NOTE 2 — STOCK PLANS AND STOCK BASED COMPENSATION

From time to time, common stock and options to buy common stock are granted to directors and officers of the Company under the MainSource Financial Group, Inc. 2007 Stock Incentive Plan (the “2007 Stock Incentive Plan”), which was adopted and approved by the Board of Directors of the Company on January 16, 2007. The plan was effective upon the approval of the plan by the Company’s shareholders, which occurred on April 26, 2007 at the Company’s annual meeting of shareholders. The 2007 Stock Incentive Plan provides for the grant of incentive stock options, nonstatutory stock options, stock bonuses and restricted stock awards. Incentive stock options may be granted only to employees. An aggregate of 650,000 shares of common stock are reserved for issuance under the 2007 Stock Incentive Plan. Shares issuable under the 2007 Stock Incentive Plan will be authorized from unissued shares of common stock or treasury shares. The 2007 Stock Incentive Plan is in addition to, and not in replacement of, the MainSource Financial Group, Inc. 2003 Stock Option Plan (“the 2003 Option Plan”), which was approved by the Company’s Board of Directors on January 21, 2003, and was effective upon approval by the Company’s shareholders on April 23, 2003. The 2003 Option Plan provided for the grant of up to 607,754 incentive and nonstatutory stock options. Upon the approval of the 2007 Stock Incentive Plan, no further awards of options may be made under the 2003 Option Plan. Unexercised options which were previously issued under the 2003 Option Plan have not been terminated, but will otherwise continue in accordance with the 2003 Option Plan and the agreements pursuant to which the options were issued. All stock options granted under either the 2003 Option Plan or the 2007 Stock Incentive Plan have an exercise price that is at least equal to the fair market value of the Company’s common stock on the date the options were granted. The maximum option term is ten years, and options vest immediately for the directors’ grant and over four years for the officers’ grant, except as otherwise determined by the Executive Compensation Committee of the Board of Directors.

All share-based payments to employees, including grants of employee stock options, are recognized as compensation expense over the service period (generally the vesting period) in the consolidated financial statements based on their fair values. For options with graded vesting, the Company values the stock option grants and recognizes compensation expense as if each vesting portion of the award was a single award.

The following table summarizes stock option activity:

	Nine Months Ended September 30, 2013
	Shares		Weighted Average Exercise Price
Outstanding, beginning of year	433,132		$	13.06
Granted	52,283		13.66
Exercised	(45,224	)	8.16
Forfeited or expired	(40,552	)	12.68
Outstanding, period end	399,639		$	13.73
Options exercisable at period end	268,246		$	14.53
Fully vested and expected to vest	389,024		$	13.76

The following table details stock options outstanding:

	September 30, 2013		December 31, 2012
Stock options vested and currently exercisable:
Number	268,246		344,722
Weighted average exercise price	$	14.53	$	13.53
Aggregate intrinsic value	$	809	$	826
Weighted average remaining life (in years)	3.7		4.1

The intrinsic value for stock options is calculated based on the exercise price of the underlying awards and the market price of our common stock as of the reporting date for those options where the exercise price is less than the market price. The Company recorded $26 and $98 in stock compensation expense during the three and nine month period ended September 30, 2013 and $43 and $91 in stock compensation expense during the three and nine month period ended September 30, 2012 to salaries and employee benefits. There were 2,500 options granted in the first quarter of 2013 and 49,783 options granted in the second quarter of 2013. In order to calculate the fair value of the options granted in 2013, the following weighted-average assumptions were used as of the grant dates: risk free interest rate of 1.25%, expected option life 7.0 years, expected price volatility 34.5%, and dividend yield of 1.76%. The fair value of each stock option granted is estimated on the date of grant using the Black-Scholes based stock option valuation model. This model requires the input of subjective assumptions that will usually have a significant impact on the fair value estimate. Expected volatilities are based on historical volatility of the Company’s stock, and other factors. Expected dividends are based on dividend trends and the market price of the Company’s stock price at grant. The Company uses historical data to estimate option exercises within the valuation model. The risk-free rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of grant.

