Stock-Based Compensation

Our employees may be granted awards under Integrys Energy Group’s stock-based compensation plans. Compensation cost associated with these awards is allocated to us based on the percentages used for allocation of the award recipients’ labor costs.

The following table reflects the stock-based compensation expense and the related deferred income tax benefit recognized in income for the three and nine months ended September 30:



	Three Months Ended September 30				Nine Months Ended September 30
(Millions)	2014		2013		2014		2013
Stock options	$	0.1	$	0.2	$	0.4	$	0.5
Performance stock rights	0.1		0.4		3.9		1.7
Restricted share units	0.7		0.8		2.7		2.6
Total stock-based compensation expense	$	0.9	$	1.4	$	7.0	$	4.8
Deferred income tax benefit	$	0.4	$	0.6	$	2.8	$	1.9

No stock-based compensation cost was capitalized during the three and nine months ended September 30, 2014, and 2013.

Stock Options

The fair value of stock option awards granted is estimated using a binomial lattice model. The expected term of option awards is derived from the output of the binomial lattice model and represents the period of time that options are expected to be outstanding. The risk-free interest rate is based on the United States Treasury yield curve. The expected dividend yield incorporates the current and historical dividend rate of Integrys Energy Group's common stock. The expected stock price volatility is estimated using its 10-year historical volatility. The following table shows the assumptions incorporated into the valuation model:



		February 2014 Grant
Expected term		8 years
Risk-free interest rate		0.12% – 2.88%
Expected dividend yield		5.28%
Expected volatility		18%

The weighted-average fair value per stock option granted during the nine months ended September 30, 2014, and 2013, was $6.70 and $6.03, respectively.

A summary of stock option activity for the nine months ended September 30, 2014, and information related to outstanding and exercisable stock options at September 30, 2014, is presented below:



	Stock Options		Weighted-Average Exercise Price Per Share		Weighted-Average Remaining Contractual Life (in Years)	Aggregate Intrinsic Value (Millions)
Outstanding at December 31, 2013	49,993		$	53.03
Granted	13,890		55.23
Exercised	(17,333	)	51.48
Outstanding at September 30, 2014	46,550		$	54.26	8.2	$	0.5
Exercisable at September 30, 2014	9,270		$	52.15	7.2	$	0.1

The aggregate intrinsic value for outstanding and exercisable options in the above table represents the total pre-tax intrinsic value that would have been received by the option holders had they all exercised their options on September 30, 2014. This is calculated as the difference between Integrys Energy Group’s closing stock price on September 30, 2014, and the option exercise price, multiplied by the number of in-the-money stock options. The intrinsic value of options exercised during the nine months ended September 30, 2014, and 2013, was not significant.

Effective October 24, 2014, Integrys Energy Group's Board of Directors accelerated the vesting of all unvested stock options held by active employees in order to mitigate the tax impacts of Section 280G of the Internal Revenue Code on us and certain of our employees. All stock options awarded to active employees also became exercisable as of this date. As a result of this modification, an insignificant amount of unrecognized compensation expense related to unvested and outstanding stock options at September 30, 2014, will be recognized in the fourth quarter of 2014.

Performance Stock Rights

The fair values of performance stock rights are estimated using a Monte Carlo valuation model. The risk-free interest rate is based on the United States Treasury yield curve. The expected dividend yield incorporates the current and historical dividend rate of Integrys Energy Group's common stock. The expected volatility is estimated using one to three years of historical data. The table below reflects the assumptions used in the valuation of the outstanding grants at September 30:



		2014
Risk-free interest rate		0.06% – 0.60%
Expected dividend yield		5.28% – 5.33%
Expected volatility		17% – 23%

A summary of the activity for the nine months ended September 30, 2014, related to performance stock rights accounted for as equity awards is presented below:



	Performance Stock Rights		Weighted-Average Fair Value ⁽²⁾
Outstanding at December 31, 2013	5,561		$	45.16
Granted	1,113		44.28
Award modifications ⁽¹⁾	2,295		85.09
Adjustment for shares not distributed	(3,347	)	41.90
Outstanding at September 30, 2014	5,622		$	63.23

⁽¹⁾

Six months prior to the end of the performance period, employees can no longer change their election to defer the value of their performance stock rights into the deferred compensation plan. As a result, any awards not elected for deferral at this point in the performance period will be settled in Integrys Energy Group's common stock. This changes the classification of these awards from a liability award to an equity award. The change in classification is accounted for as an award modification.


⁽²⁾	Reflects the weighted-average fair value used to measure equity awards. Equity awards are measured using the grant date fair value or the fair value on the modification date.

The weighted-average grant date fair value of performance stock rights awarded during the nine months ended September 30, 2014, and 2013, was $44.28 and $48.50 per performance stock right, respectively.

A summary of the activity for the nine months ended September 30, 2014, related to performance stock rights accounted for as liability awards is presented below:



	Performance Stock Rights
Outstanding at December 31, 2013	9,222
Granted	4,440
Award modifications *	(2,295	)
Adjustment for shares not distributed	(379	)
Outstanding at September 30, 2014	10,988

The weighted-average fair value of all outstanding performance stock rights accounted for as liability awards as of September 30, 2014, was $77.97 per performance stock right.

No shares of Integrys Energy Group's common stock were distributed for performance stock rights during the nine months ended September 30, 2014, because the performance percentage was below the threshold payout level for those rights that were eligible for distribution. The total intrinsic value of shares distributed during the nine months ended September 30, 2013, was not significant.

Effective October 24, 2014, Integrys Energy Group's Board of Directors approved the acceleration of the distribution of certain performance stock rights held by active employees. For those performance stock rights with a performance period ending December 31, 2014, a portion of the estimated distribution will be made in December 2014. This change was made to help mitigate the tax impacts of Section 280G of the Internal Revenue Code on us and certain of our employees.

As of September 30, 2014, $1.9 million of compensation cost related to unvested and outstanding performance stock rights (equity and liability awards) was expected to be recognized over a weighted-average period of 1.4 years.

Restricted Share Units

A summary of the activity related to all restricted share unit awards (equity and liability awards) for the nine months ended September 30, 2014, is presented below:



	Restricted Share Unit Awards		Weighted-Average Grant Date Fair Value
Outstanding at December 31, 2013	67,741		$	52.06
Granted	28,725		55.23
Dividend equivalents	2,262		54.46
Vested and released	(28,325	)	49.50
Transfers	332		54.55
Forfeited	(804	)	54.64
Outstanding at September 30, 2014	69,931		$	54.46

The weighted-average grant date fair value of restricted share units awarded during the nine months ended September 30, 2014, and 2013, was $55.23 and $56.05 per unit, respectively.

The total intrinsic value of restricted share unit awards vested and released during the nine months ended September 30, 2014, and 2013, was

$1.5 million and $1.6 million, respectively. The actual tax benefit realized for the tax deductions from the vesting and release of restricted share units during the nine months ended September 30, 2014, and 2013, was not significant.

As of September 30, 2014, $3.9 million of compensation cost related to unvested and outstanding restricted share units was expected to be recognized over a weighted-average period of 2.3 years.