Valuing Deferred Stock Units
Valuing Deferred Stock Units
In this blog, we discuss valuing Deferred Stock Units, building upon the considerations previously described in our blog on Restricted Stock Units.
(Originally Posted December 22, 2020)
Executives are often compensated with a fixed salary, benefits, and an array of variable incentives. Traditionally, stock options represent one of the most common forms of variable compensation, however, alternative forms have become increasingly popular in recent years.
In our previous Davis Martindale blog, Valuing Restricted Stock Units, we provided readers with a general understanding of one alternative form of executive compensation, Restricted Stock Units (“RSUs”). In this blog, we expand on alternative forms of executive compensation with an introduction to Deferred Stock Units (“DSUs”), which share some similar characteristics to RSUs.
What are DSUs?
DSUs represent a form of future compensation whereby the employer promises to issue shares in the company or cash equivalents – typically upon retirement, termination, or death.
The value of DSUs will fluctuate in accordance with the underlying company stock. Although DSUs do not provide actual ownership until they are converted to shares upon redemption, they can be designed to mirror share ownership, allowing the holder to participate in dividends issued by the company. When dividends are issued, the DSU holder will typically receive additional DSUs, rather than cash or equivalents.
DSU Sample Scenario
Rebecca is a senior executive for a publicly traded software company. As part of her compensation arrangement, she received 6,000 DSUs in 2016, 6,000 DSUs in 2017, and 8,000 DSUs in 2018.
In 2019, due to an atypically good year, Rebecca’s company decided to pay a one-time 5% dividend to all shareholders. Under her DSU plan, she received an additional 1,000 DSUs (20,000 DSUs x 5%).
On December 31, 2022, Rebecca turns 65 years old and decides to retire. At her retirement, her company’s stock is trading at $10 per share. Her 21,000 DSUs are now converted to common shares with a value of $210,000 (21,000 x $10).
Valuing DSUs? Here are a few considerations:
Similar to RSUs, the value of DSUs are a product of the following inputs:
- The stock price at the Valuation Date;
- The expected volatility of the stock price through the vesting period;
- Dividends anticipated to be issued by the Company;
- The taxes payable upon vesting;
- The likelihood of the DSUs vesting;
- Expected number of years to vesting; and
- The time value of money.
Upon vesting, the DSU holder receives shares in the company or cash equivalents, which can be sold at their discretion. Therefore, the stock price at the Valuation Date may serve as a baseline value for the DSU. 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, CBVs can calculate the impact of notional hedging strategies that notionally eliminate the price risk between the Valuation Date and the vesting date. The 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 hedging strategies.
Dividends Issued by the Company
DSUs can be designed to mirror share ownership and, as such, the holder may be granted additional DSUs equivalent to the value of dividends paid on the underlying shares.
Taxes Payable upon Vesting
The employee receiving a DSU (i.e., the holder) does not incur any taxes when the DSU is initially granted. Instead, DSUs are considered income upon vesting and a portion of the shares, or cash equivalents, may be withheld to pay income taxes. Therefore, the employee’s income tax rate may be an important input when assessing the DSU’s value.
Likelihood of Vesting
DSUs typically vest upon the employee’s retirement, termination, or death. Therefore, if the employee does not reach these requirements (i.e., if they leave the company to work for a competitor) the DSUs may not vest and any value is forfeited.
Expected Number of Years to Vesting and the Time Value of Money
The time value of money is the concept that money in the future is worth less than the same amount of money in the present (see our blog Money Now vs. Money Later). Since DSUs vest in the future, any future proceeds need to be discounted to account for the time value of money. The length of the vesting period is the key difference between DSUs and RSUs. This is particularly important to consider when valuing DSUs.
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.
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