Unrecognized stock option compensation expense related to unvested awards for the remainder of 2013 and beyond is estimated as follows:

Year	(in thousands)
October 2013 - December 2013	$	64
2014	162
2015	157
2016	59

During the second quarters of 2012 and 2013, the Executive Compensation Committee of the Board of Directors of the Company granted restricted stock awards in lieu of cash awards to certain executive officers pursuant to the Company’s annual performance-based incentive bonus plan. Compensation expense is recognized over the vesting period of the awards based on the fair value of the stock at the issue date. The value of the awards was determined by multiplying the award amount by the closing price of a share of Company common stock on the grant date, April 10, 2013 ($13.67) and April 25, 2012 ($11.85). The restricted stock awards vest as follows — 80% on the second anniversary of the date of grant and 20% on the third anniversary of the date of grant. A total of 10,792 shares of common stock of the Company were granted in 2013 and 48,061 shares of common stock were granted in 2012.

Also in 2013, the Executive Compensation Committee of the Board of Directors of the Company granted restricted stock awards to certain executive officers and other employees pursuant to the Company’s annual performance-based incentive stock plan. Compensation expense is recognized over the vesting period of the awards based on the fair value of the stock at the issue date. The value of the awards was determined by multiplying the award amount by the closing price of a share of Company common stock on the grant date, April 10, 2013 ($13.67). The restricted stock awards vest as follows — 100% on the third anniversary of the date of grant. A total of 24,888 shares of common stock of the Company were granted in 2013.

Total compensation expense for the restricted stock grants was $157 and $403 for the three and nine month periods ended September 30, 2013. The compensation expense for the three and nine month periods ended September 30, 2012 was $91 and $220.

A summary of changes in the Company’s nonvested shares for the first nine months of 2013 follows:

	Shares	Weighted Average Grant Date Fair Value

Nonvested at January 1, 2013	94,305	10.79

Granted	35,680	$	13.67

Vested	36,993	10.68

Forfeited	0	0

Nonvested at September 30, 2013	92,992	$	12.90

As of September 30, 2013, there were $851 of total unrecognized compensation costs related to nonvested restricted stock awards granted under the 2007 Plan that will be recognized over the remaining vesting period of approximately 1.4 years.

During the second quarter of 2011, members of the Board of Directors of the Company were given the option of having their retainer paid in cash, Company stock, or a combination of cash and stock. The retainer was paid quarterly, on May 1, August 1, and November 1, 2011, and February 1, 2012, for all directors serving on the Board on those dates. During the second quarter of 2012, members of the Board of Directors of the Company were also given the option of having their retainer paid in cash, Company stock, or a combination of cash and stock. The retainer was paid quarterly on May 1, August 1, and November 1, 2012, and February 1, 2013, for all directors serving on the Board on those dates. The value of the quarterly awards paid in stock was determined by multiplying the award amount by the average closing price of a share of Company common stock on the five trading days prior to the issuance of the stock.

In the second quarter of 2013, members of the Board of Directors received their entire annual retainer in Company stock for the following year. The 2013 award vests quarterly for all directors who remain on the Board of Directors on the vesting date, with 25% of the award vesting on each of May 1, August 1, and November 1, 2013, and February 1, 2014. The value of the 2013 retainer award was determined by multiplying the award amount by the closing price of the stock on the issuance date.

For all awards, other expense is recognized over the three month period of the awards based on the fair value of the stock at the issue dates. Shares awarded by quarter were as follows:

Quarter	Year	Shares	Price Per Share
1Q	2012	8,750	$	9.29
2Q	2012	7,200	$	11.83
3Q	2012	7,200	$	11.58
4Q	2012	7,200	$	12.25
1Q	2013	7,200	$	13.38
2Q	2013	26,100	$	13.79