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Notes to Consolidated Financial Statements

Note 6. Stock-Based Compensation

Our stock-based compensation program is a broad-based program designed to attract and retain employees while also aligning employees’ interests with the interests of our shareholders. A majority of our employees participate in our stock-based compensation program. This program includes both our broad-based SharePower program which was established in 1989 to grant an annual award of stock options to eligible employees, based upon job level or classification and tenure (internationally), as well as our executive long-term awards program. Stock options and restricted stock units (RSU) are granted to employees under the shareholder-approved 2007 Long-Term Incentive Plan (LTIP), our only active stock-based plan. Stock-based compensation expense was $238 million in 2008, $260 million in 2007 and $270 million in 2006. Related income tax benefits recognized in earnings were $71 million in 2008, $77 million in 2007 and $80 million in 2006. Stock-based compensation cost capitalized in connection with our ongoing business transformation initiative was $4 million in 2008, $3 million in 2007 and $3 million in 2006. At year-end 2008, 57 million shares were available for future stock-based compensation grants.

Method of Accounting and Our Assumptions

We account for our employee stock options, which include grants under our executive program and our broad-based SharePower program, under the fair value method of accounting using a Black-Scholes valuation model to measure stock option expense at the date of grant. All stock option grants have an exercise price equal to the fair market value of our common stock on the date of grant and generally have a 10-year term. We do not backdate, reprice or grant stock-based compensation awards retroactively. Repricing of awards would require shareholder approval under the LTIP.

The fair value of stock option grants is amortized to expense over the vesting period, generally three years. Executives who are awarded long-term incentives based on their performance are offered the choice of stock options or RSUs. Executives who elect RSUs receive one RSU for every four stock options that would have otherwise been granted. Senior officers do not have a choice and are granted 50% stock options and 50% performance-based RSUs. Vesting of RSU awards for senior officers is contingent upon the achievement of pre-established performance targets approved by the Compensation Committee of the Board of Directors. RSU expense is based on the fair value of PepsiCo stock on the date of grant and is amortized over the vesting period, generally three years. Each RSU is settled in a share of our stock after the vesting period.

Our weighted-average Black-Scholes fair value assumptions are as follows:

                 
   
2008
   
2007
   
2006
 
Expected life
 
6 yrs.
   
6 yrs.
   
6 yrs.
 
Risk free interest rate
 
3.0
%
 
4.8
%
 
4.5
%
Expected volatility
 
16
%
 
15
%
 
18
%
Expected dividend yield
 
1.9
%
 
1.9
%
 
1.9
%

The expected life is the period over which our employee groups are expected to hold their options. It is based on our historical experience with similar grants. The risk free interest rate is based on the expected U.S. Treasury rate over the expected life. Volatility reflects movements in our stock price over the most recent historical period equivalent to the expected life. Dividend yield is estimated over the expected life based on our stated dividend policy and forecasts of net income, share repurchases and stock price.

A summary of our stock-based compensation activity for the year ended December 27, 2008 is presented below:

                       
Our Stock Option Activity
                       
   
Options
(a)
Average
Price
(b)
 
Average
Life (years)
(c)
Aggregate
Intrinsic
Value
(d)
Outstanding at December 29, 2007
 
108,808
 
$
47.47
             
Granted
 
12,512
   
68.74
             
Exercised
 
(14,651
)
 
42.19
             
Forfeited/expired
 
(2,997
)
 
60.13
             
Outstanding at December 27, 2008
 
103,672
 
$
50.42
   
4.93
 
$
736,438
 
Exercisable at December 27, 2008
 
61,085
 
$
43.41
   
3.16
 
$
683,983
 
(a) Options are in thousands and include options previously granted under Quaker plans. No additional options or shares may be granted under the Quaker plans.
(b) Weighted-average exercise price.
(c) Weighted-average contractual life remaining.
(d) In thousands.
 
                       
Our RSU Activity
                       
   
RSUs
(a)
Average
Intrinsic
Value
(b)
 
Average
Life (years)
(c)
Aggregate
Intrinsic
Value
(d)
Outstanding at December 29, 2007
 
7,370
 
$
58.63
             
Granted
 
2,135
   
68.73
             
Converted
 
(2,500
)
 
54.59
             
Forfeited/expired
 
(854
)
 
62.90
             
Outstanding at December 27, 2008
 
6,151
 
$
63.18
   
1.20
 
$
335,583
 
(a) RSUs are in thousands.
(b) Weighted-average intrinsic value at grant date.
(c) Weighted-average contractual life remaining.
(d) In thousands.
 

Other Stock-Based Compensation Data

                 
   
2008
   
2007
   
2006
 
Stock Options
                 
Weighted-average fair value of options granted
$
11.24
 
$
13.56
 
$
12.81
 
Total intrinsic value of options exercised(a)
$
410,152
 
$
826,913
 
$
686,242
 
RSUs
                 
Total number of RSUs granted(a)
 
2,135
   
2,342
   
2,992
 
Weighted-average intrinsic value of RSUs granted
$
68.73
 
$
65.21
 
$
58.22
 
Total intrinsic value of RSUs converted(a)
$
180,563
 
$
125,514
 
$
10,934
 
(a) In thousands.
 

At December 27, 2008, there was $243 million of total unrecognized compensation cost related to nonvested share-based compensation grants. This unrecognized compensation is expected to be recognized over a weighted-average period of 1.7 years.