Treasury Stock Method
The standard way to count dilution from in-the-money options: assume exercise, then assume the proceeds repurchase shares at the current price, so only the net new shares increase the diluted count.
Why Treasury Stock Method matters in interviews
The treasury stock method is the mechanical step between basic and diluted shares, and it is asked because it is easy to describe and easy to get numerically wrong. Any question about equity value or EPS can turn into this one.
How it works in practice
The method assumes all in-the-money options and warrants are exercised, and that the company uses the exercise proceeds to buy back shares at the current market price. The net increase in shares is what dilutes.
A worked case: 10m options struck at $15 with the stock at $25. Exercise brings in 10m x $15 = $150m, which repurchases $150m / $25 = 6m shares. Net dilution is 10m − 6m = 4m shares.
The higher the share price relative to the strike, the greater the dilution — because the fixed exercise proceeds buy back proportionally fewer shares.
What candidates get wrong
- Including out-of-the-money options. Only options with a strike below the current price are counted.
- Repurchasing at the strike price rather than the market price. Proceeds come in at strike; the buyback happens at market.
- Forgetting restricted stock units, which generally add to the diluted count in full since there are no exercise proceeds.
Treasury Stock Method: frequently asked questions
How does the treasury stock method work?
Assume every in-the-money option is exercised at its strike price, then assume the company immediately uses those cash proceeds to repurchase shares at the current market price. The difference between shares issued on exercise and shares repurchased is the net dilution added to the basic share count.
Why does dilution increase as the share price rises?
Because the cash raised on exercise is fixed at the strike price while the repurchase happens at the market price. A higher market price means those fixed proceeds buy back fewer shares, so more net new shares remain outstanding.
Go deeper
This term comes up constantly in accounting interviews and on the desk.
IB technical questions guideRelated Accounting terms
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