Stock-based Compensation

9 Months Ended

Sep. 30, 2021

4. Stock-Based Compensation

We have several stock-based compensation plans where employees receive nonvested stock options, nonvested retention shares, and nonvested stock units. We refer to the nonvested shares and stock units collectively as “retention awards”. Employees are also able to participate in our employee stock purchase plan (ESPP). We issue treasury shares to cover option exercises, stock unit vestings, and ESPP shares, while new shares are issued when retention shares are granted.

Information regarding stock-based compensation appears in the table below:



	Three Months Ended				Nine Months Ended
	September 30,				September 30,
Millions	2021		2020		2021		2020
Stock-based compensation, before tax:
Stock options	$	4	$	4	$	12	$	12
Retention awards		16		13		50		45
ESPP		4		-		4		-
Total stock-based compensation, before tax	$	24	$	17	$	66	$	57
Excess tax benefits from equity compensation plans	$	1	$	16	$	18	$	51

Stock Options – We estimate the fair value of our stock option awards using the Black-Scholes option pricing model. The table below shows the annual weighted-average assumptions used for valuation purposes:



Weighted-Average Assumptions	2021		2020
Risk-free interest rate		0.4%		1.5%
Dividend yield		1.9%		2.1%
Expected life (years)		4.6		4.9
Volatility		28.3%		23.4%
Weighted-average grant-date fair value of options granted	$	39.97	$	32.20

The risk-free rate is based on the U.S. Treasury yield curve in effect at the time of grant; the expected dividend yield is calculated as the ratio of dividends paid per share of common stock to the stock price on

the date of grant; the expected life is based on historical and expected exercise behavior; and expected volatility is based on the historical volatility of our stock price over the expected life of the option.

A summary of stock option activity during the nine months ended September 30, 2021, is presented below:



	Options (thous.)	Weighted-Average ‎Exercise Price		Weighted-Average Remaining Contractual Term		Aggregate Intrinsic Value (millions)
Outstanding at January 1, 2021	2,569	$	132.49	6.4	yrs.	$	195
Granted	387		204.45		N/A		N/A
Exercised	(356)		121.82		N/A		N/A
Forfeited or expired	(90)		159.45		N/A		N/A
Outstanding at September 30, 2021	2,510	$	144.13	6.2	yrs.	$	133
Vested or expected to vest at September 30, 2021	2,486	$	143.82	6.2	yrs.	$	133
Options exercisable at September 30, 2021	1,731	$	123.54	5.1	yrs.	$	125

Stock options are granted at the closing price on the date of grant, have 10 year contractual terms, and vest no later than 3 years from the date of grant. None of the stock options outstanding at September 30, 2021, are subject to performance or market-based vesting conditions.

At September 30, 2021, there was $18 million of unrecognized compensation expense related to nonvested stock options, which is expected to be recognized over a weighted-average period of 1.3 years. Additional information regarding stock option exercises appears in the following table:



	Three Months Ended				Nine Months Ended
	September 30,				September 30,

Millions	2021		2020		2021		2020
Intrinsic value of stock options exercised	$	1	$	40	$	33	$	105
Cash received from option exercises		1		29		35		80
Treasury shares repurchased for employee taxes		-		(8)		(7)		(20)
Tax benefit realized from option exercises		-		11		6		25
Aggregate grant-date fair value of stock options vested		-		-		14		14

Retention Awards – The fair value of retention awards is based on the closing price of the stock on the grant date. Dividends and dividend equivalents are paid to participants during the vesting periods.

Changes in our retention awards during the nine months ended September 30, 2021, were as follows:



	Shares ‎(thous.)	Weighted-Average ‎Grant-Date Fair Value
Nonvested at January 1, 2021	1,476	$	141.06
Granted	289		205.10
Vested	(414)		108.32
Forfeited	(53)		162.23
Nonvested at September 30, 2021	1,298	$	164.90

Retention awards are granted at no cost to the employee and vest over periods lasting up to 4 years. At September 30, 2021, there was $99 million of total unrecognized compensation expense related to nonvested retention awards, which is expected to be recognized over a weighted-average period of 1.7 years.

Performance Retention Awards – In February 2021, our Board of Directors approved performance stock unit grants. This plan is based on performance targets for annual return on invested capital (ROIC) and operating income growth (OIG) compared to companies in the S&P 100 Industries Index plus the Class I railroads. We define ROIC as net operating profit adjusted for interest expense (including interest on

average operating lease liabilities) and taxes on interest divided by average invested capital adjusted for average operating lease liabilities.

The February 2021 stock units awarded to selected employees are subject to continued employment for 37 months, the attainment of certain levels of ROIC, and the relative three-year OIG. We expense two-thirds of the fair value of the units that are probable of being earned based on our forecasted ROIC over the 3-year performance period, and with respect to the third year of the plan, the remaining one-third of the fair value is subject to the relative three-year OIG. We measure the fair value of these performance stock units based upon the closing price of the underlying common stock as of the date of grant. Dividend equivalents are accumulated during the service period and paid to participants only after the units are earned.

Changes in our performance retention awards during the nine months ended September 30, 2021, were as follows:



	Shares ‎(thous.)	Weighted-Average ‎Grant-Date Fair Value
Nonvested at January 1, 2021	773	$	148.17
Granted	227		204.45
Vested	(147)		132.66
Unearned	(165)		135.57
Forfeited	(41)		183.55
Nonvested at September 30, 2021	647	$	172.41

At September 30, 2021, there was $25 million of total unrecognized compensation expense related to nonvested performance retention awards, which is expected to be recognized over a weighted-average period of 1.6 years. This expense is subject to achievement of the performance measures established for the performance stock unit grants.

Employee Share Purchase Plan – In May 2021, our shareholders approved our ESPP, to begin in July 2021, whereby employee and Company contributions are used to issue treasury shares the month after employee contributions are withheld based on the settlement date closing price. The Company matches 40% contributed by the employee up to a maximum employee contribution of 5% of monthly salary (limited to $15,000 annually). We expense the Company contributions in the month the employee services were rendered (i.e., the month the employee contributions were withheld).