Note K – Incentive Plans

Murphy utilizes cash-based and/or share-based incentive awards to supplement normal salaries as compensation for executive management and certain employees. For share-based awards that qualify for equity accounting, costs are recognized as an expense in the Consolidated Statements of Operations using a grant date fair value-based measurement method over the periods that the awards vest. For share-based awards that are required to be accounted for under liability accounting rules, costs are recognized as expense using a fair value-based measurement method over the vesting period, but expense is adjusted as necessary through the date the award value is finally determined. Total expense for liability awards is ultimately adjusted to the final intrinsic value for the award.

At the Company’s annual stockholders’ meeting held on May 9, 2018, shareholders approved replacement of the 2012 Long-Term Incentive Plan (2012 Long-Term Plan) with the 2018 Long-Term Incentive Plan (2018 Long-Term Plan). The 2018 Long-Term Plan authorizes the Committee to make grants of the Company’s Common Stock to employees in the same form as the 2012 Long-Term Plan. The new plan can be found in the Company’s Definitive Proxy statement (Definitive 14A) dated March 23, 2018. All awards on or after May 9, 2018 will be made under the 2018 Long-Term Plan.

The Company currently has outstanding incentive awards issued to certain employees under the 2017 Annual Incentive Plan, the 2012 Long-Term Plan and the 2018 Long-Term Plan. The 2017 Annual Plan authorizes the Executive Compensation Committee (the Committee) to establish specific performance goals associated with annual cash awards that may be earned by officers, executives and certain other employees. Cash awards under the 2017 Annual Plan are determined based on the Company’s actual financial and operating results as measured against the performance goals established by the Committee.

The 2018 Long-Term Plan and the 2012 Long-term Plan authorize the Committee to make grants of the Company’s Common Stock to employees. These grants may be in the form of stock options (nonqualified or incentive), stock appreciation rights (SAR), restricted stock, restricted stock units, performance units, performance shares, dividend equivalents and other stock-based incentives. The 2018 Long-Term Plan expires in 2028. A total of 6.75 million shares are issuable during the life of the 2018 Long-Term Plan, with annual grants limited to 1% of Common shares outstanding; allowed shares not granted in an earlier year may be granted in future years. Based on awards made to date, 3.4 million shares are available for grant under the 2018 Long-Term Plan at December 31, 2018. In 2018, the Company’s shareholders approved the 2018 Stock Plan for Non-Employee Directors (2018 NED Plan) that permits the issuance of restricted stock, restricted stock units and stock options or a combination thereof to the Company’s Non-Employee Directors.

The Company generally expects to issue treasury shares to satisfy future stock option exercises and vesting of restricted stock and restricted stock units.

Amounts recognized in the financial statements with respect to share-based plans are shown in the following table:



(Thousands of dollars)	2018		2017	2016
Compensation charged against income (loss) before income tax benefit	$	34,467	40,365	46,300
Related income tax benefit recognized in income		4,383	5,017	15,244

As of December 31, 2018, there were $46.5 million in compensation costs to be expensed over approximately the next five years related to unvested share-based compensation arrangements granted by the Company. Employees receive net shares, after applicable statutory withholding taxes, upon each stock option exercise and restricted stock award. Total income tax benefits realized from tax deductions related to stock option exercises under share-based payment arrangements were immaterial for the year ended December 31, 2018. There were no income tax benefits realized in either 2017 or 2016 due to no stock option exercises during those years.

Equity-Settled Awards

STOCK OPTIONS – The Committee fixes the option price of each option granted at no less than fair market value (FMV) on the date of the grant and fixes the option term at no more than seven years from such date. Each option granted to date under the 2012 Long-Term Plan has been nonqualified, with a term of seven years and an option price equal to FMV at date of grant. Under these plans, one-half of each grant is generally exercisable after two years and the remainder after three years. For stock options, the number of shares issued upon exercise is reduced for settlement of applicable statutory income tax withholdings owed by the grantee.

Note K – Incentive Plans (Contd.)

