Stock-based compensation

Our stock-based compensation plans primarily provide for the granting of stock options, stock-settled stock appreciation rights (SARs), restricted stock units (RSUs) and performance-based restricted stock units (PRSUs) to Officers and other key employees, as well as non-employee Directors. Stock options permit a holder to buy Caterpillar stock at the stock’s price when the option was granted. SARs permit a holder the right to receive the value in shares of the appreciation in Caterpillar stock that occurred from the date the right was granted up to the date of exercise. RSUs are agreements to issue shares of Caterpillar stock at the time of vesting. PRSUs are similar to RSUs and include performance conditions in the vesting terms of the award.

Our long-standing practices and policies specify that all stock-based compensation awards are approved by the Compensation Committee (the Committee) of the Board of Directors. The award approval process specifies the grant date, value and terms of the award. The same terms and conditions are consistently applied to all employee grants, including Officers. The Committee approves all individual Officer grants. The number of stock-based compensation award units included in an individual’s award is determined based on the methodology approved by the Committee. The exercise price methodology approved by the Committee is the closing price of the Company stock on the date of the grant. In June of 2014, shareholders approved the Caterpillar Inc. 2014 Long-Term Incentive Plan (the Plan) under which all new stock-based compensation awards are granted. In June of 2017, the Plan was amended and restated. The Plan initially provided that up to 38,800,000 Common Shares would be reserved for future issuance under the Plan, subject to adjustment in certain events. Subsequent to the shareholder approval of the amendment and restatement of the Plan, an additional 36,000,000 Common Shares became available for all awards under the Plan.

Common stock issued from Treasury stock under the plans totaled 5,590,641 for 2018, 11,139,748 for 2017 and 4,164,134 for 2016. The total number of shares authorized for equity awards under the amended and restated Caterpillar Inc. 2014 Long-Term Incentive Plan is 74,800,000, of which 44,139,162 shares remained available for issuance as of December 31, 2018.

Stock option and RSU awards generally vest according to a three-year graded vesting schedule. One-third of the award will become vested on the first anniversary of the grant date, one-third of the award will become vested on the second anniversary of the grant date and one-third of the award will become vested on the third anniversary of the grant date. PRSU awards generally have a three-year performance period and cliff vest at the end of the period based upon achievement of performance targets established at the time of grant.

Upon separation from service, if the participant is 55 years of age or older with more than five years of service, the participant meets the criteria for a "Long Service Separation." Award terms for awards granted in 2016 allow for immediate vesting upon separation of all outstanding options and RSUs with no requisite service period for employees who meet the criteria for a "Long Service Separation." Compensation expense for the 2016 grant was fully recognized immediately on the grant date for these employees. Award terms for the 2018 and 2017 grants allow for continued vesting as of each vesting date specified in the award document for employees who meet the criteria for a "Long Service Separation" and fulfill a requisite service period of six months. Compensation expense for eligible employees for the 2018 and 2017 grants was recognized over the period from the grant date to the end date of the six-month requisite service period. For employees who become eligible for a "Long Service Separation" subsequent to the end date of the six-month requisite service period and prior to the completion of the vesting period, compensation expense is recognized over the period from the grant date to the date eligibility is achieved.

At grant, SARs and option awards have a term life of ten years. For awards granted prior to 2016, if the “Long Service Separation” criteria are met, the vested options/SARs have a life that is the lesser of ten years from the original grant date or five years from the separation date. For awards granted in 2018, 2017, and 2016, the vested options have a life equal to ten years from the original grant date.

Prior to 2017, all outstanding PRSU awards granted to employees eligible for a "Long Service Separation" may vest at the end of the performance period based upon achievement of the performance target. Compensation expense for the 2016 PRSU grant was fully recognized immediately on the grant date for these employees. For PRSU awards granted in 2018 and 2017, only a prorated number of shares may vest at the end of the performance period based upon achievement of the performance target, with the proration based upon the number of months of continuous employment during the three-year performance period. Employees with a "Long Service Separation" must also fulfill a six-month requisite service period in order to be eligible for the prorated vesting of outstanding PRSU awards granted in 2018 and 2017. Compensation expense for the 2018 and 2017 PRSU grants is being recognized on a straight-line basis over the three-year performance period for all participants.

Accounting guidance on share-based payments requires companies to estimate the fair value of options/SARs on the date of grant using an option-pricing model. The fair value of our option/SAR grants was estimated using a lattice-based option-pricing model. The lattice-based option-pricing model considers a range of assumptions related to volatility, risk-free interest rate and historical employee behavior. Expected volatility was based on historical Caterpillar stock price movement and current implied volatilities from traded options on Caterpillar stock. The risk-free interest rate was based on U.S. Treasury security yields at the time of grant. The weighted-average dividend yield was based on historical information. The expected life was determined from the lattice-based model. The lattice-based model incorporated exercise and post vesting forfeiture assumptions based on analysis of historical data. The following table provides the assumptions used in determining the fair value of the Option/SAR awards for the years ended December 31, 2018, 2017 and 2016, respectively.



	Grant Year
	2018		2017		2016
Weighted-average dividend yield	2.7	%	3.4	%	3.2	%
Weighted-average volatility	30.2	%	29.2	%	31.1	%
Range of volatilities	21.5-33.0%		22.1-33.0%		22.5-33.4%
Range of risk-free interest rates	2.02-2.87%		0.81-2.35%		0.62-1.73%
Weighted-average expected lives	8 years		8 years		8 years

Beginning with the 2018 grant, RSU and PRSU awards are credited with dividend equivalent units on each date that a cash dividend is paid to holders of Common Stock. The fair value of the RSU and PRSU awards granted in 2018 was determined as the closing stock price on the date of the grant. Prior to 2018, RSU and PRSU awards were not credited with dividend equivalent units and the fair value was determined by reducing the stock price on the date of the grant by the present value of the estimated dividends to be paid during the vesting period. The estimated dividends were based on Caterpillar's quarterly divided per share at the time of the grant.

