STOCK COMPENSATION

The Company uses various equity-based compensation programs to provide long-term performance incentives for its global workforce. Currently, these incentives consist principally of stock options, restricted stock units and, to a lesser extent, executive performance shares and restricted stock grants. During 2015, the Company changed the mix of equity compensation, awarding an increasing number of restricted stock units and fewer stock option awards. The Company also sponsors a discounted stock purchase plan in the United States and matching-grant programs in several international locations. Additionally, the Company awards restricted stock to its outside directors. These awards are administered through several plans, as described within this Note.

The 2013 Long-Term Incentive Plan (2013 Plan), approved by shareholders in 2013, permits awards to employees and officers in the form of incentive and non-qualified stock options, performance units, restricted stock or restricted stock units, and stock appreciation rights. The 2013 Plan, which replaced the 2009 Long-Term Incentive Plan (2009 Plan), authorizes the issuance of a total of (a) 22 million shares; plus (b) the total number of shares remaining available for future grants under the 2009 Plan. The total number of shares remaining available for issuance under the 2013 Plan will be reduced by two shares for each share issued pursuant to an award under the 2013 Plan other than a stock option or stock appreciation right, or potentially issuable pursuant to an outstanding award other than a stock option or stock appreciation right, which will in each case reduce the total number of shares remaining by one share for each share issued. The 2013 Plan includes several limitations on awards or payments to individual participants. Options granted under the 2013 and 2009 Plans generally vest over three years. At December 31, 2016, there were 12 million remaining authorized, but unissued, shares under the 2013 Plan.

The Non-Employee Director Stock Plan (2009 Director Plan) was approved by shareholders in 2009 and

allows each eligible non-employee director to receive shares of the Company’s common stock annually. The number of shares granted pursuant to each annual award will be determined by the Nominating and Governance Committee of the Board of Directors. The 2009 Director Plan, which replaced the 2000 Non-Employee Director Stock Plan (2000 Director Plan), reserves 500,000 shares for issuance, plus the total number of shares as to which awards granted under the 2009 Director Plan or the 2000 Director Plans expire or are forfeited, terminated or settled in cash. Under both the 2009 and 2000 Director Plans, shares (other than stock options) are placed in the Kellogg Company Grantor Trust for Non-Employee Directors (the Grantor Trust). Under the terms of the Grantor Trust, shares are available to a director only upon termination of service on the Board. Under the 2009 Director Plan, awards were as follows (number of shares): 2016-24,249; 2015-26,877; 2014-23,890.

The 2002 Employee Stock Purchase Plan was approved by shareholders in 2002 and permits eligible employees to purchase Company stock at a discounted price. This plan allows for a maximum of 2.5 million shares of Company stock to be issued at a purchase price equal to 95% of the fair market value of the stock on the last day of the quarterly purchase period. Total purchases through this plan for any employee are limited to a fair market value of $25,000 during any calendar year. At December 31, 2016, there were approximately 0.3 million remaining authorized, but unissued, shares under this plan. Shares were purchased by employees under this plan as follows (approximate number of shares): 2016–63,000; 2015–73,000; 2014–75,000. Options granted to employees to purchase discounted stock under this plan are included in the option activity tables within this note.

Additionally, an international subsidiary of the Company maintains a stock purchase plan for its employees. Subject to limitations, employee contributions to this plan are matched 1:1 by the Company. Under this plan, shares were granted by the Company to match an equal number of shares purchased by employees as follows (approximate number of shares): 2016–57,000; 2015–48,000; 2014–58,000.

Compensation expense for all types of equity-based programs and the related income tax benefit recognized were as follows:



(millions)	2016		2015		2014
Pre-tax compensation expense	$	68	$	55	$	41
Related income tax benefit	$	25	$	20	$	15

As of December 31, 2016, total stock-based compensation cost related to non-vested awards not yet recognized was $85 million and the weighted-average period over which this amount is expected to be recognized was 2 years.

Cash flows realized upon exercise or vesting of stock-based awards in the periods presented are included in the following table. Tax benefits realized upon exercise or vesting of stock-based awards generally represent the tax benefit of the difference between the exercise price and the strike price of the option.

Cash used by the Company to settle equity instruments granted under stock-based awards was insignificant.



(millions)	2016		2015		2014
Total cash received from option exercises and similar instruments	$	368	$	261	$	217
Tax benefits realized upon exercise or vesting of stock-based awards:
Windfall benefits classified as cash flow from operating activities	$	36	NA		NA
Windfall benefits classified as cash flow from financing activities	NA		$	14	$	11

Shares used to satisfy stock-based awards are normally issued out of treasury stock, although management is authorized to issue new shares to the extent permitted by respective plan provisions. Refer to Note 6 for information on shares issued during the periods presented to employees and directors under various long-term incentive plans and share repurchases under the Company’s stock repurchase authorizations. The Company does not currently have a policy of repurchasing a specified number of shares issued under employee benefit programs during any particular time period.

Stock options

During the periods presented, non-qualified stock options were granted to eligible employees under the 2013 and 2009 Plans with exercise prices equal to the fair market value of the Company’s stock on the grant date, a contractual term of ten years, and a three-year graded vesting period.

Management estimates the fair value of each annual stock option award on the date of grant using a lattice-based option valuation model. Composite assumptions are presented in the following table. Weighted-average values are disclosed for certain inputs which incorporate a range of assumptions. Expected volatilities are based principally on historical volatility of the Company’s stock, and to a lesser extent, on implied volatilities from traded options on the Company’s stock. Historical volatility corresponds to the contractual term of the options granted. The Company uses historical data to estimate option exercise and employee termination within the valuation models; separate groups of employees that have similar historical exercise behavior are considered separately for valuation purposes. The expected term of options granted represents the period of time that options granted are expected to be outstanding; the weighted-average expected term for all employee groups is presented in the following table. The risk-free rate for periods within the contractual life of the options is based on the U.S. Treasury yield curve in effect at the time of grant.



