The practice of including dividend value accruing on shares underlying share rights in executive incentives is not uncommon. It is also logical. That is, an incentive which has value contingent on both share price and dividends is the same as saying it is contingent on total shareholder return (TSR). It is illogical that a company provide an executive rights to shares that exclude a critical component of TSR, and fails to encourage executives to consider the best ways in which TSR could be delivered.

That being the case, it remains surprising that many companies provide equity grants whereby the payment vehicle’s value is based only on share price. This could partly be because ISS is not supportive of dividend-equivalent payments on vested LTI (PSUs), a stance which has now been made explicit in their latest guidelines (see HERE). Grants that fail to recognise and pay for dividends management generate for shareholders fail to be aligned with shareholder interests.

Of the many companies that do recognise the importance of dividends in share rights, we have noticed their rules drafted by some of the law firms are not quite getting it right. TSR is calculated assuming any dividends are reinvested in the company’s stock. This is the return that shareholders enjoy under a dividend reinvestment plan. A dividend earned in year 1 of a 3-year incentive can be reinvested and earn compounding dividends on itself. A simple solution is to draft equity plan rules and/or offer letters to provide dividend value on the same basis as a company’s dividend reinvestment plan.

The prevalence and method of paying dividends varies by company and incentive type.

To determine how companies are including dividends within equity grants, we analysed FY24 ASX 100 CEO incentive grants. Incentives are considered to have dividends included if:

• The instrument utilised includes dividends.
• Dividend equivalents are paid after vesting on the proportion that vests.
• More instruments are allocated at grant to account for dividends forgone.
• The equity allocation basis accounts for dividends (e.g. Black-Scholes).

ASX 20

Of the ASX 20 CEOs who had deferred STI equity or Other (restricted share units or RSUs vesting based on service only), 100% had dividends incorporated. Approximately 2 thirds of CEOs with an LTI (performance share units or PSUs vesting based on performance) included dividend value.

Figure 1: Prevalence of dividends in equity plans by incentive (ASX 20)

ASX 50

Of the ASX 50 CEOs who had deferred STI equity or Other (RSUs), approximately 80% had dividends incorporated. More than half the CEOs with an LTI (PSUs) included dividend value.

Figure 2: Prevalence of dividends in equity plans by incentive (ASX 50)

ASX 100

Of the ASX 100 CEOs who had deferred STI equity or Other (RSUs), approximately 70% had dividends incorporated. Less than half the CEOs with an LTI (PSUs) included dividend value.

Figure 3: Prevalence of dividends in equity plans by incentive (ASX 100)

As the sample widens from ASX 20 companies to ASX 100 companies, the prevalence of dividend payments across all incentive types decreases. This may be influenced by the presence of growth-oriented companies who do not issue any dividends.

Type of dividend payment:

Figure 4 below shows the breakdown of dividend inclusions by type and incentive:

• Short-term equity incentives typically have dividends included; a function of shares being more prevalent than rights in these plans. Shares provide dividends, which are paid out during the vesting period on the understanding that the executive has already earned the shares.
• Long-term incentives (performance share units or PSUs vesting based on performance) and Other (restricted share units or RSUs vesting based on service only) typically provide an equivalent payment upon vesting.

Figure 4: Type of dividend payment by incentive (ASX 100)

Dividend entitlements are important to consider when benchmarking equity plans. A right that provides dividends is worth more over time than a right that does not provide dividends. Whilst rights may be equal on a face value basis (share price multiplied by number of instruments), they are not equal on a fair value basis that discounts for dividends forgone. This topic is covered in greater depth HERE.

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