The fair value of each option award is estimated on the date of grant using the Black-Scholes pricing model based on the assumptions noted in the following table. Expected volatility is based on historical volatility of the Company’s stock and implied volatility on publicly traded at-the-money options on the Company’s stock. The Company estimates the expected term of the options granted based on historical option exercise patterns and considers certain groups of employees exhibiting different behavior. The risk-free interest rate for periods within the expected term of the option is based on the U.S. Treasury yield curve in effect at the time of grant. In 2018, in light of a shift in the peer group compensation practices, the Company ceased the inclusion of stock options and stock appreciation rights as a part of the long-term incentive compensation mix.



	2018	2017	2016

Fair value per option grant	N/A	$7.96	$5.03
Assumptions
Dividend yield	N/A	3.60%	4.00%
Expected volatility	N/A	41.00%	45.00%
Risk-free interest rate	N/A	1.97%	1.32%
Expected life	N/A	5.30 yrs.	5.20 yrs.

Changes in stock options outstanding during the last three years are presented in the following table.



	Number of Shares	Average Exercise Price

Outstanding at December 31, 2015	5,443,288	$	52.93
Granted at FMV	862,000		17.57
Exercised	–		-
Forfeited	(547,853)		44.23
Outstanding at December 31, 2016	5,757,435		48.46
Granted at FMV	603,000		28.51
Exercised	–		–
Forfeited	(1,459,166)		49.34
Outstanding at December 31, 2017	4,901,269		45.74
Granted at FMV	–		–
Exercised	(72,000)		17.57
Forfeited	(834,674)		53.36
Outstanding at December 31, 2018	3,994,595		44.66
Exercisable at December 31, 2015	3,542,352	$	52.26
Exercisable at December 31, 2016	3,830,535		53.80
Exercisable at December 31, 2017	3,197,269		54.22
Exercisable at December 31, 2018	3,182,345		49.10

Additional information about stock options outstanding at December 31, 2018 is shown below.



	Options Outstanding				Options Exercisable
Range of Exercise Prices per Option	No. of Options	Avg. Life Remaining in Years	Aggregate Intrinsic Value		No. of Options	Avg. Life Remaining in Years	Aggregate Intrinsic Value
$17.00 to $30.00	1,131,500	4.5	$	3,719,263	319,250	4	$	1,859,631
$31.00 to $50.00	817,350	2.9		–	817,350	2.9		–
$51.00 to $65.00	2,045,745	1.0		–	2,045,745	1.0		–
	3,994,595	2.4	$	3,719,263	3,182,345	1.8	$	1,859,631

Note K – Incentive Plans (Contd.)

The total intrinsic value of options exercised during 2018 was $1 million. There were no options exercised in both 2017 and 2016 as all awards either had no intrinsic value or were not vested. Intrinsic value is the excess of the market price of stock at date of exercise over the exercise price received by the Company upon exercise. Aggregate intrinsic value is nil when the exercise price of the stock option exceeds the market price of the Company’s common stock.

PERFORMANCE-BASED RESTRICTED STOCK UNITS – Performance-based restricted stock units (PSUs) to be settled in Common shares were granted in each of the last three years under the 2012 Long-Term Plan. Each grant will vest if the Company achieves specific performance objectives at the end of the designated performance period. Additional shares may be awarded if performance objectives are exceeded. If performance goals are not met, PSUs will not vest, but recognized compensation cost associated with the stock award would not be reversed. For past awards, the performance conditions were based on the Company’s total shareholder return over the performance period compared to an industry peer group of companies. During the performance period, PSUs are subject to transfer restrictions and are subject to forfeiture if a grantee terminates for reasons other than retirement, disability or death. Termination for these three reasons will lead to a pro rata award of amounts earned. No dividends are paid or voting rights exist on awards of PSUs prior to their settlement.

Changes in PSUs outstanding for each of the last three years are presented in the following table.



