DSU's explained---the devil is in the " Vesting " terms Restricted Share Units (and their cousin, Deferred Share Units)
Many employers use restricted share units to both remunerate and incentivize future performance of employees. For cash-flush employers, in particular, RSUs where the employer promises to pay the recipient the cash equivalent to the value of a certain number of shares provide the advantages of equity based compensation, but without the dilution concerns of options.
The recipient of an RSU receives a promise by the employer to grant the recipient shares or pay the recipient the cash equivalent to the value of shares. RSUs are thus often referred to as "phantom shares". As the recipient does not actually hold or own any shares in the company, they would not be permitted to vote or entitled to dividends. Certain plans, however, will provide for payments of additional RSUs commensurate with any dividends paid to shareholders.
An RSU is typically seen as a more effective way of remunerating employees for past service performed, as its value is not contingent on the share price going above an exercise price. Unless the employer goes bankrupt (and its shares become worthless), the recipient of an RSU can generally expect to receive a positive benefit from their grant, subject to vesting conditions discussed below.
A deferred share unit is a particular form of RSU that meets certain conditions under the Income Tax Act (Canada). Shares received pursuant to a DSU plan can only be realized "after the employee's death, retirement or loss of office or employment". This may therefore limit the effectiveness of DSUs as a form of compensation, especially for young employees who need access to liquid assets at the start of their lives.
Incentivizing Performance Through RSUs
RSUs are generally seen as providing an incentives more in line with those of company's shareholders; the benefit of an RSU is not contingent upon the employer's share price and a pre-determined strike price. However, as will be discussed below, RSUs are almost always subject to certain vesting conditions that will impact the incentives imparted upon the recipient.
Generally large RSU grants will be subject to vesting conditions "“ this is to ensure the recipient does not, in effect, cut and run after the grant. If the vesting conditions are not met, the units may expire without the employee being able to claim the underlying value. A common vesting requirement is continued service with the employer or performance targets. For example, an RSU could vest as follows:
These vesting conditions make the value of an RSU asymmetric, similar to an option, but instead of payoff being zero for any share value under the strike price, payoff is zero where the vesting conditions are not met. This asymmetry, though divorced from the benefits received from actual share ownership, need not create the same risk-taking incentive that arises in the option scenario. This is because the vesting conditions are fully customizable, and thus, need not respond positively to risk-taking behaviour. The example illustrated above, where vesting was contingent upon length of continued employment, is a good example of this; in fact, employees approaching completion of a vesting term may actually decrease risky behavior so as to ensure they are not fired before vesting completes. If vesting conditions are likely to be reached, an RSU holder has incentives largely similar to those of shareholders.