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 using the fair value of the award 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. The year over year increase in expense related to performance units and stock options is primarily due to modifications to the terms of awards (see Equity Award Modifications below) and higher expected award payouts.



	Fiscal Years
(Dollars in Millions)	2017		2016		2015
Share-Based Compensation Expense
Performance Units	$	49	$	17	$	(1	)
Restricted Stock Units and Awards	15		11		11
Stock Options	22		7		—
Stock Awards for Directors	3		2		2
Total Share-based Compensation Expense	$	89	$	37	$	12
Income Tax Benefit	$	34	$	14	$	4

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 goals. 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 2015, 2016 and 2017, target performance units were granted to certain employees under three separate LTIP plans covering three-year cycles: the 2015-2017 (“2015-2017 LTIP”), 2016-2018 (“2016-2018 LTIP”) and 2017-2019 (“2017-2019 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 certain 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
	2017		2016		2015
Weighted-average grant date fair value	$	49.50	$	24.17	$	35.45
Fair value of units vested in fiscal year ending (in millions)	$	26	$	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 30, 2016	1,581		$	30.00
Granted	644		49.50
Forfeited	(530	)	38.47
Vested	(719	)	35.94
Unvested at December 31, 2017	976		$	33.90

As of December 2017, there was $24 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
	2017		2016		2015
Weighted-average grant date fair value	$	48.35	$	24.21	$	35.94
Fair value of units and awards vested during fiscal year ended (in millions)	$	8	$	14	$	9

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 30, 2016	1,076		$	28.19
Granted	328		48.35
Forfeited	(297	)	36.48
Vested	(300	)	28.09
Unvested at December 31, 2017	807		$	33.37

As of December 2017, unrecognized compensation expense for these restricted stock units and awards was approximately $7 million, which will be expensed over a weighted-average remaining period of one year.

Stock Options

Stock options were granted in 2016 and 2017 along with the corresponding LTIP plans, and to certain members of management in 2015. 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 6.5 year 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).

On March 6, 2017, the Company granted 9 million stock options to former CEO E. Hunter Harrison at a fair value of $12.88 per option. These options were granted with a ten-year term and an exercise price equal to the closing market price of the underlying stock on the date of grant. Half of the options, or 4.5 million, were to vest on Mr. Harrison's service anniversary in equal annual installments over four years. The other half were to vest based on achievement of performance targets related to both operating ratio and earnings before interest, taxes, depreciation and amortization adjusted for certain items. Upon his death on December 16, 2017, all of Mr. Harrison's 9 million options were forfeited.

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
	2017			2016			2015
Weighted-average grant date fair value	$	12.84		$	4.68		$	5.31

Stock options valuation assumptions:
Annual dividend yield	1.5		%	3		%	3		%
Risk-free interest rate	2.2		%	1		%	2		%
Annualized volatility	27.1		%	27		%	28		%
Expected life (in years)	6.3			6.5			6.5
Other pricing model inputs:
Weighted-average grant-date market price of CSX stock (strike price)	$	49.63		$	24.13		$	24.99

The stock option activity is summarized as follows:



	Stock Options Outstanding (in Thousands)		Weighted-Average Exercise Price
Outstanding at December 30, 2016	4,582		$	24.57
Granted	10,462		49.63
Forfeited	(10,860	)	46.81
Exercised	22		25.18
Outstanding at December 31, 2017	4,163		$	29.52
Exercisable at December 31, 2017	—		—

Unrecognized compensation expense related to stock options as of December 2017 was $10 million and is expected to be recognized over a weighted-average period of approximately one year.

Equity Award Modifications

The terms of performance units, restricted stock units and stock options granted as part of the Company’s long-term share-based compensation plans typically 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. As part of an enhanced severance benefit under the management streamlining and realignment initiative discussed in Note 1, unvested performance units, restricted stock units and stock options for separated employees not eligible for retirement were permitted to vest on a pro-rata basis.

Additionally, the terms of unvested equity awards for the former Chief Executive Officer, Michael J. Ward, and President, Clarence W. Gooden, were modified prior to their retirements on March 6, 2017 to permit prorated vesting through May 31, 2018. The terms were modified in exchange for each agreeing to serve in an advisory capacity upon request until May 31, 2017, and waiving various rights and claims, including the cancellation of their respective change of control agreements with the Company.

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

The award modifications noted above impacted approximately 75 employees and resulted in an increase to share-based compensation expense for revaluation of the affected awards of $39 million for the year ended December 31, 2017.

Stock Awards for Directors

CSX’s non-management directors receive a base annual retainer of $100,000 to be paid quarterly in cash, unless the director chooses to defer the retainer in the form of cash or 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. In March 2017, the non-management Chairman received approximately $250,000 in the form of CSX stock valued on the third day after E. Hunter Harrison was named Chief Executive Officer and new Board members were announced.