Pfizer 2007 Annual Report Download - page 67

2007 Financial Report 65
Notes to Consolidated Financial Statements
Pfizer Inc and Subsidiary Companies
Although not required to do so, historically, we have used
authorized and unissued shares and, to a lesser extent, shares held
in our Employee Benefit Trust and treasury stock to satisfy our
obligations under these programs.
A. Impact on Net Income
The components of share-based compensation expense and the
associated tax benefit follow:
YEAR ENDED DEC. 31,
_________________________________________________
(MILLIONS OF DOLLARS) 2007 2006 2005
Stock option expense(a) $ 286 $ 410 $ —
Restricted stock unit expense 160 184 120
PSA and PCSA (expense
reduction)/expense (9) 61 37
Share-based payment expense 437 655 157
Tax benefit for share-based
compensation expense (141) (204) (50)
Share-based payment expense,
net of tax $ 296 $ 451 $107
(a) In 2006, we adopted the fair value method of accounting for
stock options.
Amounts capitalized as part of inventory cost were not significant.
In 2007 and 2006, the impact of modifications under our cost-
reduction initiatives to share-based awards was not significant and,
in 2005, the impact of modifications under the Pharmacia
restructuring program was not significant. Generally, these
modifications resulted in an acceleration of vesting, either in
accordance with plan terms or at management’s discretion.
B. Stock Options
Stock options, which entitle the holder to purchase, at the end of
a vesting term, a specified number of shares of Pfizer common stock
at a price per share set equal to the market price of Pfizer common
stock on the date of grant, are accounted for at fair value at the date
of grant in the income statement beginning in 2006. These fair values
are generally amortized on an even basis over the vesting term into
Cost of sales, Selling, informational and administrative expenses and
Research and development expenses, as appropriate.
In 2005 and earlier years, stock options were accounted for under
APB No. 25, using the intrinsic value method in the income
statement and fair value information was disclosed. In these
disclosures of fair value, we allocated stock option compensation
expense based on the nominal vesting period, rather than the
expected time to achieve retirement eligibility. In 2006, we changed
our method of allocating stock option compensation expense to
a method based on the substantive vesting period for all new
awards, while continuing to allocate outstanding nonvested awards
not yet recognized as of December 31, 2005, under the nominal
vesting period method. Specifically, under this prospective change
in accounting policy, compensation expense related to stock options
granted prior to 2006, that are subject to accelerated vesting upon
retirement eligibility, is being recognized over the vesting term of
the grant, even though the service period after retirement eligibility
is not considered to be a substantive vesting requirement. The
impact of this change was not significant.
All employees may receive stock option grants. In virtually all
instances, stock options vest after three years of continuous
service from the grant date and have a contractual term of ten
years; for certain grants to certain members of management,
vesting typically occurs in equal annual installments after three,
four and five years from the grant date. In all cases, even for stock
options that are subject to accelerated vesting upon voluntary
retirement, stock options must be held for at least one year from
grant date before any vesting may occur. In the event of a
divestiture or restructuring, options held by employees are
immediately vested and are exercisable from three months to their
remaining term, depending on various conditions.
The fair value of each stock option grant is estimated on the grant
date using, for virtually all grants, the Black-Scholes-Merton
option-pricing model, which incorporates a number of valuation
assumptions noted in the following table, shown at their
weighted-average values:
YEAR ENDED DEC. 31,
________________________________________________
2007 2006 2005
Expected dividend yield(a) 4.49% 3.65% 2.90%
Risk-free interest rate(b) 4.69% 4.59% 3.96%
Expected stock price volatility(c) 21.28% 24.47% 21.93%
Expected term(d) (years) 5.75 6.0 5.75
(a) Determined in 2007 and 2006, using a constant dividend yield
during the expected term of the option. In 2005, determined
using a historical pattern of dividend payments.
(b) Determined using the extrapolated yield on U.S. Treasury zero-
coupon issues.
(c) Determined using implied volatility, after consideration of
historical volatility.
(d) Determined using historical exercise and post-vesting termination
patterns.
Starting in the first quarter of 2006, we changed our method of
estimating expected stock price volatility to reflect market-based
inputs under emerging stock option valuation considerations.
We use the implied volatility in a long-term traded option, after
consideration of historical volatility. In 2005, we used an average
term structure of volatility after consideration of historical
volatility.