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STOCK-BASED COMPENSATION, DIVIDEND RESTRICTIONS, AND CALCULATIONS OF EARNINGS PER SHARE OF COMMON STOCK

Stock-Based Compensation

PHI maintains a Long-Term Incentive Plan (LTIP), the objective of which is to increase shareholder value by providing a long-term incentive to reward officers and key employees of Pepco Holdings and its subsidiaries and to increase the ownership of Pepco Holdings' common stock by such individuals. Any officer or key employee of Pepco Holdings or its subsidiaries may be designated by the PHI Board of Directors as a participant in the LTIP. Under the LTIP, awards to officers and key employees may be in the form of restricted stock, restricted stock units, stock options, performance units, stock appreciation rights, unrestricted stock, and dividend equivalents. At inception, 10 million shares of common stock were authorized for issuance under the LTIP.

Total stock-based compensation expense recorded in the consolidated statements of income for the years ended December 31, 2011, 2010 and 2009 was $6 million, $5 million and $5 million, respectively, all of which was associated with restricted stock and restricted stock unit awards.

No material amount of stock compensation expense was capitalized for the years ended December 31, 2011, 2010 and 2009.

Restricted Stock and Restricted Stock Unit Awards

Description of awards

A number of programs have been established under the LTIP involving the issuance of restricted stock and restricted stock unit awards, including awards of performance-based restricted stock units, time-based restricted stock and restricted stock units, retention restricted stock and the Conectiv performance accelerated restricted stock (PARS). A summary of each of these programs is as follows:

•

Under the performance-based program, performance criteria are selected and measured over the specified performance period. Depending on the extent to which the performance criteria are satisfied, the participants are eligible to earn shares of common stock at the end of the performance period, ranging from 0% to 200% of the target award, and dividends accrued thereon.

•

Generally, time-based restricted stock and restricted stock unit award opportunities have a requisite service period of three years and, with respect to restricted stock awards, participants have the right to receive dividends on the shares during the vesting period. Under restricted stock unit awards, dividends are credited quarterly in the form of additional restricted stock units, which are paid when vested at the end of the three-year service period.

•

In connection with the acquisition of Conectiv by Pepco in 2002, PARS previously issued to Conectiv employees were converted to shares of Pepco Holdings restricted stock. These shares typically vested over periods of 5 to 7 years. In January 2009, all 6,669 of the remaining PARS outstanding fully vested.

•

In September 2007, retention awards in the form of 9,015 shares of restricted stock were granted to certain PHI executives, with vesting periods of two or three years. In September 2009, 5,409 of these shares vested. In September 2010, all 3,606 of the remaining shares outstanding vested.

Activity for the year

The 2011 activity for non-vested, time-based restricted stock, restricted stock units and performance-based restricted stock unit awards is summarized in the table below. For performance-based restricted stock unit awards, the table reflects awards projected to achieve 100% of targeted performance criteria for the 2010-2012 and 2011-2013 award cycles.


	Number of Shares			Total Number of Shares			Weighted Average Grant Date Fair Value
Balance at January 1, 2011
Time-based restricted stock		316,194					$	18.15
Performance-based restricted stock units		586,883						20.75

Total					903,077
Granted during 2011
Time-based restricted stock units		177,895						18.87
Performance-based restricted stock units		354,979						19.56

Total					532,874
Vested during 2011
Time-based restricted stock		(63,764	)					23.70
Time-based restricted stock units		(173	)					18.84
Performance-based restricted stock units		(144,451	)					25.36

Total					(208,388	)
Forfeited during 2011
Time-based restricted stock		(10,741	)					17.06
Time-based restricted stock units		(7,191	)					18.84
Performance-based restricted stock units		(32,272	)					21.78

Total					(50,204	)
Balance at December 31, 2011
Time-based restricted stock		241,689						16.74
Time-based restricted stock units		170,531						18.87
Performance-based restricted stock units		765,139						19.28

Total					1,177,359

Grants included in the table above reflect 2011 grants of performance-based restricted stock units and time-based restricted stock units. PHI recognizes compensation expense related to performance-based restricted stock unit awards and time-based restricted stock and restricted stock unit awards based on the fair value of the awards at date of grant. The fair value is based on the market value of PHI common stock at the date the award opportunity is granted. The estimated fair value of the performance-based awards is also a function of PHI's projected future performance relative to established performance criteria and the resulting payout of shares based on the achieved performance levels. PHI employed a Monte Carlo simulation to forecast PHI's performance relative to the performance criteria and to estimate the potential payout of shares under the performance-based awards.

The following table provides the weighted average grant date fair value of those awards granted during each of the years ended December 31, 2011, 2010 and 2009:


	2011		2010		2009
Weighted average grant-date fair value of each performance-based restricted stock unit granted during the year	$	19.56	$	20.11	$	17.51
Weighted average grant-date fair value of each award of time-based restricted stock granted during the year	$	—	$	16.55	$	17.18
Weighted average grant-date fair value of each time-based restricted stock unit granted during the year	$	18.87	$	—	$	—

As of December 31, 2011, there was approximately $9 million of future compensation cost (net of estimated forfeitures) related to non-vested restricted stock awards and restricted stock unit awards granted under the LTIP that PHI expects to recognize over a weighted-average period of approximately two years.

Stock options

Stock options to purchase shares of PHI's common stock granted under the LTIP must have an exercise price at least equal to the fair market value of the underlying stock on the grant date. Stock options that have been granted under the LTIP generally have become exercisable on a specified vesting date or dates. All stock options have an expiration date of no greater than ten years from the date of grant. No options have been granted under the LTIP since May 1, 2002.

