Stock Plans and Share-Based Compensation

Under CSX's share-based compensation plans, awards consist of performance units, restricted stock units, restricted stock awards and stock options for management and stock grants for directors. Awards granted under the various programs are determined and approved by the Compensation Committee of the Board of Directors or, in certain circumstances, by the Chief Executive Officer for awards to management employees other than senior executives. The Board of Directors approves awards granted to the Company’s non-management directors upon recommendation of the Governance Committee.

Share-based compensation expense is measured at fair value of the Company’s stock on the grant date and is recognized on a straight-line basis over the service period of the respective award. Forfeitures are recognized as they occur. Total pre-tax expense associated with share-based compensation and its related income tax benefit is shown in the table below.



	Fiscal Years
(Dollars in Millions)	2016		2015			2014
Share-Based Compensation Expense
Performance Units	$	17	$	(1	)	$	20
Restricted Stock Units and Awards	11		11			11
Stock Options	7		—			—
Stock Awards for Directors	2		2			2
Total Share-based Compensation Expense	$	37	$	12		$	33
Income Tax Benefit	$	14	$	4		$	13

Long-term Incentive Plans

The CSX Long-term Incentive Plans (“LTIP”) were adopted under the 2010 CSX Stock and Incentive Award Plan. The objective of these plans is to motivate and reward certain employees for achieving and exceeding certain financial and strategic initiatives. Grants were made in performance units, with each unit being equivalent to one share of CSX common stock, and payouts will be made in CSX common stock. The payout range for participants will be between 0% and 200% of the target awards depending on Company performance against predetermined goals for each three-year cycle. In 2014, 2015 and 2016, target performance units were granted to certain employees under three separate LTIP plans covering three-year cycles: the 2014-2016 (“2014-2016 LTIP”), 2015-2017 (“2015-2017 LTIP”) and 2016-2018 (“2016-2018 LTIP”) plans (collectively, the “plans”).

The key financial targets for the plans will be based on the achievement of goals related to both operating ratio and return on assets (tax-adjusted operating income divided by net property) excluding non-recurring items as disclosed in the Company's financial statements. The three-year cumulative operating ratio and average return on assets over the performance period will each comprise 50% of the payout and are measured independently of the other. The plans state that payouts for certain executive officers are subject to downward adjustment by up to 30% based upon total shareholder return relative to specified comparable groups.

NOTE 4. Stock Plans and Share-Based Compensation, continued

Performance unit grant and vesting information is summarized as follows:



	Fiscal Years
	2016		2015		2014
Weighted-average grant date fair value	$	24.17	$	35.45	$	28.13
Fair value of units vested in fiscal year ending (in millions)	$	31	$	34	$	—

The performance unit activity related to the outstanding long-term incentive plans and corresponding fair value is summarized as follows:



	Performance Units Outstanding (in Thousands)		Weighted-Average Fair Value at Grant Date
Unvested at December 25, 2015	1,941		$	31.73
Granted	852		24.17
Forfeited	(118	)	29.22
Vested	(1,094	)	28.60
Unvested at December 30, 2016	1,581		$	30.00

As of December 2016, there was $18 million of total unrecognized compensation cost related to performance units that is expected to be recognized over a weighted-average period of approximately two years.

Restricted Stock Grants

Restricted stock grants consist of units and awards, each equivalent to one share of CSX stock. Restricted stock units are issued along with corresponding LTIP plans and vest three years after the date of grant. Separately, restricted stock awards generally vest over an employment period of up to five years. Participants receive cash dividend equivalents on the unvested shares during the restriction period. These awards are time-based and not based upon CSX’s attainment of operational targets.

Restricted stock grant and vesting information is summarized as follows:



	Fiscal Years
	2016		2015		2014
Weighted-average grant date fair value	$	24.21	$	35.94	$	28.08
Fair value of units and awards vested during fiscal year ended (in millions)	$	14	$	9	$	11

NOTE 4. Stock Plans and Share-Based Compensation, continued

The restricted stock activity related to the outstanding long-term incentive plans and corresponding fair value is summarized as follows:



	Restricted Stock Units and Awards Outstanding (in Thousands)		Weighted-Average Fair Value at Grant Date
Unvested at December 25, 2015	1,157		$	28.66
Granted	509		24.21
Forfeited	(52	)	28.19
Vested	(538	)	25.44
Unvested at December 30, 2016	1,076		$	28.19

As of December 2016, unrecognized compensation expense for these restricted stock units and awards was approximately $13 million, which will be expensed over a weighted-average remaining period of two years.

Stock Options

Stock options were granted in 2016 along with the corresponding LTIP plan and in 2015 to certain members of management. No stock options were granted in 2014. Under this program, an employee receives an award that provides the opportunity in the future to purchase CSX shares at the closing market price of the stock on the date the award is granted (the strike price). The options become exercisable after a three-year vesting period and expire 10 years from the grant date if they are not exercised.

The fair value of stock options granted was estimated as of the dates of grant using the Black-Scholes-Merton option model which uses the following assumptions: dividend yield, risk-free interest rate, annualized volatility and expected life. The annual dividend yield is based on the most recent quarterly CSX dividend payment annualized. The risk-free interest rate is based on U.S. Treasury yield curve in effect at the time of grant. The annualized volatility is based on historical volatility of daily CSX stock price returns over a 6.5year look-back period ending on the grant date. The expected life is calculated using the safe harbor approach due to lack of historical data on CSX options, which is the midpoint between the vesting schedule (three year cliff) and contractual term (10 years).

NOTE 4. Stock Plans and Share-Based Compensation, continued

Assumptions and inputs used to estimate fair value of stock options are summarized as follows:



	Fiscal Years
	2016			2015
Weighted-average grant date fair value	$	4.68		$	5.31

Stock options valuation assumptions:
Annual dividend yield	3		%	3		%
Risk-free interest rate	1		%	2		%
Annualized volatility	27		%	28		%
Expected life (in years)	6.5			6.5
Other pricing model inputs:
Weighted-average grant-date market price of CSX stock (strike price)	$	24.13		$	24.99

The stock option activity is summarized as follows:



	Stock Options Outstanding (in Thousands)		Weighted-Average Exercise Price
Outstanding at December 25, 2015	2,514		$	24.99
Granted	2,383		24.13
Forfeited	(316	)	24.63
Outstanding	4,582		$	24.57
Exercisable at December 30, 2016	—		—

Unrecognized compensation expense related to stock options as of December 2016 was $15 million and is expected to be recognized over a weighted-average period of approximately two years.

The terms of performance units, restricted stock units and stock options all require participants to be employed through the final day of the respective performance or vesting periods as applicable, except in the case of death, disability or retirement.

Stock Awards for Directors

CSX’s non-management directors receive a base annual retainer of $90,000 to be paid quarterly in cash, unless the director chooses to receive the retainer in the form of CSX common stock. Additionally, non-management directors receive an annual grant of common stock in the amount of approximately $150,000, with the number of shares to be granted based on the average closing price of CSX stock in the months of November, December and January.