Stock option valuation model assumptions for grants within the year ended:	2016			2015			2014
Weighted-average expected volatility	17.00		%	16.00		%	15.00		%
Weighted-average expected term (years)	6.88			6.87			7.34
Weighted-average risk-free interest rate	1.60		%	1.98		%	2.35		%
Dividend yield	2.60		%	3.00		%	3.00		%
Weighted-average fair value of options granted	$	9.44		$	7.21		$	6.70

A summary of option activity for the year ended December 31, 2016 is presented in the following table:



Employee and director stock options	Shares (millions)		Weighted- average exercise price		Weighted- average remaining contractual term (yrs.)	Aggregate intrinsic value (millions)
Outstanding, beginning of year	19		$	58
Granted	3		76
Exercised	(6	)	56
Forfeitures and expirations	(1	)	67
Outstanding, end of year	15		$	62	7.0	$	172
Exercisable, end of year	8		$	58	5.8	$	133

Additionally, option activity for the comparable prior year periods is presented in the following table:



(millions, except per share data)	2015			2014
Outstanding, beginning of year	21			20
Granted	3			6
Exercised	(5		)	(4		)
Forfeitures and expirations	—			(1		)
Outstanding, end of year	19			21
Exercisable, end of year	10			10
Weighted-average exercise price:
Outstanding, beginning of year	$	56		$	54
Granted	64			60
Exercised	53			50
Forfeitures and expirations	60			58
Outstanding, end of year	$	58		$	56
Exercisable, end of year	$	55		$	53

The total intrinsic value of options exercised during the periods presented was (in millions): 2016–$145; 2015–$65; 2014–$56.

Other stock-based awards

During the periods presented, other stock-based awards consisted principally of executive performance shares and restricted stock granted under the 2013 and 2009 Plans.

In the first quarter of 2016, the Company granted performance shares to a limited number of senior executive-level employees, which entitle these employees to receive a specified number of shares of the Company's common stock upon vesting. The number of shares earned could range between 0 and 200% of the target amount depending upon performance achieved over the three year vesting period. The performance conditions of the award include three-year currency-neutral comparable operating profit growth and total shareholder return (TSR) of the Company's common stock relative to a select group of peer companies.

A Monte Carlo valuation model was used to determine the fair value of the awards. The TSR performance metric is a market condition. Therefore, compensation cost of the TSR condition is fixed at the measurement date and is not revised based on actual performance. The TSR metric was valued as a multiplier of possible levels of comparable operating profit growth achievement. Compensation cost related to comparable operating profit growth performance is revised for changes in the expected outcome. The 2016 target grant currently corresponds to approximately 176,000 shares, with a grant-date fair value of $80 per share.

In 2015, the Company granted performance shares to a limited number of senior executive-level employees, which entitle these employees to receive a specified number of shares of the Company's common stock upon vesting. The number of shares earned could range between 0 and 200% of the target amount depending upon performance achieved over the three year vesting period. The performance conditions of the award include three-year cumulative operating cash flow and TSR of the Company's common stock relative to a select group of peer companies. The 2015 target grant currently corresponds to approximately 158,000 shares, with a grant-date fair value of $58 per share.

In 2014, the Company granted performance share awards to a limited number of senior executive-level employees, which entitles these employees to receive a specified number of shares of the Company’s common stock on the vesting date, provided cumulative three-year targets are achieved. The cumulative three-year targets involved operating profit and comparable net sales growth. Management estimates the fair value of performance share awards based on the market price of the underlying stock on the date of grant, reduced by the present value of estimated dividends foregone during the performance period. The 2014 target grant (as revised for non-vested forfeitures and other adjustments) currently correspond to approximately 194,000 shares, respectively, with a grant-date fair value of $54 per share. The actual number of shares issued on the vesting date could range from 0 to 200% of target, depending on actual performance achieved.

Based on the market price of the Company’s common stock at year-end 2016, the maximum future value that could be awarded on the vesting date was (in millions): 2016 award–$26; 2015 award–$23; and 2014 award–$29. The 2013 performance share award, payable in stock, was settled at 35% of target in February 2016 for a total dollar equivalent of $3 million.

The Company also grants restricted stock and restricted stock units to eligible employees under the 2013 Plan. Restrictions with respect to sale or transferability generally lapse after three years and, in the case of restricted stock, the grantee is normally entitled to receive shareholder dividends during the vesting period. Management estimates the fair value of restricted stock grants based on the market price of the underlying stock on the date of grant. A summary of restricted stock and restricted stock unit activity for the year ended December 31, 2016, is presented in the following table:



Employee restricted stock and restricted stock units	Shares (thousands)		Weighted- average grant-date fair value
Non-vested, beginning of year	806		$	57
Granted	601		70
Vested	(116	)	56
Forfeited	(125	)	63
Non-vested, end of year	1,166		$	63

Additionally, restricted stock and restricted stock unit activity for 2015 and 2014 is presented in the following table:



Employee restricted stock and restricted stock units	2015			2014
Shares (in thousands):
Non-vested, beginning of year	346			318
Granted	617			114
Vested	(113		)	(65		)
Forfeited	(44		)	(21		)
Non-vested, end of year	806			346
Weighted-average exercise price:
Non-vested, beginning of year	$	54		$	52
Granted	59			56
Vested	50			51
Forfeited	58			53
Non-vested, end of year	$	57		$	54

The total fair value of restricted stock and restricted stock units vesting in the periods presented was (in millions): 2016–$7; 2015–$7; 2014–$4.