Non-employee directors are entitled, under the terms of the LTIP, to a grant on May 1 of each year of a nonqualified stock option for 1,000 shares of common stock. However, the Board of Directors has determined that these grants will not be made.

Stock option activity for the year ended December 31, 2011 is summarized below:


	Number of Options			Weighted Average Exercise Price			Weighted Average Remaining Contractual Term (Years)		Aggregate Intrinsic Value
Outstanding at January 1, 2011		280,266		$	22.30			0.70
Options granted		—			—			—
Options exercised		(81,918	)		19.03			—
Options forfeited or expired		(167,423	)		24.19			—

Outstanding at December 31, 2011		30,925			20.75			0.03	$	—

Exercisable at December 31, 2011		30,925			20.75	(a)		0.03	$	—

(a)	The range of exercise prices is $19.03 to $22.69

Total intrinsic value and tax benefits recognized for stock options exercised in 2011, 2010 and 2009 were immaterial.

Directors' Deferred Compensation

Under the Pepco Holdings' Executive and Director Deferred Compensation Plan, Pepco Holdings non-employee directors may elect to defer all or part of their retainer and meeting fees. Deferred retainer or meeting fees, at the election of the director, can be credited with interest at the prime rate or the return on selected investment funds or can be deemed invested in phantom shares of Pepco Holdings common stock on which dividend equivalent accruals are credited when dividends are paid on the common stock (or a combination of these options). All deferrals are settled in cash. The amount deferred by directors for each of the years ended December 31, 2011, 2010 and 2009 was not material.

Compensation expense recognized in respect of dividends and the increase in fair value for each of the years ended December 31, 2011, 2010 and 2009 was not material. The deferred compensation balance under this program was approximately $1 million at December 31, 2011 and 2010.

Dividend Restrictions

PHI, on a stand-alone basis, generates no operating income of its own. Accordingly, its ability to pay dividends to its shareholders depends on dividends received from its subsidiaries. In addition to their future financial performance, the ability of PHI's direct and indirect subsidiaries to pay dividends is subject to limits imposed by: (i) state corporate laws, which impose limitations on the funds that can be used to pay dividends and, in the case of ACE, the regulatory requirement that it obtain the prior approval of the NJBPU before dividends can be paid if its equity as a percent of its total capitalization, excluding securitization debt, falls below 30%; (ii) the prior rights of holders of mortgage bonds and other long-term debt issued by the subsidiaries, and any other restrictions imposed in connection with the incurrence of liabilities; and (iii) certain provisions of ACE's charter that impose restrictions on payment of common stock dividends for the benefit of preferred stockholders. Pepco, DPL and ACE have no shares of preferred stock outstanding at December 31, 2011. Currently, the capitalization ratio limitation to which ACE is subject and the restriction in the ACE charter do not limit ACE's ability to pay common stock dividends. PHI had approximately $1,072 million and $1,059 million of retained earnings free of restrictions at December 31, 2011 and 2010, respectively. These amounts represent the total retained earnings balances at those dates.

For the years ended December 31, Pepco Holdings received dividends from its subsidiaries as follows:


Subsidiary	2011		2010		2009
	*(millions of dollars)*
Pepco	$	25	$	115	$	—
DPL		60		23		28
ACE		—		35		64

Total	$	85	$	173	$	92

Calculations of Earnings per Share of Common Stock

The numerator and denominator for basic and diluted earnings per share of common stock calculations are shown below.


	For the Years Ended December 31 ,
	2011			2010			2009
	*(millions of dollars, except per share data)*
Income (Numerator):
Net income from continuing operations	$	260		$	139		$	223
Net (loss) income from discontinued operations		(3	)		(107	)		12

Net income	$	257		$	32		$	235

Shares (Denominator) (in millions):
Weighted average shares outstanding for basic computation:
Average shares outstanding		226			224			221
Adjustment to shares outstanding		—			—			—

Weighted Average Shares Outstanding for Computation of Basic Earnings Per Share of Common Stock		226			224			221
Net effect of potentially dilutive shares (a)		—			—			—

Weighted Average Shares Outstanding for Computation of Diluted Earnings Per Share of Common Stock		226			224			221

Basic and diluted earnings per share of common stock from continuing operations	$	1.15		$	0.62		$	1.01
Basic and diluted (loss) earnings per share of common stock from discontinued operations		(0.01	)		(0.48	)		0.05

Basic and diluted earnings per share	$	1.14		$	0.14		$	1.06

(a)	The number of options to purchase shares of common stock that were excluded from the calculation of diluted earnings per share as they are considered to be anti-dilutive were 14,900, 280,266 and 334,966 for the years ended December 31, 2011, 2010 and 2009, respectively.

Shareholder Dividend Reinvestment Plan

PHI maintains a Shareholder Dividend Reinvestment Plan (DRP) through which shareholders may reinvest cash dividends. In addition, both existing shareholders and new investors can make purchases of shares of PHI common stock through the investment of not less than $25 each calendar month nor more than $200,000 each calendar year. Shares of common stock purchased through the DRP may be new shares or, at the election of PHI, shares purchased in the open market. Approximately 2 million new shares were issued and sold under the DRP in each of 2011, 2010 and 2009.

Pepco Holdings Common Stock Reserved and Unissued

The following table presents Pepco Holdings' common stock reserved and unissued at December 31, 2011:


Name of Plan	Number of Shares
DRP		3,448,048
Conectiv Incentive Compensation Plan (a)		1,093,701
Potomac Electric Power Company Long-Term Incentive Plan (a)		327,059
Pepco Holdings Long-Term Incentive Plan		7,791,543
Pepco Holdings Non-Management Directors Compensation Plan		462,429
Pepco Holdings Retirement Savings Plan		1,298,849

Total		14,421,629

(a)	No further awards will be made under this plan.