Share-Based Compensation

Under CSX's share-based compensation plans, awards consist of performance units, restricted stock awards, restricted stock units 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 CSX's non-management directors upon recommendation of the Governance Committee.

In May 2018, shareholders approved the 2018 CSX Employee Stock Purchase Plan (“ESPP”) for the benefit of Company employees. The Company registered 4 million shares of common stock that may be issued pursuant to this plan. Under the ESPP, employees may contribute between 1% and 10% of base compensation, after-tax, to purchase up to $25,000 of CSX common stock per year. No shares will be issued under the ESPP until first quarter 2019.

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. 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 decrease in third quarter share-based compensation expense is primarily due to the prior year expense related to 9 million stock options granted in February 2017 to former President and CEO E. Hunter Harrison, which were forfeited upon his death in December 2017. Additionally, the decrease in nine months expense was also due to modifications to the terms of awards in the first and second quarters of 2017 (see Equity Award Modifications below).



	Third Quarters				Nine Months
(Dollars in millions)	2018		2017		2018		2017

Share-Based Compensation Expense:
Performance Units	$	8	$	3	$	22	$	41
Stock Options	4		14		10		47
Restricted Stock Units and Awards	1		2		4		11
Stock Awards for Directors	—		—		2		2
Total Share-Based Compensation Expense	$	13	$	19	$	38	$	101
Income Tax Benefit	$	6	$	12	$	23	$	41

Long-term Incentive Plan

In February 2018, the Company granted approximately 350 thousand performance units to certain employees under a new long-term incentive plan ("LTIP") for the years 2018 through 2020, which was adopted under the CSX Stock and Incentive Award Plan. During third quarter 2018, there were immaterial grants of performance units to certain members of management. No performance units were granted during third quarter 2017.

Payouts of performance units for the cycle ending with fiscal year 2020 will be based on the achievement of goals related to both operating ratio and free cash flow, in each case excluding non-recurring items as disclosed in the Company's financial statements. The final year operating ratio and cumulative free cash flow over the plan period will each comprise 50% of the payout and will be measured independently of the other.

NOTE 3. Share-Based Compensation, continued

Grants were made in performance units, with each unit representing the right to receive 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. Payouts for certain executive officers are subject to upward or downward adjustment by up to 25%, capped at an overall payout of 200%, based upon the Company's total shareholder return relative to specified comparable groups over the performance period. The fair value of the performance units awarded during the quarter and nine months ended September 30, 2018 was calculated using a Monte-Carlo simulation model with the following weighted-average assumptions:



	Third Quarter		Nine Months
	2018		2018
Weighted-average assumptions used:
Annual dividend yield	1.2	%	1.6	%
Risk-free interest rate	2.7	%	2.3	%
Annualized volatility	27.9	%	29.1	%
Expected life (in years)	2.3		2.9

Stock Options

Also, in February 2018, the Company granted approximately 950 thousand stock options along with the corresponding LTIP. The fair value of stock options on the date of grant was $14.55 per option which was calculated using the Black-Scholes valuation model. Stock options have been granted with ten-year terms and vest three years after the date of grant. The exercise price for stock options granted equals the closing market price of the underlying stock on the date of grant. These awards are time-based and are not based upon attainment of performance goals. During third quarter 2018, there were immaterial grants of stock options to certain members of management. No stock options awards were granted during third quarter 2017.

The fair values of all stock option awards during the quarter and nine months ended September 30, 2018 and September 30, 2017 were estimated at the grant date with the following weighted average assumptions:



	Third Quarters						Nine Months
	2018			2017			2018			2017
Weighted-average grant date fair value	$	20.52		$	—		$	14.65		$	12.83

Stock options valuation assumptions:
Annual dividend yield	1.2		%	—		%	1.5		%	1.5		%
Risk-free interest rate	2.8		%	—		%	2.6		%	2.2		%
Annualized volatility	25.5		%	—		%	27.0		%	27.1		%
Expected life (in years)	6.5			—			6.5			6.3

Other pricing model inputs:
Weighted-average grant-date market price of CSX stock (strike price)	$	74.84		$	—		$	54.19		$	49.60

NOTE 3. Share-Based Compensation, continued

Restricted Stock Units

Finally, in February 2018, the Company granted approximately 85 thousand restricted stock units along with the corresponding LTIP. The restricted stock units vest three years after the date of grant. Participants receive cash dividend equivalents on the unvested shares during the restriction period. These awards are time-based and are not based upon attainment of performance goals. For information related to the Company's other outstanding long-term incentive compensation, see CSX's most recent annual report on Form 10-K. During third quarter 2018, there were immaterial grants of restricted stock units to certain members of management. No restricted stock units were granted during third quarter 2017.

Equity Award Modifications

In 2017, 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 former President, Clarence W. Gooden, were modified prior to their retirements on March 6, 2017 to permit prorated vesting through May 31, 2018. These award modifications impacted approximately 70 employees and resulted in an increase to share-based compensation expense for revaluation of the affected awards of $31 million for the nine months ended September 30, 2017. The expense associated with these award modifications was included in the 2017 restructuring charge. No significant award modifications took place in 2018 or in third quarter 2017.