Many listed companies provide two sets of profit figures: one set follows Generally Accepted Accounting Principles (GAAP) in the United States ( GAAP ), while the other is the adjusted profit according to management's interpretation. Foreign media have identified that one of the common sources of differences between the two is the cost of equity incentives.
Why is equity incentive excluded?
When a company issues equity instruments such as restricted stocks and options to its employees, it is still required to recognize these as an expense according to accounting rules. In other words, even if the company does not pay cash immediately, this compensation will still reduce the GAAP profit.
However, in indicators other than GAAP, many companies include this expense back. A common explanation from management is that such expenditures do not directly affect the current cash flow, so it is more appropriate to separate them from the operating performance. Similar treatments are also often seen in the adjusted EBITDA and adjusted earnings per share.
Taking the example in the text, if a software company has revenue of $1 billion and other operating costs of $700 million, with equity incentive expenses of $100 million, then the operating profit calculated using GAAP would be approximately $200 million; if this $100 million is excluded, the adjusted operating profit would become $300 million.
Not consuming cash does not equal having no cost.
The article points out that including equity incentives in profits does not mean that this form of compensation comes without a cost. The real issue is that after employees receive the shares, the holdings of existing shareholders may be diluted.
Alphabet is one of the cases mentioned in the text. In 2025, the company recognized equity incentive expenses of $27.1 billion, of which $24.1 billion was related to rewards expected to be settled in shares. This figure indicates that even if equity incentives do not directly consume cash, they can still result in ongoing costs at the equity level.
The US Securities and Exchange Commission (SEC) allows companies to disclose non-GAAP indicators, but requires that they be clearly compared with the corresponding GAAP data. At the same time, regulators have repeatedly reminded that if companies exclude costs that are necessary for maintaining daily operations and that occur repeatedly, such adjustments may mislead investors.
When looking at profits, one also needs to consider share repurchases and additional share issues.
The article argues that the concepts of GAAP profit and adjusted profit represent different questions. The former reflects how much money a company actually earns after taking into account all prescribed expenses; the latter attempts to show how the core business performs after excluding certain items.
The situation that truly requires vigilance is when the scale of equity incentives remains large over a long period of time. At this point, focusing solely on the adjusted profits can lead to an overestimation of the quality of a company's earnings.
- GAAP The gap between profit and adjusted profit
- Is corporate repurchase mainly used for hedging against dilution?
- Has equity incentive become a long-term operating cost?
The article also mentions that large-scale repurchases do not necessarily equate to substantial capital returns. Although some companies announce repurchases of billions of dollars, a considerable portion of the funds may simply be used to offset the dilution effect caused by equity incentives.
Overall, equity incentives can not affect current cash flow, but they still impact shareholders' equity. When interpreting financial reports, relying solely on adjusted profits is often insufficient.
