Overhang is a measure of the potential dilution of stock shares due to possible awards of stock-based compensation. It is usually represented as a percentage and is calculated as the sum total of all outstanding options granted plus remaining options to be granted divided by the total number of shares outstanding ((SO+RO)/TSO). This metric provides investors with an indication on how much their current shareholding could be diluted if all existing and future option grants are exercised.The concept behind overhang can have significant implications for shareholders, particularly those who already hold large amounts or majority stakes in companies that issue substantial amounts in stock-based compensation.For example, if a company has issued 1 million new common stocks through employee incentive programs but only has 8 million currently outstanding, then there would be an overhang rate equal to 12%. This means that any additional issuance will further dilute shareholder value unless offset by other factors such as increased revenues or cost savings from issuing these incentives instead of cash salaries.It’s important for investors to pay attention when evaluating companies with high levels of overhangs since it can indicate potential risks associated with investing into them such as lower returns due to greater competition amongst shareholders for profits generated by operations; however it also presents opportunities where undervalued firms may offer higher returns than expected given their underlying fundamentals remain strong despite elevated levels in equity based compensation plans offered within them. Ultimately understanding this concept helps provide insight into what type investments might prove successful down the road without taking too much risk along way.
