Notice of 2010 Annual Meeting and Proxy Statement

 

March 8, 2010

 

Dear Shareholder:

 

You are cordially invited to attend our annual meeting of shareholders on Monday, April 19, 2010, at the Lilly Center Auditorium, Lilly Corporate Center, Indianapolis, Indiana, at 11:00 a.m. EDT.

The notice of meeting and proxy statement that follow describe the business we will consider at the meeting. Your vote is very important. I urge you to vote by mail, by telephone, or on the Internet to be certain your shares are represented at the meeting, even if you plan to attend.

Please note our procedures for admission to the meeting described on page 4.

I look forward to seeing you at the meeting.

 

 

John C. Lechleiter, Ph.D.

Chairman, President, and Chief Executive Officer

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Important notice regarding the availability of proxy materials for the shareholder meeting to be held April 19, 2010: The annual report and proxy statement are available at http://www.lilly.com/pdf/lillyar2009.pdf

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Notice of Annual Meeting of Shareholders

 

April 19, 2010

 

The annual meeting of shareholders of Eli Lilly and Company will be held at the Lilly Center Auditorium, Lilly Corporate Center, Indianapolis, Indiana, on Monday, April 19, 2010, at 11:00 a.m. EDT for the following purposes:

 

 

Shareholders of record at the close of business on February 12, 2010, will be entitled to vote at the meeting and at any adjournment of the meeting.

Attendance at the meeting will be limited to shareholders, those holding proxies from shareholders, and invited guests from the media and financial community. A page at the back of this report contains an admission ticket. If you plan to attend the meeting, please bring this ticket with you.

This combined proxy statement and annual report to shareholders and the proxy voter card are being mailed on or about March 8, 2010.

 

By order of the board of directors,

 

James B. Lootens

Secretary

 

March 8, 2010

Indianapolis, Indiana

 

 

1

General Information

 

Why did I receive this proxy statement?

The board of directors of Eli Lilly and Company is soliciting proxies to be voted at the annual meeting of shareholders (the annual meeting) to be held on Monday, April 19, 2010, and at any adjournment of the annual meeting. When the company asks for your proxy, we must provide you with a proxy statement that contains certain information specified by law.

 

What will the shareholders vote on at the annual meeting?

Eight items:

 

 

Will there be any other items of business on the agenda?

We do not expect any other items of business because the deadline for shareholder proposals and nominations has already passed. Nonetheless, in case there is an unforeseen need, the accompanying proxy gives discretionary authority to the persons named on the proxy with respect to any other matters that might be brought before the meeting. Those persons intend to vote that proxy in accordance with their best judgment.

 

Who is entitled to vote?

Shareholders as of the close of business on February 12, 2010 (the record date) may vote at the annual meeting. You have one vote for each share of common stock you held on the record date, including shares:

 

 

What constitutes a quorum?

A majority of the outstanding shares, present or represented by proxy, constitutes a quorum for the annual meeting. As of the record date, 1,153,145,432 shares of company common stock were issued and outstanding.

 

How many votes are required for the approval of each item?

There are differing vote requirements for the various proposals.

 

—the appointment of principal independent auditor

—the shareholder proposals.

Abstentions will not be counted either for or against these proposals.

 

 

Broker discretionary voting. If your shares are held by a broker, the broker will ask you how you want your shares to be voted. If you give the broker instructions, your shares will be voted as you direct. If you do not give instructions, one of two things can happen, depending on the type of proposal. For the ratification of the auditor and the management proposals on amending the articles of incorporation to provide for annual election of all directors and to eliminate all supermajority voting requirements, the broker may vote your shares in its discretion. For all other proposals, the broker may not vote your shares at all.

 

 

2

How do I vote by proxy?

If you are a shareholder of record, you may vote your proxy by any one of the following methods:

 

By mail. Sign and date each proxy card you receive and return it in the prepaid envelope. Sign your name exactly as it appears on the proxy. If you are signing in a representative capacity (for example, as an attorney-in-fact, executor, administrator, guardian, trustee, or the officer or agent of a corporation or partnership), please indicate your name and your title or capacity. If the stock is held in custody for a minor (for example, under the Uniform Transfers to Minors Act), the custodian should sign, not the minor. If the stock is held in joint ownership, one owner may sign on behalf of all owners. If you return your signed proxy but do not indicate your voting preferences, we will vote on your behalf for the election of the nominees for director listed below, for the ratification of the appointment of the independent auditor, for the management proposals on amending the articles of incorporation to provide for annual election of all directors and to eliminate all supermajority voting requirements, and against the shareholder proposals.

If you did not receive a proxy card in the materials you received from the company and you wish to vote by mail rather than by telephone or on the Internet as discussed below, you may request a paper copy of these materials and a proxy card by calling 317-433-5112. If you received an e-mail message notifying you of the electronic availability of these materials, please provide the control number from the e-mail, along with your name and mailing address.

