The NASPP Blog

The practice of paying dividends (or dividend equivalents, in the case of units) on unvested awards has been declining since we first started tracking it in 2007. No one likes the practice, other than companies and the employees who benefit from it. Investors certainly aren’t a fan, FASB imposes some onerous accounting requirements on it, and even the IRS has taken issue with the practice. Now, ISS’s 2017 Equity Plan Scorecard deducts points for this.

What’s the Big Deal?

The main criticism of paying dividends on unvested awards is philosophical: if dividends are paid out before an award vests, employees have arguably received compensation they aren’t entitled to. And, if the awards are subsequently forfeited, no one makes the employees pay back the dividends; they are allowed to keep the dividends on shares that they ultimately didn’t earn.  Here are a few of the consequences of this practice:

• Implicates the dreaded two-class method of reporting earnings-per-share, something few people, if any, even understand (I’ll admit it—I am not one of the few) (see “Applying the Two-Class EPS Method to Share-Based Payments,” by KPMG)
• When the awards are forfeited, any dividends paid prior to vesting that aren’t also forfeited are treated as compensation expense (normally, dividends do not increase the expense associated with an award)
• If paid on performance awards, the dividends cannot be considered performance-based compensation for purposes of Section 162(m) unless they are subject to vesting contingent on performance goals (see “IRS Clarifies Treatment of Dividends Under Section 162(m)“)

ISS Gets into the Game

One of ISS’s changes to its 2017 Corporate Governance Policy is to add paying dividends on unvested awards to the Plan Features pillar of its Equity Plan Scorecard. Plans will receive full points for this test only if they prohibit paying dividends prior to vesting for all awards offered under the plan. If the plan is silent or includes the prohibition for some awards but not others, the plan receives no points for this test.

It is permissible for dividends to accrue on awards prior to vesting, so long as the dividends are still subject to forfeiture in the event that the underlying award is forfeited.

The Data

This handy interactive infographic shows how payment of dividends on unvested awards has declined since 2007 (click on the years to see the data change):

Perhaps one day, paying dividends on unvested awards will go the way of reloads and pyramid exercises: mythic transactions rarely, if ever, seen in the wild.

– Barbara

* Data referenced in this blog, including the infographic, are from the Domestic Stock Plan Design Survey (years 2007, 2010, 2103, and 2016), co-sponsored by the NASPP and Deloitte Consulting LLP.