just the right to buy at a price. This makes them a more reliable retention tool: even if the share price falls 40% after grant, the RSU still has 60% of its original value.
Most CEO RSU grants vest over three or four years, with shares delivered in equal installments (often 25% per year for four-year cliffs, or 33% per year for three-year cliffs). Once vested, the executive owns the shares outright and can sell at any time, subject to insider trading windows and any company stock-ownership guidelines. The fair value at grant — the amount disclosed in the proxy statement's Summary Compensation Table — equals the share count multiplied by the closing price on the grant date.
Worked Example
Grant: A CEO receives 50,000 RSUs when the stock is trading at $50, for a grant-date fair value of $2,500,000.
If the stock rises to $80 at vesting: realized value = 50,000 × $80 = $4,000,000
If the stock stays at $50: realized value = $2,500,000 (still meaningful).
If the stock falls to $40: realized value = $2,000,000 (still has retention value).
What Are PSUs (Performance Share Units)?
Performance Share Units behave like RSUs with an additional condition: vesting is contingent not only on time but on the company hitting specific operating or financial targets, usually measured over a three-year performance period. Common metrics include relative total shareholder return (TSR) versus a peer index, cumulative earnings per share, return on invested capital, free cash flow, and revenue growth. If the company misses the threshold target, PSUs are forfeited; if it meets the maximum target, the payout can scale to 200% or even 250% of the original grant.
PSUs are increasingly the dominant equity vehicle for CEO compensation precisely because they tie wealth to measurable results rather than to overall stock-market drift. Proxy advisors ISS and Glass Lewis publish detailed guidance favoring performance-based equity, and S&P 500 companies that grant predominantly time-based RSUs to CEOs increasingly receive negative recommendations. SEC proxy statements must disclose target metrics and achievement levels in the Compensation Discussion & Analysis (CD&A) section.
Why Companies Shifted From Options to RSUs and PSUs
For most of the 1990s and early 2000s, stock options dominated executive pay because companies were not required to expense them on the income statement. The adoption of FASB ASC 718 (formerly FAS 123R) in 2005 changed the calculus: companies now had to record fair value of options as compensation expense, eliminating the accounting advantage that had made options uniquely attractive. Combined with the post-2008 collapse of many option packages into “underwater” territory — where options retained no retention value — boards rapidly migrated to RSUs and PSUs.
Today, the typical S&P 500 CEO receives roughly 50-70% PSUs, 20-40% time-based RSUs, and 0-15% stock options at the equity-grant level. Pure-options grants are now rare outside of high-growth IPO companies and certain founder-led firms.
How Equity Awards Appear in SEC Filings
In the Summary Compensation Table (SCT) of Form DEF 14A, stock awards (RSUs + PSUs) and option awards are reported at grant-date fair value computed under FASB ASC 718. The number reported is an estimate at the time of grant — the actual value the CEO receives when shares vest or options are exercised may be substantially higher or lower depending on share price movement and PSU achievement levels.
For a more accurate picture of realized pay, look at the Option Exercises and Stock Vested table in the proxy statement, which shows the dollar value the executive actually received during the year from option exercises and RSU/PSU vesting. The Outstanding Equity Awards at Fiscal Year-End table shows what remains unvested. All three tables can be retrieved free from SEC EDGAR by searching the company name and filtering for filing type DEF 14A.
Key Differences at a Glance
| Feature | Stock Options | RSUs | PSUs |
|---|---|---|---|
| Value if stock drops | $0 if underwater | Reduced but positive | Reduced; can be $0 if targets missed |
| Vesting condition | Time only (typical) | Time only | Time + performance metric |
| Upside leverage | High (no cost basis until exercise) | Moderate (1:1 with stock) | High (multiplier up to 200%+) |
| Retention power | Low if underwater | High | High (if on track) |
| Tax timing | At exercise | At vest | At vest |
| Prevalence today | Declining | Common | Dominant |
How This Connects to Pay-for-Performance Grading
The CEOPayWatch Pay-for-Performance Score weighs equity-pay structure heavily because it influences whether realized compensation tracks shareholder outcomes. PSUs with rigorous, multi-year, relative-TSR-based metrics earn higher marks than time-based RSUs, which in turn rate higher than mega-grants of underwater stock options. Explore CEO equity breakdowns on our highest-paid CEO rankings, where you can see how stock awards, options, and cash divide across the top earners.