 

By telephone. Shareholders in the United States, Puerto Rico, and Canada may vote by telephone by following the instructions on your proxy card or, if you received these materials electronically, by following the instructions in the e-mail message that notified you of their availability. Voting by telephone has the same effect as voting by mail. If you vote by telephone, do not return your proxy card. Telephone voting will be available until 11:59 p.m. EDT, April 18, 2010.

 

On the Internet. You may vote online at www.proxyvote.com. Follow the instructions on your proxy card or, if you received these materials electronically, follow the instructions in the e-mail message that notified you of their availability. Voting on the Internet has the same effect as voting by mail. If you vote on the Internet, do not return your proxy card. Internet voting will be available until 11:59 p.m. EDT, April 18, 2010.

You have the right to revoke your proxy at any time before the meeting by (i) notifying the company’s secretary in writing or (ii) delivering a later-dated proxy by telephone, on the Internet, or by mail. If you are a shareholder of record, you may also revoke your proxy by voting in person at the meeting.

 

How do I vote shares that are held by my broker?

If you have shares held by a broker or other nominee, you may instruct your broker or other nominee to vote your shares by following instructions that the broker or nominee provides to you. Most brokers offer voting by mail, by telephone, and on the Internet.

 

How do I vote in person?

If you are a shareholder of record, you may vote your shares in person at the meeting. However, we encourage you to vote by mail, by telephone, or on the Internet even if you plan to attend the meeting.

 

How do I vote my shares in the 401(k) plan?

You may instruct the plan trustee on how to vote your shares in the 401(k) plan by mail, by telephone, or on the Internet as described above, except that, if you vote by mail, the card that you use will be a voting instruction card rather than a proxy card.

 

How many shares in the 401(k) plan can I vote?

You may vote all the shares allocated to your account on the record date. In addition, unless you decline, your vote will also apply to a proportionate number of other shares held in the 401(k) plan for which voting directions are not received. These undirected shares include:

 

 

All participants are named fiduciaries under the terms of the 401(k) plan and under the Employee Retirement Income Security Act (ERISA) for the limited purpose of voting shares credited to their accounts and the portion of undirected shares to which their vote applies. Under ERISA, fiduciaries are required to act prudently in making voting decisions.

If you do not want to have your vote applied to the undirected shares, you should check the box marked “I decline.” Otherwise, the trustee will automatically apply your voting preferences to the undirected shares proportionally with all other participants who elected to have their votes applied in this manner.

 

 

3

What happens if I do not vote my 401(k) plan shares?

Your shares will be voted by other plan participants who have elected to have their voting preferences applied proportionally to all shares for which voting instructions are not otherwise received.

 

What does it mean if I receive more than one proxy card?

It means that you hold shares in more than one account. To ensure that all your shares are voted, sign and return each card. Alternatively, if you vote by telephone or on the Internet, you will need to vote once for each proxy card and voting instruction card you receive.

 

What does it mean if I did not receive a proxy card?

You may have elected to receive your proxy statement electronically, in which case you should have received an email with directions on how to access the proxy statement and how to vote your shares. If you wish to request a paper copy of these materials and a proxy card, please call 317-433-5112.

 

Who tabulates the votes?

The votes are tabulated by an independent inspector of election, IVS Associates, Inc.

 

What should I do if I want to attend the annual meeting?

All shareholders as of the record date may attend by presenting the admission ticket that appears at the end of this proxy statement. Please fill it out and bring it with you to the meeting. The meeting will be held at the Lilly Center Auditorium. Please use the Lilly Center entrance to the south of the fountain at the intersection of Delaware and McCarty streets. You will need to pass through security, including a metal detector. Present your ticket to an usher at the meeting.

Parking will be available on a first-come, first-served basis in the garage indicated on the map at the end of this report. If you have questions about admittance or parking, you may call 317-433-5112.

 

How do I contact the board of directors?

You may send written communications to one or more members of the board, addressed to:

Lead Director, Board of Directors

Eli Lilly and Company

c/o Corporate Secretary

Lilly Corporate Center

Indianapolis, Indiana 46285

 

All such communications (from shareholders or other interested parties) will be forwarded to the relevant director(s), except for solicitations or other matters unrelated to the company.

 

How do I submit a shareholder proposal for the 2011 annual meeting?

The company’s 2011 annual meeting is scheduled for April 18, 2011. If a shareholder wishes to have a proposal considered for inclusion in next year’s proxy statement, he or she must submit the proposal in writing so that we receive it by November 8, 2010. Proposals should be addressed to the company’s corporate secretary, Lilly Corporate Center, Indianapolis, Indiana 46285. In addition, the company’s bylaws provide that any shareholder wishing to propose any other business at the annual meeting must give the company written notice by November 8, 2010. That notice must provide certain other information as described in the bylaws. Copies of the bylaws are available online at http://investor.lilly.com/governance.cfm or in paper form upon request to the company’s corporate secretary.

