Merck & Co. Inc. | 2013 | FY | 3


Share-Based Compensation Plans
The Company has share-based compensation plans under which the Company grants restricted stock units (“RSUs”) and performance share units (“PSUs”) to certain management level employees. In addition, employees, non-employee directors and employees of certain of the Company’s equity method investees may be granted options to purchase shares of Company common stock at the fair market value at the time of grant. These plans were approved by the Company’s shareholders.
At December 31, 2013, 143 million shares collectively were authorized for future grants under the Company’s share-based compensation plans. These awards are settled primarily with treasury shares.
Employee stock options are granted to purchase shares of Company stock at the fair market value at the time of grant. These awards generally vest one-third each year over a three-year period, with a contractual term of 7-10 years. RSUs are stock awards that are granted to employees and entitle the holder to shares of common stock as the awards vest. The fair value of the stock option and RSU awards is determined and fixed on the grant date based on the Company’s stock price. PSUs are stock awards where the ultimate number of shares issued will be contingent on the Company’s performance against a pre-set objective or set of objectives. The fair value of each PSU is determined on the date of grant based on the Company’s stock price. For RSUs and certain PSUs granted before December 31, 2009 employees participate in dividends on the same basis as common shares and such dividends are nonforfeitable by the holder. For RSUs and PSUs issued on or after January 1, 2010, dividends declared during the vesting period are payable to the employees only upon vesting. Over the PSU performance period, the number of shares of stock that are expected to be issued will be adjusted based on the probability of achievement of a performance target and final compensation expense will be recognized based on the ultimate number of shares issued. RSU and PSU distributions will be in shares of Company stock after the end of the vesting or performance period, generally three years, subject to the terms applicable to such awards.
Total pretax share-based compensation cost recorded in 2013, 2012 and 2011 was $276 million, $335 million and $369 million, respectively, with related income tax benefits of $84 million, $105 million and $118 million, respectively.
The Company uses the Black-Scholes option pricing model for determining the fair value of option grants. In applying this model, the Company uses both historical data and current market data to estimate the fair value of its options. The Black-Scholes model requires several assumptions including expected dividend yield, risk-free interest rate, volatility, and term of the options. The expected dividend yield is based on historical patterns of dividend payments. The risk-free rate is based on the rate at grant date of zero-coupon U.S. Treasury Notes with a term equal to the expected term of the option. Expected volatility is estimated using a blend of historical and implied volatility. The historical component is based on historical monthly price changes. The implied volatility is obtained from market data on the Company’s traded options. The expected life represents the amount of time that options granted are expected to be outstanding, based on historical and forecasted exercise behavior.
The weighted average exercise price of options granted in 2013, 2012 and 2011 was $45.01, $39.51 and $36.47 per option, respectively. The weighted average fair value of options granted in 2013, 2012 and 2011 was $6.21, $5.47 and $5.39 per option, respectively, and were determined using the following assumptions:
Years Ended December 31
2013
 
2012
 
2011
Expected dividend yield
4.2
%
 
4.4
%
 
4.3
%
Risk-free interest rate
1.2
%
 
1.3
%
 
2.5
%
Expected volatility
25.0
%
 
25.2
%
 
23.4
%
Expected life (years)
7.0

 
7.0

 
7.0


Summarized information relative to stock option plan activity (options in thousands) is as follows:
 
Number
of Options
 
Weighted
Average
Exercise
Price
 
Weighted
Average
Remaining
Contractual
Term (Years)
 
Aggregate
Intrinsic
Value
Outstanding January 1, 2013
165,941

 
$
39.46

 
 
 
 
Granted
5,703

 
45.01

 
 
 
 
Exercised
(33,278
)
 
36.37

 
 
 
 
Forfeited
(22,561
)
 
49.01

 
 
 
 
Outstanding December 31, 2013
115,805

 
$
38.75

 
3.79
 
$
1,320

Exercisable December 31, 2013
101,600

 
$
38.48

 
3.25
 
$
1,187


Additional information pertaining to stock option plans is provided in the table below:
Years Ended December 31
2013
 
2012
 
2011
Total intrinsic value of stock options exercised
$
374

 
$
528

 
$
125

Fair value of stock options vested
42

 
80

 
189

Cash received from the exercise of stock options
1,210

 
1,310

 
321


A summary of nonvested RSU and PSU activity (shares in thousands) is as follows:
 
 
RSUs
 
PSUs
  
 
Number
of Shares
 
Weighted
Average
Grant Date
Fair Value
 
Number
of Shares
 
Weighted
Average
Grant Date
Fair Value
Nonvested January 1, 2013
 
22,743

 
$
36.38

 
1,648

 
$
33.78

Granted
 
6,394

 
45.04

 
963

 
38.25

Vested
 
(8,705
)
 
34.10

 
(839
)
 
34.17

Forfeited
 
(1,298
)
 
40.02

 
(99
)
 
36.71

Nonvested December 31, 2013
 
19,134

 
$
40.07

 
1,673

 
$
35.98


At December 31, 2013, there was $374 million of total pretax unrecognized compensation expense related to nonvested stock options, RSU and PSU awards which will be recognized over a weighted average period of 1.9 years. For segment reporting, share-based compensation costs are unallocated expenses.

us-gaap:DisclosureOfCompensationRelatedCostsShareBasedPaymentsTextBlock