IBM 2007 Annual Report Download - page 105

103
Notes to Consolidated Financial Statements
International Business Machines Corporation and Subsidiary Companies
or the value of the award, the exercise price or formula for determin-
ing the exercise price and the date of grant. All option awards for
senior management are approved by the Committee. All option awards
for employees other than senior management are approved by senior
management pursuant to a series of delegations that were approved
by the Committee. The grants made pursuant to these delegations are
reviewed periodically with the Committee. Options that are awarded
as part of annual total compensation for senior management and other
employees are made on specific cycle dates scheduled in advance.
With respect to option awards given in connection with promotions
or new hires, the company’s policy requires approval of such awards
prior to the grant date, which is typically the date of the promotion
or the date of hire. The exercise price of these options is the average
of the high and low market price on the date of grant.
STOCK OPTIONS
Stock options are awards which allow the employee to purchase shares
of the company’s stock at a fixed price. Stock options are granted at an
exercise price equal to or greater than the company’s stock price on the
date of grant. These awards, which generally vest 25 percent per year,
are fully vested four years from the date of grant and have a contractual
term of 10 years. The company also has a stock-based program for its
senior executives, designed to drive improved performance and increase
the ownership executives have in the company. These executives have
the opportunity to receive at-the-money stock options by agreeing to
defer a certain percentage of their annual incentive compensation
into IBM equity, where it is held for three years or until retirement.
In 2005, this program was expanded to cover all executives of the
company. Options under this program become fully vested three
years from the date of grant and have a contractual term of 10 years.
The plan element permitting deferral of annual incentive compensa-
tion into IBM equity and receiving at-the-money stock options was
terminated at December 31, 2006.
The company estimates the fair value of stock options using the
Black-Scholes valuation model, consistent with the provisions of SFAS
No. 123(R), “Share-Based Payment” (SFAS No. 123(R)) and SAB No.
107. Key inputs and assumptions used to estimate the fair value of stock
options include the grant price of the award, the expected option term,
volatility of the company’s stock, the risk-free rate and the company’s
dividend yield. Estimates of fair value are not intended to predict actual
future events or the value ultimately realized by employees who receive
equity awards, and subsequent events are not indicative of the reason-
ableness of the original estimates of fair value made by the company.
The fair value of each stock option grant was estimated at the date
of grant using a Black-Scholes option pricing model. The following
table presents the weighted-average assumptions used in the valuation
and the resulting weighted-average fair value per option granted:
FOR THE YEAR ENDED DECEMBER 31: 2007 2006 2005
Option term (years)* 5 5 5
Volatility ** 23.1% 26.2% 34.7%
Risk-free interest rate (zero
coupon U.S. treasury note) 4.5% 4.9% 4.0%
Dividend yield 1.4% 1.3% 0.9%
Weighted-average fair value
per option granted $26 $23 $29
* The Option term is the number of years that the company estimates, based upon history,
that options will be outstanding prior to exercise or forfeiture.
** The company’s estimates of expected volatility are principally based on daily price changes
of the company’s stock over the expected option term, as well as the additional requirements
included in the provisions of SFAS No. 123(R) and the guidance provided by SAB No. 107.
The following table summarizes option activity under the Plans during the years ended December 31, 2007, 2006 and 2005:
2007 2006 2005
WTD. AVG. NO. OF SHARES WTD. AVG. NO. OF SHARES WTD. AVG. NO. OF SHARES
EXERCISE PRICE UNDER OPTION EXERCISE PRICE UNDER OPTION EXERCISE PRICE UNDER OPTION
Balance at January 1 $ 95 207,663,223 $ 91 236,070,040 $ 89 249,347,906
Options granted 103 1,087,381 85 2,013,623 100 13,016,765
Options exercised 77 (46,961,380) 53 (21,685,948) 47 (11,690,186)
Options canceled/expired 106 (4,127,967) 100 (8,734,492) 97 (14,604,445)
Balance at December 31 $100 157,661,257 $ 95 207,663,223 $ 91 236,070,040
Exercisable at December 31 $100 144,092,169 $ 95 177,318,905 $ 92 176,962,180
During the year ended December 31, 2007, the company did not grant any stock options with exercise prices greater than the stock price at
the date of grant. During the years ended December 31, 2006 and 2005, the company granted approximately 0.5 million and 12.5 million stock
options, respectively, with exercise prices greater than the stock price at the date of grant. These stock options had weighted-average exercise
prices of $91 and $100 for the years ended December 31, 2006 and 2005, respectively, and are included in the table above.