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Valuing Restricted Stock Units

November 10, 2020

Blog

Valuing Restricted Stock Units

This blog provides a general understanding of how RSUs work, their history, and the factors to consider when assessing their value.

You’ve seen it in the headlines – executive compensation is on the rise. In fact, executive compensation has been rising for the better part of three decades, and with it comes increasing complexities for corporations and employees alike.

Ideally, executive compensation is configured to efficiently address tax law and the desires of the organization at large; typically representing a mixture of salary, bonuses, benefits, stock options and restricted stocks.

In recent years, Restricted Stock Units (“RSU”) have become a popular alternative form of executive compensation, acting as a hybrid between stock options and restricted stocks. RSUs involve a promise by the employer to grant stocks (or cash equivalents) to the employee after they complete a specified number of years of service. This blog is intended to provide readers with a general understanding of how RSUs work, their history, and the factors to consider when assessing their value.

What are RSUs?

RSUs represent a method of compensation issued to an employee in the form of company shares (or cash equivalents). RSUs are issued through a vesting plan and are distributed after completing a specified number of years of service. Upon vesting, the RSU holder receives shares from the company (or cash equivalents) which are able to be held or sold at their discretion. 

Example of RSUs
Kevin is a manager for a publically-traded oil and gas company. As part of his annual compensation arrangement, Kevin receives 500 RSUs from his employer. At the end of the two year vesting period, Kevin will receive 1 common share for each RSU. At the time of issuing, the stock price is trading at $20 per share, meaning the intrinsic value of the RSUs he received is $10,000 (500 RSUs x $20). However, this does not necessarily mean Kevin is entitled to this money – If he leaves his current employer before the RSUs vest, the value is forfeited. Similarly, if the stock price fluctuates between now and when the RSUs vest, Kevin may receive proceeds equal to more or less than the $10,000.

Two years later, Kevin is still with his currently employer and his RSUs vest. However, now his company’s stock price is $18 per share – meaning that the proceeds Kevin actually receives have a value of $9,000 (500 RSUs x $18).

History of RSUs

RSUs became a popular form of executive compensation following the accounting scandals in the early-2000’s involving companies such as Enron and WorldCom. RSUs, compared to stock options, were largely regarded as a better mechanism to align employee and shareholder interests. Between 2003 and 2005, the median number of stock options granted by Fortune 1000 companies declined by 40%, while the median number of RSUs increased by nearly 41% during the same period[1].

What Considerations Are There When Valuing RSUs?

Broadly speaking, the value of an RSU is a product of the following inputs:

  • The stock price at the Valuation Date;
  • The expected volatility of the stock price through the vesting period;
  • The taxes payable upon vesting;
  • The likelihood of the RSUs vesting; and
  • The time value of money.

Stock Price
Upon vesting, the RSU holder receives shares in the company (or cash equivalents), which are able to be sold at their discretion. Therefore, the stock price at the Valuation Date may serve as a baseline value for the RSU. Of course, there are other factors that may materially increase or decrease this baseline value.

Expected Volatility of the Stock Price through the Vesting Period
Most stock prices are not stable – their price may increase or decrease between the valuation date and the vesting date. Fortunately, CBV’s are able to implement various notional hedging strategies that eliminate the price risk between the valuation date and the vesting date. The price volatility of the stock (i.e. the measure of the variation of stock prices over time) is an important input when determining the cost or benefit of implementing these strategies.

Taxes Payable upon Vesting
The employee receiving an RSU (i.e. the holder) does not incur any taxes when the RSU is initially granted. Instead, RSUs are considered to be income upon vesting, and a portion of the shares (or cash equivalents) may be withheld to pay income taxes. The employee’s income tax rate, therefore, may be an important input when assessing the RSU’s value.

Likelihood of Vesting
RSUs are issued through a vesting plan and are distributed after completing a specified number of years of service. Therefore, if an employee does not reach these service requirements (for example: if they leave the company to work for a competitor), the RSUs may not vest and any value is forfeited.

Time Value of Money
The time value of money is the concept that money in the future is worth less than the identical amount of money in the present. Since RSUs vest in the future, any future proceeds need to be discounted to account for the time value of money.

At Davis Martindale, we have experience valuing all types of compensation arrangements. If you need an expert to value your RSUs, we would love to work with you, give the experts at Davis Martindale a call

Co-Authors

Ron Martindale - Valuation & Litigation Partner - Davis Martindale
Ron Martindale

BASc, CPA, CA, LPA, CBV, CFF
Partner
Valuation & Litigation

Tyler Kelly - Valuation Associate - Davis Martindale
Tyler Kelly

CPA
Associate
Valuation

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