 

Does the company offer an opportunity to receive future proxy materials electronically?

Yes. If you are a shareholder of record or a member of the 401(k) plan, you may, if you wish, receive future proxy statements and annual reports online. If you elect this feature, you will receive an e-mail message notifying you when the materials are available, along with a web address for viewing the materials and instructions for voting by telephone or on the Internet. If you have more than one account, you may receive separate e-mail notifications for each account.

You may sign up for electronic delivery in two ways:

 

 

If you received these materials electronically, you do not need to do anything to continue receiving materials electronically in the future.

If you hold your shares in a brokerage account, you may also have the opportunity to receive proxy materials electronically. Please follow the instructions of your broker.

 

What are the benefits of electronic delivery?

Electronic delivery reduces the company’s printing and mailing costs. It is also a convenient way for you to receive your proxy materials and makes it easy to vote your shares online. If you have shares in more than one account, it is an easy way to avoid receiving duplicate copies of proxy materials.

 

 

4

What are the costs of electronic delivery?

The company charges nothing for electronic delivery. You may, of course, incur the usual expenses associated with Internet access, such as telephone charges or charges from your Internet service provider.

 

Can I change my mind later?

Yes. You may discontinue electronic delivery at any time. For more information, call 317-433-5112.

 

What is “householding”?

We have adopted “householding,” a procedure under which shareholders of record who have the same address and last name and do not receive proxy materials electronically will receive only one copy of our annual report and proxy statement unless one or more of these shareholders notifies us that they wish to continue receiving individual copies. This procedure saves printing and postage costs by reducing duplicative mailings.

Shareholders who participate in householding will continue to receive separate proxy cards. Householding will not affect dividend check mailings.

Beneficial shareholders can request information about householding from their banks, brokers, or other holders of record.

 

What if I want to receive a paper copy of the annual report and proxy statement?

If you wish to receive a paper copy of the 2009 annual report and 2010 proxy statement, or future annual reports and proxy statements, please call 1-800-542-1061 or write to: Householding Department, 51 Mercedes Way, Edgewood, New York 11717. We will deliver the requested documents to you promptly upon your request.

 

 

5

Board of Directors

 

Directors’ Biographies

 

Class of 2010

The following five directors’ terms will expire at this year’s annual meeting. Each of these directors has been nominated and is standing for election to serve a term that will expire in 2013. See page 55 of this proxy statement for more information.

 

 

 

6

 

Class of 2011

The following four directors will continue in office until 2011.

 

 

 

7

 

Class of 2012

The following four directors will continue in office until 2012.

 

 

 

8

 

 

9

Highlights of the Company’s Corporate Governance Guidelines

 

The board of directors has established guidelines that it follows in matters of corporate governance. The following summary provides highlights of those guidelines. A complete copy of the guidelines is available online at http://investor.lilly.com/governance.cfm or in paper form upon request to the company’s corporate secretary.

 

The directors are elected by the shareholders to oversee the actions and results of the company’s management. Their responsibilities include:

 

 

Mix of Independent Directors and Officer-Directors

There should always be a substantial majority (75 percent or more) of independent directors. The chief executive officer should be a board member. Other officers may, from time to time, be board members, but no officer other than the chief executive officer should expect to be elected to the board by virtue of his or her position in the company.

 

Selection of Director Candidates

The board is responsible for selecting candidates for board membership and for establishing the criteria to be used in identifying potential candidates. The board delegates the screening process to the directors and corporate governance committee. For more information on the director nomination process, including the current selection criteria, see “Directors and Corporate Governance Committee Matters” on pages 21-23.

 

Independence Determinations

The board annually determines and discloses the independence of directors based on a review by the directors and corporate governance committee. No director is considered independent unless the board has determined that he or she has no material relationship with the company, either directly or as a partner, significant shareholder, or officer of an organization that has a material relationship with the company. Material relationships can include commercial, industrial, banking, consulting, legal, accounting, charitable, and familial relationships, among others. To evaluate the materiality of any such relationship, the board has adopted categorical independence standards consistent with the New York Stock Exchange (NYSE) listing standards, except that the “look-back period” for determining whether a director’s prior relationship with the company impairs independence is extended from three to four years.

Specifically, a director is not considered independent if (i) the director or an immediate family member is a current partner of the company’s independent auditor (currently Ernst & Young LLP); (ii) the director is a current employee of such firm; (iii) the director has an immediate family member who is a current employee of such firm and who participates in the firm’s audit, assurance, or tax compliance (but not tax planning) practice; or (iv) the director or an immediate family member was within the last four years (but is no longer) a partner or employee of such firm and personally worked on our audit within that time.

In addition, a director is not considered independent if any of the following relationships existed within the previous four years:

 

 

 

 

 

10

 

 

 

Members of board committees must meet all applicable independence tests of the NYSE, Securities and Exchange Commission (SEC), and Internal Revenue Service (IRS).

