Understanding Restricted Stock Units (RSU) vs Performance Share Units (PSU)

In the world of corporate compensation, especially in publicly traded companies, Restricted Stock Units (RSUs) and Performance Share Units (PSUs) are two primary forms of stock-based compensation awarded to employees. While both serve as a key part of employee incentive programs, they differ significantly in terms of how they’re structured and awarded. This article aims to demystify these two types of equity compensation and highlight their differences.

What are Restricted Stock Units (RSU)?

Restricted Stock Units are a form of stock-based compensation used to incentivize employees. When an employee receives RSUs, they are being promised a specific number of company shares at a future date, once certain vesting conditions are met. These conditions usually include continued employment for a specified period.

Key Characteristics of RSUs:

  • Vesting Schedule: RSUs typically come with a vesting schedule. Commonly, this is a (linear or degressive) time-based schedule, where a certain percentage of the units vests over a period, say annually over four years.
  • Taxation: Employees are taxed when the RSUs vest, based on the fair market value of the shares at the time of vesting. This is treated as ordinary income and subject to federal, state, and employment taxes.
  • No Voting Rights or Dividends: Until vested, the employee doesn’t have voting rights or receive dividends because they do not possess the shares. Some companies, however, offer dividend equivalents that are paid out upon vesting.

What are Performance Share Units (PSU)?

Performance Share Units, on the other hand, are also a form of stock-based compensation but with a key difference. The award and the number of shares an employee receives depend on meeting certain performance criteria, typically tied to the company’s financial goals or stock performance.

Key Characteristics of PSUs:

  • Performance-Based Vesting: The vesting of PSUs is contingent upon achieving predefined performance targets. These targets can be company-specific metrics like EBITDA, stock price targets, or comparative metrics like relative total shareholder return (TSR).
  • Flexible and Variable Rewards: The number of shares ultimately awarded can vary. An employee might receive more, fewer, or no shares at all, depending on whether the performance targets are exceeded, met, or not met.
  • Taxation: Similar to RSUs, PSUs are taxed at vesting. The taxable income is the fair market value of the shares at vesting, but the amount can vary greatly depending on the level of performance achieved.

Comparing RSUs and PSUs

While RSUs and PSUs may seem similar in that they both involve stock compensation, their core difference lies in the vesting criteria.

  • Vesting Criteria: RSUs are primarily time-based, making them somewhat predictable as long as the employee remains with the company. PSUs, in contrast, are performance-based, adding a variable element based on either individual or company performance.
  • Reward Predictability: RSUs offer more predictability in terms of the reward that an employee might expect, whereas PSUs are more uncertain and can potentially offer higher rewards if the performance targets are exceeded.
  • Tax Implications: The variable nature of PSUs can lead to more complex tax planning compared to RSUs. The value of PSU awards at vesting can vary significantly, making it harder to predict the tax burden.
  • Employee Motivation: PSUs are often seen as a way to align employees’ interests with those of shareholders and can be more motivating in driving performance. RSUs, while still a valuable incentive, may not directly tie to company performance.
  • Market Influence: PSU payouts can be significantly influenced by market conditions, which can be outside the control of employees. RSUs are less susceptible to market fluctuations once granted, except for the usual market risks associated with holding stock.

Conclusion

In conclusion, both RSUs and PSUs play a crucial role in modern corporate compensation and incentive strategies. RSUs offer a more straightforward, time-based reward system, making them a stable form of compensation. PSUs, however, link compensation more directly to company or individual performance, potentially offering higher rewards but with greater variability and risk.

Understanding the nuances between RSUs and PSUs is essential for both employers designing compensation packages and employees evaluating their benefits. Each has its place in incentivizing and rewarding employees, but they cater to different objectives and risk profiles. As with any form of compensation, employees must understand the tax implications and how these awards fit into their overall financial plan.

For further information, we gladly forward you to Incentrium’s ESOP/VSOP Knowledge Center, a platform for the management, valuation, and reporting of RSUs, PSU, and every other kind of share-based compensation program like ESOP, VSOP, and LTIP.