Dividend equivalent rights: Overview, definition, and example
What are dividend equivalent rights?
Dividend equivalent rights (DERs) are rights granted to the holder of certain types of securities, such as stock options, restricted stock units (RSUs), or other equity-based compensation instruments, which entitle the holder to receive cash or additional securities equivalent to the value of dividends that would have been paid on the underlying stock. DERs are designed to provide the equivalent value of dividends on a stock, even if the holder does not actually own the stock or is not eligible for dividends in the traditional sense.
For example, if an employee holds stock options or RSUs but does not receive dividends directly from the company, dividend equivalent rights may allow them to receive cash payments or additional units that represent the value of the dividends paid on the underlying stock.
Why are dividend equivalent rights important?
Dividend equivalent rights are important because they align the interests of employees and investors by ensuring that holders of equity-based compensation receive similar financial benefits to those owning the underlying shares, such as dividends. DERs can help increase the attractiveness of equity-based compensation plans, especially when the actual ownership of shares would not yield direct dividend payments.
For companies, offering dividend equivalent rights in compensation plans can make equity-based compensation more competitive and appealing to employees, helping to attract and retain talent.
Understanding dividend equivalent rights through an example
An employee receives RSUs from their employer as part of a compensation package. The RSUs are linked to the company’s stock, but since the employee does not actually own the shares yet, they are not eligible for dividends paid to shareholders. To make up for this, the company provides dividend equivalent rights that pay the employee the same amount as the dividend that would have been paid to a shareholder, even though the employee is not yet a shareholder.
In another example, a company grants stock options to its employees but offers dividend equivalent rights on those options. If the company pays a dividend of $2 per share to its common stockholders, the employees holding the options will receive $2 per option as a dividend equivalent, even though they haven’t exercised the options yet.
An example of a dividend equivalent rights clause
Here’s how this type of clause might appear in an employee stock option or RSU agreement:
“The Participant shall be entitled to receive dividend equivalent rights with respect to the unvested RSUs. The Company shall pay to the Participant an amount equivalent to the dividends paid on the shares of the Company’s common stock that correspond to the RSUs held by the Participant, provided that such dividends are paid during the term of the RSUs. Such payments shall be made in cash or additional RSUs, as determined by the Company in its sole discretion.”
Conclusion
Dividend equivalent rights ensure that holders of equity-based compensation are treated similarly to shareholders when it comes to receiving the benefits of dividends. These rights help align employee interests with company performance, making equity compensation packages more attractive. By understanding and offering DERs, companies can enhance the value of their compensation plans and improve employee retention and satisfaction.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.