In February 2010, the directors and corporate governance committee reviewed directors’ responses to a questionnaire asking about their relationships with the company (and those of their immediate family members) and other potential conflicts of interest, as well as material provided by management related to transactions, relationships, or arrangements between the company and the directors or parties related to the directors. The committee determined that all 12 nonemployee directors listed below are independent, and that the members of each committee also meet the independence standards referenced above. The committee recommended this conclusion to the board and explained the basis for its decision, and this conclusion was adopted by the board. The committee and the board determined that none of the 12 directors listed below has had during the last four years (i) any of the relationships listed above or (ii) any other material relationship with the company that would compromise his or her independence. The table below includes a description of categories or types of transactions, relationships, or arrangements considered by the board (in addition to those listed above) in reaching its determination that the directors are independent. All of these relationships and transactions were entered into at arm’s length in the normal course of business and, to the extent they are commercial relationships, have standard commercial terms. None of these relationships or transactions exceeded the thresholds described above or otherwise compromises the independence of the named directors.

 

 

Director Tenure and Retirement Policy

Subject to the company’s charter documents, the following are the board’s expectations for director tenure:

 

 

Other Board Service

Effective November 1, 2009, no new director may serve on more than three other public company boards, and no incumbent director may accept new positions on public company boards that would result in service on more than three other public company boards. The directors and corporate governance committee or the chair of that committee may approve exceptions to this limit upon a determination that such additional service will not impair the director’s effectiveness on the company board.

 

 

11

Voting for Directors

In an uncontested election, any nominee for director who fails to receive a majority of the votes cast shall promptly tender his or her resignation following certification of the shareholder vote. The directors and corporate governance committee will consider the resignation offer and recommend to the board whether to accept it. The board will act on the committee’s recommendation within 90 days following certification of the shareholder vote. Board action on the matter will require the approval of a majority of the independent directors.

The company will disclose the board’s decision on a Form 8-K furnished to the SEC within four business days after the decision, including a full explanation of the process by which the decision was reached and, if applicable, the reasons why the board rejected the director’s resignation. If the resignation is accepted, the directors and corporate governance committee will recommend to the board whether to fill the vacancy or reduce the size of the board.

Any director who tenders his or her resignation under this provision will not participate in the committee or board deliberations regarding whether to accept the resignation offer. If all members of the directors and corporate governance committee fail to receive a majority of the votes cast at the same election, then the independent directors who did receive a majority of the votes cast will appoint a committee amongst themselves to consider the resignation offers and recommend to the board whether to accept them.

 

The directors and corporate governance committee annually reviews board compensation. Any recommendations for changes are made to the board by the committee.

Directors should hold meaningful equity ownership positions in the company; accordingly, a significant portion of overall director compensation is in the form of company equity. Directors are required to hold company stock valued at not less than five times their annual cash retainer; new directors are allowed five years to reach this ownership level.

 

Selection of Chairman and Chief Executive Officer; Succession Planning

The board currently combines the role of chairman of the board with the role of chief executive officer, coupled with a lead director position to further strengthen the governance structure. The board believes this provides an efficient and effective leadership model for the company. Combining the chairman and CEO roles fosters clear accountability, effective decision-making, and alignment on corporate strategy. To assure effective independent oversight, the board has adopted a number of governance practices, including:

 

 

 

 

However, no single leadership model is right for all companies and at all times. The board recognizes that depending on the circumstances, other leadership models, such as a separate independent chairman of the board, might be appropriate. Accordingly, the board periodically reviews its leadership structure.

The lead director recommends to the board an appropriate process by which a new chairman and chief executive officer will be selected. The board has no required procedure for executing this responsibility because it believes that the most appropriate process will depend on the circumstances surrounding each such decision.

A key responsibility of the CEO and the board is ensuring that an effective process is in place to provide continuity of leadership over the long term at all levels in the company. Each year, succession-planning reviews are held at every significant organizational level of the company, culminating in a full review of senior leadership talent by the independent directors. During this review, the CEO and the independent directors discuss future candidates for senior leadership positions, succession timing for those positions, and development plans for the highest-potential candidates. This process ensures continuity of leadership over the long term, and it forms the basis on which the company makes ongoing leadership assignments. It is a key success factor in managing the long planning and investment lead times of our business.

In addition, the CEO maintains in place at all times, and reviews with the independent directors, a confidential plan for the timely and efficient transfer of his or her responsibilities in the event of an emergency or his or her sudden incapacitation or departure.

 

Evaluation of Chief Executive Officer

The lead director is responsible for leading the independent directors in executive session to assess the performance of the chief executive officer at least annually. The results of this assessment are reviewed with the chief executive officer and considered by the compensation committee in establishing the chief executive officer’s compensation for the next year.

 

Succession Management and Election of Officers

The independent directors are responsible for overseeing the succession and management development program for senior leadership. The chief executive officer develops and maintains a process for advising the board on succession planning for the chief executive officer and other key senior leadership positions. The chief executive officer reviews this plan with the independent directors at least annually.

