Share-based payment plans in operation during the year
The Group had the following share-based payment plans in operation during the year:
Performance Share Plan (PSP)
This plan involves the award of shares to participants subject to performance conditions. Vesting of the performance shares is based on the achievement of both non-market based conditions (EPS and cash flow per share – CPS) and a market based performance condition (Total Shareholder Return – TSR).
ShareSave share option plan
Based on a three or five year monthly savings contract, eligible employees are granted share options with an exercise price of up to 20 per cent below the share price when the contract is entered into. Vesting of the options is not subject to the achievement of a performance target. In the UK, the plan is HM Revenue & Customs approved. Overseas, employees in 28 countries participate in ShareSave plans through arrangements broadly comparable to the UK plan. A small proportion of the ShareSave options are settled in cash.
Executive Share Option Plan (ESOP)
This plan involves the grant of market value share options to participants. The options are subject to a non-market based performance condition (growth in EPS). The options have a maximum contractual life of ten years. There was no grant of executive share options in either 2005 or 2006. Following the introduction of the PSP, it is not intended to grant any further executive share options.
Annual Performance Related Award (APRA) plan deferred shares
Deferred shares are awarded as part of the APRA plan. One third of the value of any annual bonus is delivered in the form of a deferred share award. The release of deferred share awards is not dependent on the achievement of any further performance conditions other than that participants remain an employee of the Group for two years from the date of the award in order to retain the full number of shares. During the two year deferral period, participants are entitled to receive dividends on the deferred shares.
Share Incentive Plan (SIP)
There is a 'Free Share' element of the UK Share Incentive Plan. Eligible employees may receive shares with a value of up to one week's salary as part of any bonus paid. There are no conditions attached to the shares.
Further information regarding the operation of the plans can be found in the Directors' remuneration report section.
In accordance with the transitional provisions of IFRS 2 Share-based Payment, the Group has recognised an expense in respect of all grants under these plans made after November 7, 2002 and unvested at January 1, 2005.
The Group recognised a total expense of £36m (2005 £26m).
The movements in awards under the Group's various share plans are shown in the tables below. A further breakdown of the options outstanding at the year end is provided in the table below.
| Number of shares awarded | ||
|---|---|---|
| PSP | 2006 Millions |
2005 Millions |
| Outstanding at January 1 | 11 | 6 |
| Awarded during the year | 5 | 5 |
| Forfeited during the year | (1) | — |
| Vested during the year | — | — |
| Outstanding at December 31 | 15 | 11 |
| 2006 | 2005 | ||||
|---|---|---|---|---|---|
| ShareSave | Number of share options Millions |
Weighted average exercise price Pence |
Number of share options Millions |
Weighted average exercise price Pence |
|
| Outstanding at January 1 | 65 | 157p | 74 | 130p | |
| Granted during the year | — | — | 12 | 298p | |
| Forfeited during the year | (1) | 168p | (1) | 139p | |
| Exercised during the year | (9) | 140p | (20) | 140p | |
| Outstanding at December 31 | 55 | 160p | 65 | 157p | |
| Exercisable at December 31 | 1 | 141p | — | — | |
| 2006 | 2005 | ||||
|---|---|---|---|---|---|
| ESOP | Number of share options Millions |
Weighted average exercise price Pence |
Number of share options Millions |
Weighted average exercise price Pence |
|
| Outstanding at January 1 | 77 | 148p | 80 | 149p | |
| Granted during the year | — | — | — | — | |
| Forfeited during the year | (1) | 216p | (3) | 169p | |
| Exercised during the year | (57) | 134p | — | — | |
| Outstanding at December 31 | 19 | 188p | 77 | 148p | |
| Exercisable at December 31 | 6 | 124p | — | — | |
| Number of shares awarded | ||
|---|---|---|
| Deferred shares under APRA | 2006 Millions |
2005 Millions |
| Outstanding at January 1 | 8 | 12 |
| Awarded during the year | 2 | 3 |
| Forfeited during the year | — | — |
| Vested during the year | (5) | (7) |
| Outstanding at December 31 | 5 | 8 |
| Number of shares awarded | ||
|---|---|---|
| Free Shares under SIP | 2006 Millions |
2005 Millions |
| Awarded during the year | 1 | 1 |
Options were exercised on a regular basis during the year. The average share price during the year was 439p (2005 310p).
| 2006 Pence |
2005 Pence |
||
|---|---|---|---|
| PSP awards | 494p | 282p | |
| ShareSave | – 3 year grants | — | 131p |
| ShareSave | – 5 year grants | — | 154p |
| APRA deferred share awards | 448p | 260p | |
| SIP Free Share awards | 462p | 257p | |
Details of the assumptions used in the calculation of these fair values are set out below. Expected volatility was based on the historical volatility of the Company's share price over the seven years prior to the grant or award date. Expected dividends were based on the Company's payments to shareholders over the five years prior to the grant or award date.
