Dividends on Unearned Shares and Corporate Payout Policy: An Analysis of Dividend Equivalent Rights

We investigate a little-known executive compensation device called dividend equivalents, which are provisions on some options and performance-based equity awards permitting executives to receive dividends on shares not owned and which they may ultimately never own. We find that up to 30% of sample firms have had this policy. While dividend equivalents may appear to exacerbate agency problems, they have a positive impact on cash holdings and help align incentives — firms with dividend equivalent policies tend to pay dividends, and firms that make dividend equivalent payments tend to pay higher dividends and keep lower excess cash.