 

 

12

Consistent with the succession-management plan, the chief executive officer recommends to the board candidates for the company’s principal corporate offices.

 

Corporate Strategy

Once each year, the board devotes an extended meeting to an update from management regarding the strategic issues and opportunities facing the company, allowing the board an opportunity to provide direction for the corporate strategic plan. These strategy sessions also provide the board an opportunity to interact extensively with the company’s senior leadership team. This assists the board in its succession-management responsibilities.

Throughout the year, significant corporate strategy decisions are brought to the board for approval.

 

Code of Ethics

The board approved the company’s code of ethics, which complies with the requirements of the NYSE and the SEC. This code is set out in:

 

 

Both documents are available online at http://www.lilly.com/about/compliance/conduct/ or in paper form upon request to the company’s corporate secretary.

The audit committee and public policy and compliance committee assist in the board’s oversight of compliance programs with respect to matters covered in the code of ethics.

 

Risk Oversight

The company has an enterprise risk management program overseen by its chief ethics and compliance officer and senior vice president, enterprise risk management, who reports directly to the CEO and is a member of the company’s top leadership committee. Enterprise risks are identified and prioritized by management, and each prioritized risk is assigned to a board committee or the full board for oversight. For example, strategic risks are overseen by the full board; financial risks are overseen by the audit or finance committee; compliance and reputational risks are typically overseen by the public policy and compliance committee; and scientific risks are overseen by the science and technology committee. Management regularly reports on each such risk to the relevant committee or the board. The enterprise risk management program as a whole is reviewed annually at a joint meeting of the audit and public policy and compliance committees, as well as at an annual board strategy session. Additional review or reporting on enterprise risks is conducted as needed or as requested by the board or committee. Also, the compensation committee periodically reviews the most important enterprise risks to ensure that compensation programs do not encourage excessive risk-taking.

 

Executive Session of Directors

The independent directors meet alone in executive session and in private session with the chief executive officer at every regularly scheduled board meeting.

 

Lead Director

The board annually appoints a lead director from among the independent directors (currently Ms. Horn). The lead director:

 

 

Conflicts of Interest

Occasionally a director’s business or personal relationships may give rise to an interest that conflicts, or appears to conflict, with the interests of the company. Directors must disclose to the company all relationships that create a conflict or an appearance of a conflict. The board, after consultation with counsel, takes appropriate steps to ensure that all directors voting on an issue are disinterested. In appropriate cases, the affected director will be excused from discussions on the issue.

 

 

13

To avoid any conflict or appearance of a conflict, board decisions on certain matters of corporate governance are made solely by the independent directors. These include executive compensation and the selection, evaluation, and removal of the chief executive officer.

 

Review and Approval of Transactions with Related Persons

The board has adopted a written policy and written procedures for review, approval, and monitoring of transactions involving the company and “related persons” (directors and executive officers, their immediate family members, or shareholders owning five percent or greater of the company’s outstanding stock). The policy covers any related-person transaction that meets the minimum threshold for disclosure in the proxy statement under the relevant SEC rules (generally, transactions involving amounts exceeding $120,000 in which a related person has a direct or indirect material interest).

 

 

The board or relevant committee will periodically monitor the transaction to ensure that there are no changed circumstances that would render it advisable for the company to amend or terminate the transaction.

 

 

There are currently no related-person transactions.

 

Orientation of New Directors; Director Education

A comprehensive orientation process is in place for new directors. In addition, directors receive ongoing continuing education through educational sessions at meetings, the annual strategy retreat, and periodic communications between meetings. We hold periodic mandatory training sessions for the audit committee, to which other directors and executive officers are invited. We also afford directors the opportunity to attend external director education programs.

 

Director Access to Management and Independent Advisors

Independent directors have direct access to members of management whenever they deem it necessary. The independent directors and committees are also free to retain their own independent advisors, at company expense, whenever they feel it would be desirable to do so. In accordance with NYSE listing standards, the audit, compensation, and directors and corporate governance committees have sole authority to retain independent advisors to their respective committees.

 

Assessment of Board Processes and Performance

The directors and corporate governance committee annually assesses the performance of the board, its committees, and board processes based on inputs from all directors. The committee also considers the contributions of individual directors at least every three years when considering whether to recommend nominating the director to a new three-year term.

 

Number, Structure, and Independence

The duties and membership of the six board-appointed committees are described below. Only independent directors may serve on the committees.

 

 

14

Committee membership and selection of committee chairs are recommended to the board by the directors and corporate governance committee after consulting the chairman of the board and after considering the backgrounds, skills, and desires of the board members. The board has no set policy for rotation of committee members or chairs but annually reviews committee memberships and chair positions, seeking the best blend of continuity and fresh perspectives on the committees.

