NOTE 13. Stock-Based Compensation

The 3M 2008 Long-Term Incentive Plan (LTIP), as discussed in 3M’s Current Report on Form 8-K dated May 17, 2016 (which updated 3M’s 2015 Annual Report on Form 10-K), provides for the issuance or delivery of up to 100 million shares of 3M common stock (including additional shareholder approvals subsequent to 2008) pursuant to awards granted under the plan. In May 2016, shareholders approved the 2016 LTIP, providing an additional 23,965,000 shares, increasing the number of approved shares to 123,965,000 shares. The 2016 LTIP succeeds the 3M 2008 LTIP. Awards may be issued in the form of incentive stock options, nonqualified stock options, progressive stock options, stock appreciation rights, restricted stock, restricted stock units, other stock awards, and performance units and performance shares. Awards denominated in shares of common stock other than options and Stock Appreciation Rights, count against the 123,965,000 share limit as 3.38 shares for every one share covered by such award (for full value awards with grant dates prior to May 11, 2010), as 2.87 shares for every one share covered by such award (for full value awards with grant dates on or after May 11, 2010 and prior to May 8, 2012), as 3.50 shares for every one share covered by such award (for full value awards with grant dates on or after of May 8, 2012 and prior to May 10, 2016), or as 2.50 shares for every one share covered by such award (for full value awards with grant dates of May 10, 2016 or later). The remaining total shares available for grant under the LTIP Program are 35,855,889 as of September 30, 2016.

The Company’s annual stock option and restricted stock unit grant is made in February to provide a strong and immediate link between the performance of individuals during the preceding year and the size of their annual stock compensation grants. The grant to eligible employees uses the closing stock price on the grant date. Accounting rules require recognition of expense under a non-substantive vesting period approach, requiring compensation expense recognition when an employee is eligible to retire. Employees are considered eligible to retire at age 55 and after having completed ten years of service. This retiree-eligible population represents 35 percent of the 2016 annual grant stock-based compensation award expense dollars; therefore, higher stock-based compensation expense is recognized in the first quarter.

In addition to the annual grants, the Company makes other minor grants of stock options, restricted stock units and other stock-based grants. The Company issues cash settled restricted stock units and stock appreciation rights in certain countries. These grants do not result in the issuance of common stock and are considered immaterial by the Company.

During the first quarter of 2016, the Company adopted ASU No. 2016-09, Improvements to Employee Share-Based Payment Accounting. The adoption is required to be implemented prospectively and resulted in income tax benefits of $35 million and $175 million in the third quarter and first nine months of 2016, respectively. See Note 1 for additional information regarding ASU No. 2016-09.

Amounts recognized in the financial statements with respect to stock-based compensation programs, which include stock options, restricted stock, restricted stock units, performance shares and the General Employees’ Stock Purchase Plan (GESPP), are provided in the following table. Capitalized stock-based compensation amounts were not material.

Stock-Based Compensation Expense


	Three months ended				Nine months ended
	September 30,				September 30,
(Millions)	2016		2015		2016		2015
Cost of sales	$	8	$	8	$	39	$	39
Selling, general and administrative expenses		36		31		166		154
Research, development and related expenses		7		7		39		40

Stock-based compensation expenses	$	51	$	46	$	244	$	233

Income tax benefits	$	(49)	$	(13)	$	(248)	$	(74)

Stock-based compensation expenses (benefits), net of tax	$	2	$	33	$	(4)	$	159

Stock Option Program

The following table summarizes stock option activity during the nine months ended September 30, 2016:


				Weighted
		Weighted		Remaining	Aggregate
	Number of	Average		Contractual	Intrinsic Value
	Options	Exercise Price		Life (months)	(millions)
Under option —
January 1	38,552,445	$	102.01
Granted:
Annual	5,591,727		147.99
Exercised	(7,318,470)		86.67
Canceled	(189,747)		148.16
September 30	36,635,955	$	111.85	72	$	2,358
Options exercisable
September 30	25,622,123	$	95.54	59	$	2,067

Stock options vest over a period from one year to three years with the expiration date at 10 years from date of grant. As of September 30, 2016, there was $87 million of compensation expense that has yet to be recognized related to non-vested stock option based awards. This expense is expected to be recognized over the remaining weighted-average vesting period of 22 months. The total intrinsic values of stock options exercised were $573 million and $393 million during the nine months ended September 30, 2016 and 2015, respectively. Cash received from options exercised was $630 million and $413 million for the September 30, 2016 and 2015, respectively. The Company’s actual tax benefits realized for the tax deductions related to the exercise of employee stock options were $212 million and $145 million for the nine months ended September 30, 2016 and 2015, respectively.

