9. Share-Based Compensation
On June 8, 2005, Devon's stockholders adopted the 2005 Long-Term Incentive Plan, which expires on June 8, 2013. Devon's stockholders adopted certain amendments to this plan on June 7, 2006. This plan, as amended, authorizes the Compensation Committee, which consists of non-management members of Devon's Board of Directors, to grant nonqualified and incentive stock options, restricted stock awards, Canadian restricted stock units, performance units, performance bonuses, stock appreciation rights and cash-out rights to eligible employees. The plan also authorizes the grant of nonqualified stock options, restricted stock awards and stock appreciation rights to directors. A total of 32 million shares of Devon common stock have been reserved for issuance pursuant to the plan. To calculate shares issued under the plan, options granted represent one share and other awards represent 2.2 shares.
Devon also has stock option plans that were adopted in 2003 and 1997 under which stock options and restricted stock awards were issued to key management and professional employees. Options granted under these plans remain exercisable by the employees owning such options, but no new options or restricted stock awards will be granted under these plans. Devon also has stock options outstanding that were assumed as part of the acquisitions of Ocean, Mitchell Energy & Development Corp., Santa Fe Snyder and PennzEnergy.
As discussed in Note 1, on January 1, 2006, Devon changed its method of accounting for share-based compensation from the APB No. 25 intrinsic value accounting method to the fair value recognition provisions of SFAS No. 123(R). The following table presents the effects of share-based compensation included in Devon's accompanying statement of operations for the years ended December 31, 2007, 2006 and 2005.
| 2007 | 2006 | 2005 | |||||||
|---|---|---|---|---|---|---|---|---|---|
| (In millions) | |||||||||
| Gross general and administrative expense | $ | 146 | 91 | 29 | |||||
| Share-based compensation expense capitalized pursuant to the full cost method of accounting for oil and gas properties |
$ | 44 | 26 | — | |||||
| Related income tax benefit | $ | 34 | 23 | 11 | |||||
Stock Options
Under Devon's 2005 Long-Term Incentive Plan, the exercise price of stock options granted may not be less than the estimated fair market value of the stock at the date of grant. In addition, options granted are exercisable during a period established for each grant, which may not exceed eight years from the date of grant. The recipient must pay the exercise price in cash or in common stock, or a combination thereof, at the time that the option is exercised. Options granted generally have a vesting period that ranges from three to four years.
The fair value of stock options on the date of grant is expensed over the applicable vesting period. Devon estimates the fair values of stock options granted using a Black-Scholes option valuation model, which requires Devon to make several assumptions. The volatility of Devon's common stock is based on the historical volatility of the market price of Devon's common stock over a period of time equal to the expected term of the option and ending on the grant date. The dividend yield is based on Devon's historical and current yield in effect at the date of grant. The risk-free interest rate is based on the zero-coupon U.S. Treasury yield for the expected term of the option at the date of grant. The expected term of the options is based on historical exercise and termination experience for various groups of employees and directors. Each group is determined based on the similarity of their historical exercise and termination behavior.
The following table presents a summary of the grant-date fair values of stock options granted and the related assumptions for the years ended December 31, 2007, 2006 and 2005. All such amounts represent the weighted-average amounts for each year.
| 2007 | 2006 | 2005 | |||||||
|---|---|---|---|---|---|---|---|---|---|
| Grant-date fair value | $ | 26.43 | 22.41 | 19.65 | |||||
| Volatility factor | 31.6 | % | 32.2 | % | 31.0 | % | |||
| Dividend yield | 0.7 | % | 0.5 | % | 0.6 | % | |||
| Risk-free interest rate | 5.0 | % | 5.7 | % | 4.4 | % | |||
| Expected term (in years) | 4.0 | 4.0 | 4.2 | ||||||
The following table presents a summary of Devon's outstanding stock options as of December 31, 2007, including changes during the year then ended.
| Options | Weighted Average Exercise Price |
Weighted Average Remaining Contractual Price |
Aggregate Intrinsic Value |
|||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| (In thousands) | (In years) | (In millions) | ||||||||||
| Outstanding at December 31, 2006 | 15,383 | $ | 38.24 | |||||||||
| Granted | 1,913 | $ | 87.68 | |||||||||
| Exercised | (3,123 | ) | $ | 29.43 | ||||||||
| Forfeited | (367 | ) | $ | 53.97 | ||||||||
| Outstanding at December 31, 2007 | 13,806 | $ | 46.66 | 3.8 | $ | 584 | ||||||
| Vested and expected to vest at December 31, 2007 | 13,688 | $ | 46.39 | 3.8 | $ | 582 | ||||||
| Exercisable at December 31, 2007 | 10,059 | $ | 35.58 | 3.2 | $ | 536 | ||||||
The aggregate intrinsic value of stock options that were exercised during 2007, 2006 and 2005 was $151 million, $119 million and $149 million, respectively. As of December 31, 2007, Devon's unrecognized compensation cost related to unvested stock options was $93 million. Such cost is expected to be recognized over a weighted-average period of 2.4 years.
Restricted Stock Awards and Units
Under Devon's 2005 Long-Term Incentive Plan, restricted stock awards and units are subject to the terms, conditions, restrictions and/or limitations, if any, that the Compensation Committee deems appropriate, including restrictions on continued employment. Generally, restricted stock awards and units vest over a minimum restriction period of at least three years from the date of grant. During the vesting period, recipients of restricted stock awards receive dividends that are not subject to restrictions or other limitations. The fair value of restricted stock awards and units on the date of grant is expensed over the applicable vesting period. Devon estimates the fair values of restricted stock awards and units as the closing price of Devon's common stock on the grant date of the award or unit.
The following table presents a summary of Devon's unvested restricted stock awards as of December 31, 2007, including changes during the year then ended.
| Restricted Stock Awards |
Weighted Average Grant-Date Fair Value |
|||||
|---|---|---|---|---|---|---|
| (In thousands) | ||||||
| Unvested at December 31, 2006 | 5,162 | $ | 58.35 | |||
| Granted | 2,026 | $ | 87.81 | |||
| Vested | (1,574 | ) | $ | 51.66 | ||
| Forfeited | (188 | ) | $ | 57.33 | ||
| Unvested at December 31, 2007 | 5,426 | $ | 71.38 | |||
The aggregate fair value of restricted stock awards that vested during 2007, 2006 and 2005 was $136 million, $82 million and $51 million, respectively. As of December 31, 2007, Devon's unrecognized compensation cost related to unvested restricted stock awards and units was $341 million. Such cost is expected to be recognized over a weighted-average period of 2.8 years.