 

Functioning of Committees

Each committee reviews and approves its own charter annually, and the directors and corporate governance committee reviews and approves all committee charters annually. The chair of each committee determines the frequency and agenda of committee meetings. In addition, the audit, compensation, and public policy and compliance committees meet alone in executive session on a regular basis; all other committees meet in executive session as needed.

All six committee charters are available online at http://investor.lilly.com/governance.cfm.

 

 

15

Committees of the Board of Directors

 

Audit Committee

The duties of the audit committee are described in the “Audit Committee Report” found on page 24.

 

Compensation Committee

The duties of the compensation committee are described on pages 26-27, and the “Compensation Committee Report” is shown on page 40.

 

Directors and Corporate Governance Committee

The duties of the directors and corporate governance committee are described on page 21.

 

Finance Committee

 

 

Public Policy and Compliance Committee

 

 

Science and Technology Committee

 

 

 

16

Membership and Meetings of the Board and Its Committees

 

In 2009, each director attended more than 90 percent of the total number of meetings of the board and the committees on which he or she serves. In addition, all board members are expected to attend the annual meeting of shareholders, and all attended in 2009. Current committee membership and the number of meetings of the board and each committee in 2009 are shown in the table below.

 

 

 

 

 

17

Directors’ Compensation

 

Director compensation is reviewed and approved annually by the board, on the recommendation of the directors and corporate governance committee. Directors who are employees receive no additional compensation for serving on the board or its committees.

 

Cash Compensation

The company provides nonemployee directors the following cash compensation:

 

 

 

 

 

Stock Compensation

Stock compensation for nonemployee directors consists of shares of company stock equaling $145,000, deposited annually in a deferred stock account in the Lilly Directors’ Deferral Plan (as described below), payable after service on the board has ended.

 

Lilly Directors’ Deferral Plan

This plan allows nonemployee directors to defer receipt of all or part of their retainer and meeting fees until after their service on the board has ended. Each director can choose to invest the funds in one or both of two accounts:

 

 

 

Both accounts may be paid in a lump sum or in annual installments for up to 10 years, beginning the second January following the director’s departure from the board. Amounts in the deferred stock account are paid in shares of company stock.

 

 

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In 2009, we provided the following compensation to directors who are not employees:

 

Directors’ Compensation

 

 

 

 

 

 

 

 

 

 

 

19

Directors’ Outstanding Stock Options

 

 

20

Directors and Corporate Governance Committee Matters

 

Overview

The directors and corporate governance committee recommends to the board candidates for membership on the board and board committees and for lead director. The committee also oversees matters of corporate governance, including board performance, director independence and compensation, and the corporate governance guidelines. The committee’s charter is available online at http://investor.lilly.com/governance.cfm or in paper form upon request to the company’s corporate secretary.

All committee members are independent as defined in the NYSE listing requirements.

 

Director Qualifications

The board seeks independent directors who represent a mix of backgrounds and experiences that will enhance the quality of the board’s deliberations and decisions. Candidates shall have substantial experience with one or more publicly traded national or multinational companies or shall have achieved a high level of distinction in their chosen fields.

Board membership should reflect diversity in its broadest sense, including persons diverse in geography, gender, and ethnicity. The board is particularly interested in maintaining a mix that includes the following backgrounds:

 

 

 

 

Finally, board members should display the personal attributes necessary to be an effective director: unquestioned integrity, sound judgment, independence in fact and mindset, ability to operate collaboratively, and commitment to the company, its shareholders, and other constituencies.

The Lilly board members represent a desirable mix of backgrounds, skills, and experiences, and they all share the personal attributes of effective directors described above. Below are some of the specific experiences and skills of our independent directors:

 

Ralph Alvarez

Through his senior executive experience at McDonalds and other global restaurant businesses, Mr. Alvarez has extensive experience in consumer marketing, global operations, international business, and strategic planning. His international experience includes a special focus on emerging markets.

 

Sir Winfried Bischoff

Sir Winfried Bischoff has a distinguished career in banking and finance, including commercial banking, corporate finance, and investment banking. He has CEO experience both in Europe and the U.S. He is a globalist, with particular expertise in European matters but with extensive experience overseeing worldwide operations. He has extensive corporate governance experience from his service on public company boards in the U.S., U.K., and other European and Asian countries.

 

Michael L. Eskew

Mr. Eskew has CEO experience with UPS, where he established a record of success in managing complex worldwide operations, strategic planning, and building a strong consumer brand focus. He is an audit committee financial expert, based on his CEO experience and his service on other U.S. company audit committees. He has extensive corporate governance experience through his service on the boards of other companies.

 

Martin S. Feldstein

Dr. Feldstein is a renowned economist, academic, and adviser to U.S. presidents of both political parties. He has deep economic and public policy expertise, financial acumen, and a global perspective. His background as an academic brings a diversity of experience and perspective to the board’s deliberations. He has also served on the boards of several major public companies.

