NOTE R. STOCK-BASED COMPENSATION

The following table presents total stock-based compensation cost included in income from continuing operations.

($ in millions)

For the year ended December 31:	2017			2016			2015
Cost	$	91		$	88		$	100
Selling, general and administrative	384			401			322
Research, development and engineering	59			55			51
Other (income) and expense*	—			—			(6		)
Pre-tax stock-based compensation cost	534			544			468
Income tax benefits	(131		)	(179		)	(156		)

Net stock-based compensation cost	$	403		$	364		$	312

*Reflects the one-time effects related to divestitures.

The implementation of the new FASB guidance for share-based payment transactions resulted in an immaterial impact to income tax benefits for the year ended December 31, 2017.

Total unrecognized compensation cost related to non-vested awards at December 31, 2017 and 2016 was $851 million and $934 million, respectively. The amount at December 31, 2017 is expected to be recognized over a weighted-average period of approximately 2.6 years.

There was no significant capitalized stock-based compensation cost at December 31, 2017, 2016, and 2015.

Incentive Awards

Stock-based incentive awards are provided to employees under the terms of the company’s long-term performance plans (the “Plans”). The Plans are administered by the Executive Compensation and Management Resources Committee of the Board of Directors (the “Committee”). Awards available under the Plans principally include restricted stock units, performance share units, stock options or any combination thereof.

The amount of shares originally authorized to be issued under the company’s existing Plans was 273 million at December 31, 2017. In addition, certain incentive awards granted under previous plans, if and when those awards were canceled, could be reissued under the company’s existing Plans. As such, 66.2 million additional shares were considered authorized to be issued under the company’s existing Plans as of December 31, 2017. There were 104.1 million unused shares available to be granted under the Plans as of December 31, 2017.

Under the company’s long-standing practices and policies, all awards are approved prior to or on the date of grant. The awards approval process specifies the individual receiving the grant, the number of options or the value of the award, the exercise price or formula for determining the exercise price and the date of grant. All awards for senior management are approved by the Committee. All awards for employees other than senior management are approved by senior management pursuant to a series of delegations that were approved by the Committee, and the grants made pursuant to these delegations are reviewed periodically with the Committee. Awards that are given as part of annual total compensation for senior management and other employees are made on specific cycle dates scheduled in advance. With respect to awards given in connection with promotions or new hires, the company’s policy requires approval of such awards prior to the grant date, which is typically the date of the promotion or the date of hire.

Stock Awards

Stock awards are made in the form of Restricted Stock Units (RSUs), including Retention Restricted Stock Units (RRSUs), or Performance Share Units (PSUs).

The tables below summarize RSU and PSU activity under the Plans during the years ended December 31, 2017, 2016 and 2015.

RSUs

	2017				2016				2015
	Weighted-				Weighted-				Weighted-
	Average		Number		Average		Number		Average		Number
	Grant Price		of Units		Grant Price		of Units		Grant Price		of Units
Balance at January 1	$	147	8,899,092		$	159	7,527,341		$	171	7,734,277
RSUs granted	137		3,540,949		140		3,985,870		143		4,230,186
RSUs released	153		(3,032,531	)	174		(1,860,660	)	164		(3,567,495	)
RSUs canceled/forfeited	147		(852,247	)	158		(753,459	)	167		(869,627	)

Balance at December 31	$	141	8,555,263		$	147	8,899,092		$	159	7,527,341

PSUs

	2017				2016				2015
	Weighted-				Weighted-				Weighted-
	Average		Number		Average		Number		Average		Number
	Grant Price		of Units		Grant Price		of Units		Grant Price		of Units
Balance at January 1	$	155	2,874,758		$	173	2,928,932		$	185	3,140,707
PSUs granted at target	137		824,875		140		990,336		153		1,137,242
Performance adjustments*	175		(623,245	)	194		(387,457	)	185		(168,055	)
PSUs released	175		(293,236	)	194		(419,759	)	185		(840,552	)
PSUs canceled/forfeited	144		(133,839	)	174		(237,294	)	184		(340,410	)

Balance at December 31**	$	144	2,649,313		$	155	2,874,758		$	173	2,928,932

*Represents the change in shares issued to employees after vesting of PSUs because final performance metrics were above or below specified targets.

**Represents the number of shares expected to be issued based on achievement of grant date performance targets. The actual number of shares issued will depend on final performance against specified targets over the vesting period.

RSUs are stock awards granted to employees that entitle the holder to shares of common stock as the award vests, typically over a one- to five-year period. For RSUs, dividend equivalents are not paid. The fair value of such RSUs is determined and fixed on the grant date based on the company’s stock price adjusted for the exclusion of dividend equivalents.

The remaining weighted-average contractual term of RSUs at December 31, 2017, 2016 and 2015 is the same as the period over which the remaining cost of the awards will be recognized, which is approximately three years. The fair value of RSUs granted during the years ended December 31, 2017, 2016 and 2015 was $484 million, $557 million and $606 million, respectively. The total fair value of RSUs vested and released during the years ended December 31, 2017, 2016 and 2015 was $463 million, $323 million and $583 million, respectively. As of December 31, 2017, 2016 and 2015, there was $763 million, $814 million and $800 million, respectively, of unrecognized compensation cost related to non-vested RSUs. The company received no cash from employees as a result of employee vesting and release of RSUs for the years ended December 31, 2017, 2016 and 2015.

