Valuing Deferred Stock Units
Fair Market Value vs. Price
In this blog, we discuss valuing Deferred Stock Units (“DSU”) and build on our previously posted blog on Restricted Stock Units (“RSU”).
Executives are often paid a fixed salary and benefits, plus an array of variable or contingent incentives. Traditionally, stock options represent one of the most common forms of variable compensation. In recent years, however, alternative forms of variable compensation have become increasingly popular.
In a previous Davis Martindale blog (Valuing Restricted Stock Units), we introduced readers to one alternative form of executive compensation. This current blog is intended to provide readers with an introduction to another form of executive compensation – namely Deferred Stock Units (“DSU”).
What are DSUs?
DSUs represent a form of long-term compensation whereby the employer promises to issue shares in the company (or cash equivalents) at a future point in time (typically upon retirement, termination, or death).
The value of the DSUs will fluctuate in accordance with the underlying company stock, but the DSUs do not represent actual ownership until they are converted to shares upon redemption. DSUs can be designed to mirror share ownership, allowing the holder to participate in dividends issued by the company on the underlying shares. When dividends are issued, the DSU holder will typically receive additional DSUs, rather than cash or equivalents.
Example of DSUs
Jennifer is a senior executive for a publically-traded e-commerce company. As part of her compensation arrangement, Jennifer received 3,000 DSUs in 2015 and 2016, and 4,000 DSUs in 2017.
In 2018, due to an abnormally good year, her company decided to pay a one-time 10% dividend to all shareholders. Under her DSU plan, Jennifer receives an additional 1,000 DSUs (10,000 DSUs x 10%).
On December 31, 2021, Jennifer turns 65 years old and decides to retire. At her retirement, her company’s stock is trading at $10 per share. Her 11,000 DSUs are now converted to common shares with a value of $110,000 (11,000 x $10).
What Considerations Are There When Valuing DSUs?
Broadly speaking, 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; and
- Expected number of years to vesting and the time value of money.
Upon vesting (which is typically at retirement, termination or death), the DSU 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 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, 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.
Dividends Issued by the Company
DSUs can be designed to mirror share ownership, and therefore DSU holder may be granted additional DSUs equal 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 for tax purposes upon vesting, and a portion of the proceeds may be withheld to pay income taxes. The employee’s income tax rate, therefore, may be an important input when assessing the DSU’s value.
The Likelihood of Vesting
DSUs typically vest upon the employee’s retirement, termination or death. Therefore, if the employee does not reach these requirements (for example: if they leave the company to work for a competitor, or in some circumstances if they are terminated with cause), 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 identical 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. This may be a particularly important consideration for DSUs, as the vesting period (between when the DSU is granted and when it vests) is typically longer than for other components of executive compensation – such as Restricted Stock Units.
At Davis Martindale, we have experience valuing all types of compensation arrangements. If you need an expert to value your DSUs, we would love to work with you.