Please refer to Tables I and II below for additional information on our stock-based compensation awards.



TABLE I — Financial Information Related to Stock-based Compensation

	Stock options / SARs				RSUs				PRSUs
	Shares		Weighted- Average Exercise Price		Shares		Weighted- Average Grant Date Fair Value		Shares		Weighted- Average Grant Date Fair Value

Outstanding at January 1, 2018	21,499,895		$	86.86	1,964,517		$	80.04	1,006,991		$	74.06
Granted to officers and key employees ¹	1,605,220		$	150.85	734,732		$	150.58	350,724		$	150.98
Exercised	(5,156,489	)	$	87.90	—		$	—	—		$	—
Vested	—		$	—	(1,065,853	)	$	78.11	(549,330	)	$	127.07
Forfeited / expired	(106,957	)	$	151.13	(67,326	)	$	113.29	(73,086	)	$	100.30
Outstanding at December 31, 2018	17,841,669		$	91.93	1,566,070		$	112.99	735,299		$	115.18
Exercisable at December 31, 2018	13,858,401		$	86.05



Stock options/SARs outstanding and exercisable as of December 31, 2018:

	Outstanding						Exercisable
Exercise Prices	Shares Outstanding at 12/31/18	Weighted- Average Remaining Contractual Life (Years)	Weighted- Average Exercise Price		Aggregate Intrinsic Value ²		Shares Outstanding at 12/31/18	Weighted- Average Remaining Contractual Life (Years)	Weighted- Average Exercise Price		Aggregate Intrinsic Value ²
$22.17-57.85	973,032	1.04	$	53.08	$	72	973,032	0.96	$	53.08	$	72
$74.77-89.75	8,954,712	6.27	$	81.25	410		8,186,590	6.17	$	81.86	370
$95.66-96.31	4,573,457	6.90	$	95.96	142		2,856,943	6.06	$	96.13	88
$102.13-110.09	1,840,740	2.75	$	106.38	38		1,840,740	2.75	$	106.38	38
$138.51-151.12	1,499,728	9.32	$	150.84	—		1,096	9.30	$	151.12	—
	17,841,669		$	91.93	$	662	13,858,401		$	86.05	$	568


¹	No SARs were granted during the year ended December 31, 2018.


²	The difference between a stock award’s exercise price and the underlying stock’s closing market price at December 31, 2018, for awards with market price greater than the exercise price. Amounts are in millions of dollars.

The computations of weighted-average exercise prices and aggregate intrinsic values are not applicable to RSUs or PRSUs since these awards represent an agreement to issue shares of stock at the time of vesting. At December 31, 2018, there were 1,566,070 outstanding RSUs with a weighted average remaining contractual life of 1.4 years and 735,299 outstanding PRSUs with a weighted-average remaining contractual life of 1.5 years.



TABLE II— Additional Stock-based Award Information

(Dollars in millions except per share data)	2018		2017		2016
Stock options/SARs activity:
Weighted-average fair value per share of stock awards granted	$	46.09	$	25.01	$	20.64
Intrinsic value of stock awards exercised	$	348	$	504	$	185
Fair value of stock awards vested ¹	$	86	$	191	$	163
Cash received from stock awards exercised	$	370	$	629	$	30

RSUs activity:
Weighted-average fair value per share of stock awards granted	$	150.58	$	90.11	$	68.04
Fair value of stock awards vested ²	$	180	$	189	$	162

PRSUs activity:
Weighted-average fair value per share of stock awards granted	$	150.98	$	86.78	$	64.71
Fair value of stock awards vested ²	$	70	$	20	$	—


¹	Based on the grant date fair value.


²	Based on the underlying stock's closing market price on the vesting date.

In accordance with guidance on share-based payments, stock-based compensation expense is based on the grant date fair value and is classified within Cost of goods sold, Selling, general and administrative expenses and Research and development expenses corresponding to the same line item as the cash compensation paid to respective employees, officers and non-employee directors. Stock-based compensation expense is recognized on a straight-line basis over the requisite service period for awards with terms that specify cliff or graded vesting and contain only service conditions. Stock-based compensation expense for PRSUs is based on the probable number of shares expected to vest and is recognized primarily on a straight-line basis.

Before tax, stock-based compensation expense for 2018, 2017 and 2016 was $197 million, $206 million and $218 million, respectively, with a corresponding income tax benefit of $36 million, $40 million and $61 million, respectively.

The amount of stock-based compensation expense capitalized for the years ended December 31, 2018, 2017 and 2016 did not have a significant impact on our financial statements.

At December 31, 2018, there was $180 million of total unrecognized compensation cost from stock-based compensation arrangements granted under the plans, which is related to non-vested stock-based awards. The compensation expense is expected to be recognized over a weighted-average period of approximately 1.8 years.

We currently use shares in treasury stock to satisfy share award exercises.

The cash tax benefits realized from stock awards exercised for 2018, 2017 and 2016 were $103 million, $205 million and $104 million, respectively. We use the direct only method and tax law ordering approach to calculate the tax effects of stock-based compensation.