For the primary 2016 annual stock option grant, the weighted average fair value at the date of grant was calculated using the Black-Scholes option-pricing model and the assumptions that follow.

Stock Option Assumptions


	Annual
	2016
Exercise price	$	147.87
Risk-free interest rate		1.5	%
Dividend yield		2.5	%
Expected volatility		20.8	%
Expected life (months)		77
Black-Scholes fair value	$	22.47

Expected volatility is a statistical measure of the amount by which a stock price is expected to fluctuate during a period. For the 2016 annual grant date, the Company estimated the expected volatility based upon the average of the most recent one year volatility, the median of the term of the expected life rolling volatility, the median of the most recent term of the expected life volatility of 3M stock, and the implied volatility on the grant date. The expected term assumption is based on the weighted average of historical grants.

Restricted Stock and Restricted Stock Units

The following table summarizes restricted stock and restricted stock unit activity during the nine months ended September 30, 2016:



		Weighted
		Average
	Number of	Grant Date
	Awards	Fair Value
Nonvested balance —
As of January 1	2,441,088	$	127.47
Granted
Annual	749,068		148.20
Other	8,115		169.00
Vested	(933,455)		101.34
Forfeited	(39,507)		144.14
As of September 30	2,225,309	$	145.27

As of September 30, 2016, there was $100 million of compensation expense that has yet to be recognized related to non-vested restricted stock units and restricted stock. This expense is expected to be recognized over the remaining weighted-average vesting period of 24 months. The total fair value of restricted stock units and restricted stock that vested during the nine months ended September 30, 2016 and 2015 was $145 million and $165 million, respectively. The Company’s actual tax benefits realized for the tax deductions related to the vesting of restricted stock units and restricted stock was $54 million and $62 million for the nine months ended September 30, 2016 and 2015, respectively.

Restricted stock units granted generally vest three years following the grant date assuming continued employment. Dividend equivalents equal to the dividends payable on the same number of shares of 3M common stock accrue on these restricted stock units during the vesting period, although no dividend equivalents are paid on any of these restricted stock units that are forfeited prior to the vesting date. Dividends are paid out in cash at the vest date on restricted stock units. Since the rights to dividends are forfeitable, there is no impact on basic earnings per share calculations. Weighted average restricted stock unit shares outstanding are included in the computation of diluted earnings per share.

Performance Shares

Instead of restricted stock units, the Company makes annual grants of performance shares to members of its executive management. The 2016 performance criteria for these performance shares (organic volume growth, return on invested capital, free cash flow conversion, and earning per share growth) were selected because the Company believes that they are important drivers of long-term stockholder value. The number of shares of 3M common stock that could actually be delivered at the end of the three-year performance period may be anywhere from 0% to 200% of each performance share granted, depending on the performance of the Company during such performance period. Non-substantive vesting requires that expense for the performance shares be recognized over one or three years depending on when each individual became a 3M executive. Prior to the 2016 performance share grant, performance shares did not accrue dividends during the performance period. Therefore, the grant date fair value was determined by reducing the closing stock price on the date of grant by the net present value of dividends during the performance period. The 2016 performance share grant accrues dividends, therefore the grant date fair value is equal to the closing stock price on the date of grant. Since the rights to dividends are forfeitable, there is no impact on basic earnings per share calculations. Weighted average performance shares whose performance period is complete are included in computation of diluted earnings per share.

The following table summarizes performance share activity during the nine months ended September 30, 2016:



		Weighted
		Average
	Number of	Grant Date
	Awards	Fair Value
Undistributed balance —
As of January 1	871,192	$	120.89
Granted	214,710		159.98
Distributed	(367,428)		99.06
Performance change	(65,246)		157.21
Forfeited	(23,542)		147.99
As of September 30	629,686	$	142.18

As of September 30, 2016, there was $22 million of compensation expense that has yet to be recognized related to performance shares. This expense is expected to be recognized over the remaining weighted-average earnings period of 10 months. The total fair values of performance shares that were distributed were $54 million for both the nine months ended September 30, 2016 and 2015. The Company’s actual tax benefits realized for the tax deductions related to the distribution of performance shares were $15 million for both the nine months ended September 30, 2016 and 2015.