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:

	Three Months Ended March 31, 2014
	Shares		Weighted Average Exercise Price
Outstanding, beginning of year	402,139		$	13.79
Granted	29,389		16.08
Exercised	(6,500	)	9.24
Forfeited or expired	(37,376	)	20.12
Outstanding, period end	387,652		$	13.43
Options exercisable at period end	256,004		$	13.43
Fully vested and expected to vest	375,671		$	13.41

The following table details stock options outstanding:

	March 31, 2014		December 31, 2013
Stock options vested and currently exercisable:
Number	256,004		295,680
Weighted average exercise price	$	13.43	$	14.21
Aggregate intrinsic value	$	1,108	$	1,327
Weighted average remaining life (in years)	4.0		3.9

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. The Company recorded $41 in stock compensation expense during the three month ended March 31, 2014 and $36 in stock compensation expense during the three months ended March 31, 2013 to salaries and employee benefits. There were 29,389 options granted in the first quarter of 2014 and 2,500 options granted in the first quarter of 2013. In order to calculate the fair value of the options granted in 2014, the following weighted-average assumptions were used as of the grant dates: risk free interest rate of 2.07%, expected option life 7.0 years, expected price volatility 28.1%, and dividend yield of 2.49%. 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 2014 and beyond is estimated as follows:

Year	(in thousands)
April 2014 - December 2014	$	147
2015	189
2016	93
2017	36

During the second quarter of 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 long-term incentive plan (the “LTIP”). 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 — 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.

Also in 2013 and the first quarter of 2014, 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 LTIP. 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. The restricted stock awards vest as follows — 100% on the third anniversary of the date of grant. A total of 21,726 shares of common stock were granted in the first quarter of 2014 at a weighted average cost of $16.12 per share and 37,179 shares of common stock of the Company were granted in 2013.

A summary of changes in the Company’s nonvested restricted shares for 2014 follows:

	Restricted Shares	Weighted Average Grant Date Fair Value
Nonvested at January 1, 2014	105,283	$	12.85
Granted	21,726	16.12
Vested	—	—
Forfeited	—	—
Nonvested at March 31, 2014	127,009	$	13.41

As of March 31, 2014, there was $1,006 of total unrecognized compensation costs related to nonvested restricted stock awards granted under the 2007 Stock Incentive Plan that will be recognized over the remaining vesting period of approximately 1.9 years. The recognized compensation costs related to the 2007 Stock Incentive Plan was $234 and $105 for the first three months of 2014 and 2013 respectively.

In the first quarter of 2013, members of the Board of Directors received the fourth installment of Company common stock for their annual retainer for the previous Board year that ended on the date of the 2013 annual meeting of shareholders. In the second quarter of 2013, members of the Board of Directors received their entire annual retainer in restricted Company stock for the following Board year ended with the 2014 annual meeting of shareholders. The 2013 award vested quarterly for all directors who remained 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		Shares	Price per Share
2013	1Q	7,200	$	13.38
	2Q	26,100	$	13.79

A total of $89 and $97 was recognized as other expense in the first three months of 2014 and 2013 respectively for these grants.