STOCK-BASED COMPENSATION

International Paper has an Incentive Compensation Plan (ICP) which is administered by the Management Development and Compensation Committee of the Board of Directors (the Committee). The ICP authorizes the grants of restricted stock, restricted or deferred stock units, performance awards payable in cash or stock upon the attainment of specified performance goals, dividend equivalents, stock options, stock appreciation rights, other stock-based awards and cash-based awards in the discretion of the Committee. A detailed discussion of the ICP, including the stock option program and executive continuity award program that provided for tandem grants of restricted stock and stock options, is presented in Note 17 to the consolidated financial statements included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2011. As of September 30, 2012, 19.1 million shares were available for grant under the ICP.

Stock-based compensation expense and related income tax benefits were as follows:



	Three Months Ended September 30,				Nine Months Ended September 30,
In millions	2012		2011		2012		2011
Total stock-based compensation expense (selling and administrative)	$	26	$	20	$	70	$	69
Income tax benefits related to stock-based compensation	—		—		40		33

At September 30, 2012, $112 million, net of estimated forfeitures, of compensation cost related to unvested restricted performance shares, executive continuity awards and restricted stock attributable to future service had not yet been recognized. This amount will be recognized in expense over a weighted-average period of 1.8 years.

Performance Share Plan

Under the Performance Share Plan (PSP), awards are granted by the Committee to approximately 1,150 employees. Awards are earned based on the Company’s performance achievement in relative return on investment (ROI) and total shareholder return (TSR) compared to peer groups. Awards are weighted 75% for ROI and 25% for TSR for all participants except for officers for whom awards are weighted 50% for ROI and 50% for TSR. The ROI component of the PSP awards is valued at the closing stock price on the day prior to the grant date. As the ROI component contains a performance condition, compensation expense, net of estimated forfeitures, is recorded over the requisite service period based on the most probable number of awards expected to vest. The TSR component of the PSP awards is valued using a Monte Carlo simulation as the TSR component contains a market condition. The Monte Carlo simulation estimates the fair value of the TSR component based on the expected term of the award, the risk-free rate, expected dividends, and the expected volatility for the Company and its competitors. The expected term was estimated based on the vesting period of the awards, the risk-free rate was based on the yield on U.S. Treasury securities matching the vesting period and the volatility was based on the Company’s historical volatility over the expected term.

Beginning with the 2011 PSP, grants will be made in performance-based restricted stock units (PSU’s). The PSP will continue to be paid in unrestricted shares of Company stock.

PSP awards issued to certain members of senior management are liability awards, which are required to be remeasured at fair value at each balance sheet date. The valuation of these PSP liability awards is computed based on the same methodology as other PSP awards.

The following table sets forth the assumptions used to determine compensation cost for the market condition component of the PSP plan:



	Three Months Ended September 30, 2012	Nine Months Ended September 30, 2012
Expected volatility	28.39% - 55.33%	28.39% - 55.33%
Risk-free interest rate	0.12% - 0.42%	0.12% - 0.42%

The following summarizes the activity for PSP for the nine months ended September 30, 2012:



	Nonvested Shares / Units		Weighted Average Grant Date Fair Value
Outstanding at December 31, 2011	8,060,059		$	22.83
Granted	3,641,911		31.57
Shares Issued (a)	(2,862,314	)	16.80
Forfeited	(154,084	)	28.95
Outstanding at September 30, 2012	8,685,572		$	28.37


(a)	Includes 63,745 shares/units held for payout at the end of the performance period.

Stock Option Program

The Company discontinued its stock option program in 2004 for members of executive management, and in 2005 for all other eligible U.S. and non-U.S. employees. Shares granted represent replacement options from a stock swap.

A summary of option activity under the plan as of September 30, 2012 is presented below:



	Options		Weighted Average Exercise Price		Weighted Average Remaining Life (years)	Aggregate Intrinsic Value (thousands)
Outstanding at December 31, 2011	15,556,786		$	38.13
Granted	2,513		35.94
Exercised	(1,887,878	)	32.83
Expired	(2,940,525	)	41.22
Outstanding at September 30, 2012	10,730,896		$	38.21	1.27	$	500

All options were fully vested and exercisable as of September 30, 2012.

Executive Continuity and Restricted Stock Award Program

The following summarizes the activity of the Executive Continuity and Restricted Stock Award Program for the nine months ended September 30, 2012:



	Nonvested Shares		Weighted Average Grant Date Fair Value
Outstanding at December 31, 2011	128,917		$	27.86
Granted	88,715		31.91
Shares Issued	(24,250	)	26.88
Forfeited	(5,000	)	28.91
Outstanding at September 30, 2012	188,382		$	29.87