PSP awards
The fair value of shares awarded under the PSP are calculated using the market value of shares at the time of the award adjusted to take into account non-entitlement to dividends during the vesting period and the TSR performance condition. The PSP fair values were calculated using the following assumptions:
| 2006 | 2005 | |
|---|---|---|
| Weighted average share price | 444p | 262p |
| Expected dividends | 7.92p | 7.81p |
| Volatility | 32% | 34% |
| Correlation | 19% | 19% |
| Expected life | 3 years | 3 years |
| Risk free interest rate | 4.3% | 4.9% |
As explained on the Directors' remuneration report, the PSP has a TSR market-based performance condition, such that the Company's TSR over the performance period will be compared with the TSR of the companies constituting the FTSE 100 index on the date of grant. If the Company's TSR exceeds the median TSR of the FTSE 100, the number of shares that vest will be increased by 25 per cent. The fair value of an award of shares under the PSP has been adjusted to take into account this market-based performance condition using a pricing model based on expectations about volatility and the correlation of share price returns in the group of FTSE 100 companies and which incorporates into the valuation the interdependency between share price performance and TSR vesting. This adjustment increases the fair value relative to the share price at the date of grant.
ShareSave awards
The fair value of options granted under the ShareSave plan are calculated using a binomial pricing model with the following assumptions (no options were granted in 2006):
| 2005 | ||
|---|---|---|
| 1 The binomial pricing model assumes that participants will exercise their options at the beginning of the six month window if the share price is greater than the exercise price. Otherwise it assumes that options are held until the expiration of their contractual term. This results in an expected life that falls somewhere between the start and end of the exercise window. | ||
| Weighted average share price | 351p | |
| Exercise price | 298p | |
| Volatility | 40% | |
| Expected dividends | 7.86p | |
| Expected life 1 | – 3 year ShareSave | 3.3-3.8 years |
| – 5 year ShareSave | 5.3-5.8 years | |
| Close periods: | ||
| From January 1 | 6 weeks | |
| From July 1 | 1 month | |
| Risk free interest rate | 4.4% | |
Deferred shares under APRA and Free Shares under SIP
The fair value of shares awarded under these plans is calculated as the share price on the date of the award.
Fair values of options granted in 2003 and 2004
The charge under IFRS 2 Share-based payments for the current period includes a charge for options granted under the PSP, ShareSave, ESOP and APRA plans during the years ended December 31, 2003 and 2004, with the following grant date fair values:
| 2004 | 2003 | ||
|---|---|---|---|
| PSP | 249p | — | |
| ShareSave | – 3 year | — | 61p |
| ShareSave | – 5 year | — | 71p |
| ESOP | — | 22.7p | |
| APRA | 220p | — | |
| PSP | ShareSave | ESOP | |||
|---|---|---|---|---|---|
| 1 For the ShareSave options, the binomial pricing model assumes that participants will exercise options at the beginning of the six month window if the share price is greater than the exercise price. Otherwise it assumes that options are held until the expiration of their contractual term. This results in an expected life that falls somewhere between the start and end of the exercise window. | |||||
| Weighted average share price | 233p | 173p | 79p | ||
| Weighted average exercise price | 142p | 78p | |||
| Volatility | 35% | 43% | 43% | ||
| Expected dividends | 7.61p | 7.61p | 7.61p | ||
| Expected life 1 | – 3 year ShareSave | 3.15-3.65 years | |||
| – 5 year ShareSave | 5.15-5.65 years | ||||
| – ESOP | 4.5 years | ||||
| – PSP | 3 years | ||||
| Correlation | 22% | ||||
| Close periods: | |||||
| From January 1 | 6 weeks | 6 weeks | |||
| From July 1 | 1 month | 1 month | |||
| Risk free interest rate | 5.2% | 4.6% | 4.1% | ||
| Date of grant | Number | Exercise price | Exercisable dates |
|
|---|---|---|---|---|
| Executive Share Option Plan | 1999 | 140,564 | 269p | 2007-2009 |
| 2000 | 241,218 | 194p | 2007-2010 | |
| 2000 | 223,652 | 194p | 2007-2010 | |
| 2001 | 76,302 | 216p | 2007-2011 | |
| 2001 | 388,318 | 216p | 2007-2011 | |
| 2001 | 12,425,441 | 216p | 2007-2011 | |
| 2001 | 8,161 | 218p | 2007-2011 | |
| 2002 | 1,021,630 | 188p | 2007-2012 | |
| 2002 | 100,718 | 188p | 2007-2012 | |
| 2002 | 581,312 | 216p | 2007-2012 | |
| 2003 | 3,610,204 | 77p | 2007-2013 | |
| ShareSave plans | 1999 | 1,931,765 | 194p | 2007 |
| 2001 | 26,839,789 | 108p | 2007/2009 | |
| 2003 | 14,150,595 | 141p | 2007/2009 | |
| 2005 | 11,666,529 | 298p | 2009/2011 |
Under the terms of the Rolls-Royce 1999 Executive Share Option Plan, options granted to 211 directors and senior executives were outstanding at December 31, 2006.