Stock-based compensation is used by companies to reward employees with stock options or equity ownership rights in the company. This helps in aligning the company's interests with that of the employees.
Suppose a company gives its employees the right to buy 2,000 shares of its stock at $20 per share. The options vest over 3 years at 30% per year and the overall term is five years. Irrespective of the stock price, the employee pays $20 per share at the time of buying the stock over the five-year duration.
Why it matters
Stock-based compensation acts as an incentive for employees to continue working with the company (since they have to wait for the vesting period to be over). It also helps align the company's interests with the employees and shareholders. Companies can also enjoy better liquidity since this form of compensation does not require cash.