 

J. Erik Fyrwald

Mr. Fyrwald has a strong record of operational and strategy leadership in two complex worldwide businesses with a focus on technology and innovation. An engineer by training, he has extensive senior executive experience at DuPont, a multinational chemical company, where he led their agriculture and nutrition division, which used chemical and biotechnology solutions to enhance plant health. More recently, he has gained CEO experience at Nalco, a global technology-based water products and services company.

 

 

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Alfred G. Gilman

Dr. Gilman is a Nobel Prize winning pharmacologist, researcher, and medical professor. He has deep expertise in basic science, including mechanisms of drug action, and experience with pharmaceutical discovery research. As the former dean of a major medical school, he brings to the board important perspectives of both the academic and practicing medical communities.

 

R. David Hoover

Mr. Hoover has extensive CEO experience at Ball Corporation, with a strong record of leadership in operations and strategy. He is an audit committee financial expert as a result of his experience as CEO and formerly as CFO of Ball. He also has extensive corporate governance experience through his service on other public company boards.

 

Karen N. Horn

Ms. Horn is a former CEO with extensive experience in various segments of the financial industry, including banking and financial services. Through her for-profit and her public-private partnership work, she has significant experience in international economics and finance. Ms. Horn has extensive corporate governance experience through service on other public company boards in a variety of industries.

 

John C. Lechleiter

Dr. Lechleiter is our chairman, president, and chief executive officer. Under our corporate governance guidelines, the CEO is expected to serve on the board of directors. Dr. Lechleiter, a Ph.D. chemist, has over 30 years of experience with the company in a variety of roles of increasing responsibility in research and development, sales and marketing, and corporate administration. As a result, he has a deep understanding of pharmaceutical research and development, sales and marketing, strategy, and operations. He also has significant corporate governance experience through service on other public company boards.

 

Ellen R. Marram

Ms. Marram is a former CEO with a strong marketing and consumer brand background. Through her nonprofit and private company activities, she has a special focus and expertise in wellness and consumer health. Ms. Marram has extensive corporate governance experience through service on other public company boards in a variety of industries.

 

Douglas R. Oberhelman

Mr. Oberhelman has a strong strategic and operational background as a senior executive (and most recently as CEO-elect) of Caterpillar, a leading manufacturing company with worldwide operations and a special focus on emerging markets. He is an audit committee financial expert as a result of his prior experience as CFO of Caterpillar and as a member and chairman of the audit committee of another U.S. public company.

 

Franklyn G. Prendergast

Dr. Prendergast is a prominent medical clinician, researcher, and academician. He has extensive experience in senior-most administration at Mayo Clinic, a major medical institution, and as director of its renowned cancer center. He has special expertise in two critical areas for Lilly—oncology and personalized medicine. As a medical doctor, he brings an important practicing physician perspective to the board’s deliberations.

 

Kathi P. Seifert

Ms. Seifert is a former senior executive of Kimberly-Clark, a global consumer products company. She has strong expertise in consumer marketing and brand management, having led sales and marketing for several worldwide brands, with a special focus on consumer health. She has extensive corporate governance experience through her other board positions.

 

Director Nomination Process

The board delegates the screening process to the directors and corporate governance committee, which receives direct input from other board members. Potential candidates are identified through recommendations from several sources, including:

 

 

The committee employs the same process for evaluating all candidates, including those submitted by shareholders. The committee initially evaluates a candidate based on publicly available information and any additional information supplied by the party recommending the candidate. If the candidate appears to satisfy the selection criteria and the committee’s initial evaluation is favorable, the committee, assisted by management or the search firm, gathers additional data on the candidate’s qualifications, availability, probable level of interest, and any

 

 

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potential conflicts of interest. If the committee’s subsequent evaluation continues to be favorable, the candidate is contacted by the chairman of the board and one or more of the independent directors for direct discussions to determine the mutual levels of interest in pursuing the candidacy. If these discussions are favorable, the committee makes a final recommendation to the board to nominate the candidate for election by the shareholders (or to select the candidate to fill a vacancy, as applicable). Mr. Alvarez and Mr. Hoover, who are standing for election, were referred to the committee by an independent executive search firm.

 

Process for Submitting Recommendations and Nominations

A shareholder who wishes to recommend a director candidate for evaluation by the committee pursuant to this process should forward the candidate’s name and information about the candidate’s qualifications to the chair of the directors and corporate governance committee, in care of the corporate secretary, at Lilly Corporate Center, Indianapolis, Indiana 46285. The candidate must meet the selection criteria described above and must be willing and expressly interested in serving on the board.

Under Section 1.9 of the company’s bylaws, a shareholder who wishes to directly nominate a director candidate at the 2011 annual meeting (i.e., to propose a candidate for election who is not otherwise nominated by the board through the recommendation process described above) must give the company written notice by November 8, 2010. The notice should be addressed to the corporate secretary at Lilly Corporate Center, Indianapolis, Indiana 46285. The notice must contain prescribed information about the candidate and about the shareholder proposing the candidate as described in more detail in Section 1.9 of the bylaws. A copy of the bylaws is available online at http://investor.lilly.com/governance.cfm. The bylaws will also be provided by mail without charge upon request to the corporate secretary.

