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Stock-based Compensation Plans
 9 Months Ended
Sep. 30, 2021
Share-based Payment Arrangement [Abstract]  
Stock-based Compensation Plans Stock-Based Compensation Plans
Periods Prior to Separation
Prior to the Separation, certain of the Company's employees participated in stock-based compensation plans sponsored by Merck. Under these plans Merck granted restricted stock units ("RSUs") and performance share units ("PSUs") to certain management level employees. In addition, employees and non-employee directors of Merck were granted options to purchase shares of Merck’s common stock at the fair market value at the time of grant.
Through the date of the Separation, Merck's stock-based compensation expense related to the Company’s employees was determined on a specific identification basis for employees transferred from Merck as well as on a proportional cost allocation method based on revenue. This expense has been recognized in the Condensed Consolidated Statement of Income for the nine months ended September 30, 2021. For the three and nine months ended September 30, 2020, Merck’s corporate employee stock-based compensation expense was allocated to the Company on the proportional cost allocation method and recognized in the Condensed Consolidated Statement of Income for those respective periods.
As of Separation Date and Periods Post Separation
In connection with the Separation, and in accordance with the EMA, Organon's employees with outstanding former Merck stock-based awards received replacement stock-based awards under the 2021 Incentive Stock Plan at Separation. The ratio used to convert the Merck stock-based awards was designed to preserve the aggregate intrinsic value of the award immediately after the Separation when compared to the aggregate intrinsic value of the award immediately prior to Separation. Due to the conversion, Organon incurred $17 million of incremental stock-based compensation expense. Of this amount, $4 million was related to vested option awards and was recognized during the second quarter of 2021 and the remainder is recognized ratably over the option awards' remaining weighted average vesting period of 2.66 years. Through September 30, 2021, $1.6 million was expensed. At September 30, 2021, the unrecognized portion of the incremental stock-based expense was $11.4 million.
Effective June 3, 2021, Organon established the 2021 Incentive Stock Plan (the "Plan"). A total of 35,000,000 shares of common stock are authorized under the Plan. The plan provides for the grant of various types of awards including restricted stock unit awards, stock appreciation rights, stock options, performance-based awards and cash awards. Under the Plan, the exercise price of awards, if any, is set on the grant date and may not be less than the fair market value per share on that date. Generally, stock options have a term of ten years and a three-year vesting period, subject to limited exceptions.

The Company measures stock-based compensation for equity awards at fair value on the date of grant and records stock-based compensation as a charge to earnings net of the estimated impact of forfeited awards. Accordingly, the Company recognizes stock-based compensation cost only for those stock-based awards that are estimated to ultimately vest over their requisite service period, based on the vesting provisions of the individual grants. The cumulative effect on current and prior periods of a change in the estimated forfeiture rate is recognized as compensation cost in earnings in the period of the change.
On August 17, 2021, the Company granted 379,000 stock option awards and 120,000 performance share units under the Plan. The terms of the Company's performance share units allow the recipients of such awards to earn a variable number of shares based on total shareholder return of the Company relative to an index of peer companies ("relative TSR"), specified in the awards. For performance share units with a market-based relative TSR goal, stock-based compensation expense is recognized based on the estimated fair value of the award at the grant date regardless of the actual number of shares earned.
Stock-based compensation expense incurred by the Company as a stand alone entity is reflected below for the three months ended September 30, 2021. In addition, total direct and allocated stock-based compensation expense for the nine months ended September 30, 2021, the allocated stock-based compensation expense for the three and nine months ended September 30, 2020 and the respective income tax benefits recognized by the Company in the Condensed Consolidated Statement of Income are as follows:
Three Months Ended September 30,Nine Months Ended September 30,
($ in millions)2021202020212020
Stock-based compensation expense$15 $11 $44 $32 
Income tax benefits3 2 9 7 
Of the total stock-based compensation expense for the three months ended September 30, 2021, $3 million, $10 million and $2 million was recognized in Cost of sales, Selling, general and administrative expense, and Research and development expense, respectively. For the three months ended September 30, 2020, $5 million was recorded in both Cost of sales and Selling, general and administrative and the remainder was recognized in Research and Development.
Of the total stock based compensation expense for nine months ended September 30, 2021, $8 million, $26 million and $10 million was recognized in Cost of sales, Selling, general and administrative expense, and Research and development, respectively. For the nine months ended September 30, 2020, $14 million was recorded in both Cost of Sales and Selling, general and administrative expense and the remainder was recognized in Research and development expense.
As noted above, and in connection with the Separation, Merck's PSUs and RSUs were converted into 3.3 million Organon RSUs at a weighted average grant date fair value of $36.77 and Merck's stock options were converted into 4.1 million Organon stock options at a weighted average grant date fair value of $8.55. Stock options at Separation were valued using a combination of option models. The Company used the Black-Scholes model as the basis for the original fair value of the options, and the Hull-White I Lattice option pricing model calculated the incremental fair value. In applying these models, the Company used both historical data and current market data to estimate the fair value of its options. The Black-Scholes model assumptions include expected dividend yield, risk-free interest rate, volatility, and term of the options. The Hull-White I Lattice model requires several assumptions including expected exercise barrier, dividend yield, risk-free interest rate, remaining vesting life and remaining contractual life. These fair value assumptions were based on the awards and terms previously granted under the Merck incentive compensation plans to Organon employees.
In connection with the stock options grant during the third quarter of 2021, the Company used the Black-Scholes model to determine the fair value of the stock options as of the grant date using the following assumptions:
Three Months Ended September 30, 2021
Expected dividend yield3.22 %
Risk-free interest rate0.92 %
Expected volatility45.80 %
Expected life (years)5.89
A summary of the transactions under the 2021 Incentive Stock Plan as of September 30, 2021 follows:
Stock OptionsRestricted Share UnitsPerformance Share Units
(shares in thousands)SharesWeighted average exercise priceWeighted average grant date fair valueSharesWeighted average grant date fair valueSharesWeighted average grant date fair value
Outstanding as of June 2, 20214,097 $34.30 $8.55 3,311 $36.77 — $— 
Granted379 $35.38 $11.20 56 $35.38 120 $51.63 
Vested/Exercised— $— $— (43)$38.83 — $— 
Forfeited/Cancelled(53)$36.61 $9.11 (42)$36.59 — $— 
Outstanding as of September 30, 2021
4,423 $34.36 $8.63 3,282 $36.72 120 $51.63 
The following table summarizes information about equity awards outstanding that are vested and expected to vest and equity awards outstanding that are exercisable at September 30, 2021:
Equity Awards Vested and Expected to VestEquity Awards That are Exercisable
(shares in thousands; aggregate intrinsic value in millions)AwardsWeighted Average Exercise PriceAggregate Intrinsic ValueRemaining TermAwardsWeighted Average Exercise PriceAggregate Intrinsic ValueRemaining Term
Stock Options4,162 $34.39 $5 8.291,454 $30.66 $5 5.90
Restricted Share Units3,016 — 108 2.18— — — — 
Performance Share Units201 — 8 2.88— — — — 
The amount of unrecognized compensation costs as of September 30, 2021 was $125 million, which will be recognized in operating expense ratably over the weighted average vesting period of 2.27 years.