(Number of stock units)	2018	2017	2016
Outstanding at beginning of year	1,187,921	992,573	1,103,986
Granted	905,500	560,000	394,000
Vested and issued	(311,866)	(272,725)	(361,096)
Forfeited	(121,138)	(91,927)	(144,317)
Outstanding at end of year	1,660,417	1,187,921	992,573

The fair value of the equity-settled performance-based awards granted in each year was estimated on the date of grant using a Monte Carlo valuation model. Expected volatility was based on daily historical volatility of the Company’s stock price compared to a peer group average over a three-year period. The risk-free interest rate is based on the yield curve of three-year U.S. Treasury bonds and the stock beta was calculated using three years of historical averages of daily stock data for Murphy and the peer group. The assumptions used in the valuation of the performance awards granted in 2018, 2017 and 2016 are presented in the following table.



	2018	2017	2016

Fair value per share at grant date	$22.99 - $30.56	$24.10 – $28.28	$12.21 – $16.34
Assumptions
Expected volatility	48.00%	47.00%	33.00%
Risk-free interest rate	2.30%	1.46%	0.93%
Stock beta	1.103	1.058	0.863
Expected life	3.0 yrs.	3.0 yrs.	3.0 yrs.

Note K – Incentive Plans (Contd.)

TIME-BASED RESTRICTED STOCK UNITS – Time-based restricted stock units (RSUs) have been granted to the Company’s Non-Employee Directors under the 2013 NED Plan and to certain employees under the 2012 Long-Term Plan and 2018 Long-Term Plan. These awards vest on the third anniversary of the date of grant. The fair value of these awards was estimated based on the market value of the Company’s stock on the date of grant, which were $25.69 to $28.43 per share in 2018, $28.51 per share in 2017, and $17.57 per share in 2016.

Changes in RSUs outstanding for each of the last three years are presented in the following table.



(Number of share units)	2018	2017	2016

Outstanding at beginning of year	1,035,980	923,282	477,244
Granted	823,803	419,720	503,555
Vested and issued	(233,456)	(217,633)	(32,092)
Forfeited	(87,473)	(89,389)	(25,425)
Outstanding at end of year	1,538,854	1,035,980	923,282

EMPLOYEE STOCK PURCHASE PLAN (ESPP) – The Company had an ESPP under which the Company’s Common stock could have been purchased by eligible U.S. and Canadian employees. The plan ceased to operate in 2017. Each quarter, an eligible employee could have elected to withhold up to 10% of his or her salary to purchase shares of the Company’s stock at the end of the quarter at a price equal to 90% of the fair value of the stock as of the first day of the quarter. Employee stock purchases under the ESPP were 2,564 shares at an average price of $26.85 per share in 2017 and 8,962 shares at an average price of $23.41 per share in 2016. Compensation costs related to the ESPP were estimated based on the value of the 10% discount and the fair value of the option that provided for the refund of participant withholdings, and such expenses were immaterial for all periods presented. The fair value per share issued under the ESPP was approximately $5.34 and $2.94 for the years ended December 31, 2017 and 2016, respectively.

Cash-Settled Awards

The Company has granted stock-based incentive awards to be settled in cash to certain employees in the form of Stock Appreciation Rights (SAR), Performance-based restricted stock units (CPSU), Time-based restricted stock units (CRSU) and Phantom units.

SAR awards have terms similar to stock options. CPSU terms are similar to other performance-based restricted stock awards (PSUs). CRSUs generally settle on the third anniversary of the date of grant. Phantom units generally settle three to five years from date of grant. Each award granted is settled, net of applicable income tax withholdings, in cash rather than with Common shares. Total expense recorded in the Consolidated Statements of Operations for all cash-settled stock-based awards was $6.5 million in 2018, $12.9 million in 2017 and $17.2 million in 2016.

The Committee also administers the Company’s incentive compensation plans, which provide for annual or periodic cash awards to officers, directors and certain other employees. These cash awards are generally determinable based on the Company achieving specific financial and/or operational objectives. Compensation expense of $30 million, $30.5 million and $25.8 million was recorded in 2018, 2017 and 2016, respectively, for these plans.