PSUs are stock awards where the number of shares ultimately received by the employee depends on the company’s performance against specified targets and typically vest over a three-year period. For PSUs, dividend equivalents are not paid. The fair value of each PSU is determined on the grant date, based on the company’s stock price, adjusted for the exclusion of dividend equivalents, and assumes that performance targets will be achieved. Over the performance period, the number of shares of stock that will be issued is adjusted upward or downward based upon the probability of achievement of performance targets. The ultimate number of shares issued and the related compensation cost recognized as expense will be based on a comparison of the final performance metrics to the specified targets. The fair value of PSUs granted at target during the years ended December 31, 2017, 2016 and 2015 was $113 million, $138 million and $174 million, respectively. Total fair value of PSUs vested and released during the years ended December 31, 2017, 2016 and 2015 was $51 million, $81 million and $156 million, respectively.

In connection with vesting and release of RSUs and PSUs, the tax benefits realized by the company for the years ended December 31, 2017, 2016 and 2015 were $180 million, $118 million and $228 million, respectively.

Stock Options

For the years ended December 31, 2017 and 2015, the company did not grant stock options. For the year ended December 31, 2016, the company made one grant of 1.5 million premium-priced stock options. The option award was granted with a three-year cliff vesting period and a 10-year contractual term. The award’s cost of $12 million is recognized ratably over the three-year vesting period.

The company estimates the fair value of stock options at the date of grant using the Black-Scholes valuation model. Key inputs and assumptions used to estimate the fair value of stock options include the grant price of the award, the expected option term, volatility of the company’s stock, the risk-free rate and the company’s dividend yield. Estimates of fair value are not intended to predict actual future events or the value ultimately realized by employees who receive equity awards, and subsequent events are not indicative of the reasonableness of the original estimates of fair value made by the company.

The following table summarizes option activity under the Plans during the years ended December 31, 2017, 2016 and 2015.

	2017				2016				2015
	Weighted-		Number of		Weighted-		Number of		Weighted-		Number of
	Average		Shares		Average		Shares		Average		Shares
	Exercise Price		Under Option		Exercise Price		Under Option		Exercise Price		Under Option
Balance at January 1	$	137	1,613,923		$	94	479,774		$	97	1,750,949
Options granted	—		—		140		1,500,000		—		—
Options exercised	103		(106,132	)	91		(361,088	)	98		(1,214,109	)
Options canceled/expired	103		(7,791	)	86		(4,763	)	100		(57,066	)

Balance at December 31	$	140	1,500,000		$	137	1,613,923		$	94	479,774

Exercisable at December 31	$	—	—		$	103	113,923		$	94	479,774

The shares under option at December 31, 2017 were in the following exercise price ranges:

	Options Outstanding
						Weighted-Average
	Weighted-		Number of	Aggregate		Remaining
	Average		Shares	Intrinsic		Contractual Life
Exercise Price Range	Exercise Price		Under Option	Value		(in Years)

$129–$154	$	140	1,500,000	$	39,236,250	8.1

Exercises of Employee Stock Options

The total intrinsic value of options exercised during the years ended December 31, 2017, 2016 and 2015 was $7 million, $20 million and $74 million, respectively. The total cash received from employees as a result of employee stock option exercises for the years ended December 31, 2017, 2016 and 2015 was approximately $11 million, $33 million and $119 million, respectively. In connection with these exercises, the tax benefits realized by the company for the years ended December 31, 2017, 2016 and 2015 were $2 million, $7 million and $26 million, respectively.

The company settles employee stock option exercises primarily with newly issued common shares and, occasionally, with treasury shares. Total treasury shares held at December 31, 2017 and 2016 were approximately 1,307 million and 1,279 million shares, respectively.

Acquisitions

In connection with various acquisition transactions, there was an additional 0.3 million options outstanding at December 31, 2017, as a result of the company’s conversion of stock-based awards previously granted by the acquired entities. The weighted-average exercise price of these awards was $42 per share.

IBM Employees Stock Purchase Plan

The company maintains a non-compensatory Employees Stock Purchase Plan (ESPP). The ESPP enables eligible participants to purchase full or fractional shares of IBM common stock at a 5 percent discount off the average market price on the day of purchase through payroll deductions of up to 10 percent of eligible compensation. Eligible compensation includes any compensation received by the employee during the year. The ESPP provides for offering periods during which shares may be purchased and continues as long as shares remain available under the ESPP, unless terminated earlier at the discretion of the Board of Directors. Individual ESPP participants are restricted from purchasing more than $25,000 of common stock in one calendar year or 1,000 shares in an offering period.

Employees purchased 1.0 million, 1.2 million and 1.3 million shares under the ESPP during the years ended December 31, 2017, 2016 and 2015, respectively. Cash dividends declared and paid by the company on its common stock also include cash dividends on the company stock purchased through the ESPP. Dividends are paid on full and fractional shares and can be reinvested. The company stock purchased through the ESPP is considered outstanding and is included in the weighted-average outstanding shares for purposes of computing basic and diluted earnings per share.

In July 2014, the “2014 ESPP Reserve” became effective and 25 million additional shares of authorized common stock were reserved and approved for issuance. The 2014 ESPP provides for semi-annual offerings commencing July 1, 2014, and continuing as long as shares remain available under the ESPP, unless terminated earlier at the discretion of the Board of Directors.

Approximately 20.8 million, 21.8 million and 23.1 million shares were available for purchase under the ESPP at December 31, 2017, 2016 and 2015, respectively.