Impact Of Special Dividends On Stock Compensation

With the prospect of dividend tax rates ballooning from 15% up to a potential 39.6% for high-income taxpayers (plus 3.8% for the Medicare surtax), many companies are making special one-time dividend distributions, as explained in an article at Motley Fool, an online magazine for retail investors. When a company pays a dividend, particularly a large special dividend, its stock value declines by the same amount after the ex-dividend date. Depending on any provisions in the stock plan documents for adjustments in outstanding grants in this situation, these special dividends can affect the value of stock options, restricted stock, and other equity awards.

For shareholders, the stock-value decline from the dividend is offset by the cash they receive. However, while dividends are usually paid on restricted stock, as the shares are outstanding, dividends are not paid to optionholders and are usually not paid on restricted stock units (RSUs).

Companies paying dividends because of the lower tax rate on "qualified" dividends may consider whether this places options and RSUs at a disadvantage (unless they pay a dividend equivalent), and they may want to think about how to adjust for this. As explained in an FAQ at myStockOptions.com, Microsoft did this when making a $3-per-share special dividend in 2004. Many stock plans have provisions that allow for an adjustment or for equity restructurings, such as a special dividend, a stock split, or a spinoff. This is sometimes called an antidilution provision. For additional details, including the accounting treatment, see a recent edition of the newsletter HRS Insight from PricewaterhouseCoopers.