 

 

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Audit Committee Matters

 

Audit Committee Membership

All members of the audit committee are independent as defined in the SEC regulations and NYSE listing standards applicable to audit committee members. The board of directors has determined that Mr. Eskew, Mr. Hoover, and Mr. Oberhelman are audit committee financial experts, as defined in the rules of the SEC.

 

Audit Committee Report

The audit committee (“we” or “the committee”) reviews the company’s financial reporting process on behalf of the board. Management has the primary responsibility for the financial statements and the reporting process, including the systems of internal controls and disclosure controls. In this context, we have met and held discussions with management and the independent auditor. Management represented to us that the company’s consolidated financial statements were prepared in accordance with generally accepted accounting principles, and we have reviewed and discussed the audited financial statements and related disclosures with management and the independent auditor, including a review of the significant management judgments underlying the financial statements and disclosures.

The independent auditor reports to us. We have sole authority to appoint and to replace the independent auditor.

We have discussed with the independent auditor matters required to be discussed by Statement on Auditing Standards No. 61 (Communication with Audit Committees), as amended and as adopted by the Public Company Accounting Oversight Board (PCAOB) in Rule 3200T, including the quality, not just the acceptability, of the accounting principles, the reasonableness of significant judgments, and the clarity of the disclosures in the financial statements. In addition, we have received the written disclosures and the letter from the independent auditor required by applicable requirements of the PCAOB regarding communications with the audit committee concerning independence, and have discussed with the independent auditor the auditor’s independence from the company and its management. In concluding that the auditor is independent, we determined, among other things, that the nonaudit services provided by Ernst & Young LLP (as described below) were compatible with its independence. Consistent with the requirements of the Sarbanes-Oxley Act of 2002, we have adopted policies to avoid compromising the independence of the independent auditor, such as prior committee approval of nonaudit services and required audit partner rotation.

We discussed with the company’s internal and independent auditors the overall scope and plans for their respective audits, including internal control testing under Section 404 of the Sarbanes-Oxley Act. We periodically meet with the internal and independent auditors, with and without management present, and in private sessions with members of senior management (such as the chief financial officer and the chief accounting officer) to discuss the results of their examinations, their evaluations of the company’s internal controls, and the overall quality of the company’s financial reporting. We also periodically meet in executive session.

In reliance on the reviews and discussions referred to above, we recommended to the board (and the board subsequently approved the recommendation) that the audited financial statements be included in the company’s annual report on Form 10-K for the year ended December 31, 2009, for filing with the SEC. We have also appointed the company’s independent auditor, subject to shareholder ratification, for 2010.

 

Audit Committee

Michael L. Eskew, Chair

Martin S. Feldstein, Ph.D.
R. David Hoover
Douglas R. Oberhelman
Kathi P. Seifert

 

Services Performed by the Independent Auditor

The audit committee preapproves all services performed by the independent auditor, in part to assess whether the provision of such services might impair the auditor’s independence. The committee’s policy and procedures are as follows:

 

 

 

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For each engagement, management provides the committee with information about the services and fees, sufficiently detailed to allow the committee to make an informed judgment about the nature and scope of the services and the potential for the services to impair the independence of the auditor.

After the end of the audit year, management provides the committee with a summary of the actual fees incurred for the completed audit year.

 

Independent Auditor Fees

The following table shows the fees incurred for services rendered on a worldwide basis by Ernst & Young LLP, the company’s independent auditor, in 2009 and 2008. All such services were preapproved by the committee in accordance with the preapproval policy.

 

 

 

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Compensation Committee Matters

 

Scope of Authority

The compensation committee oversees the company’s global compensation philosophy and establishes the compensation of executive officers. The committee also acts as the oversight committee with respect to the company’s deferred compensation plans, management stock plans, and other management incentive compensation programs. In overseeing those plans, the committee may delegate authority to company officers for day-to-day plan administration and interpretation, including selecting participants, determining award levels within plan parameters, and approving award documents. However, the committee may not delegate any authority for matters affecting the executive officers.

 

The Committee’s Processes and Procedures

The committee’s primary processes for establishing and overseeing executive compensation can be found in the “Compensation Discussion and Analysis” section under “The Committee’s Processes and Analyses” below. Additional processes and procedures include:

 

 

The consultant interacts directly with members of company management only on matters under the committee’s oversight and with the knowledge and permission of the committee chair.

 

The CEO normally does not participate in the formulation or discussion of his pay recommendations; however, for 2010 Dr. Lechleiter requested that no increases be made to his base salary or incentive targets. The CEO has no prior knowledge of the recommendations that the consultant makes to the committee.

 

 —unreasonable goals or thresholds

 

The committee noted several design features of the company’s cash and equity incentive programs for all employees that reduce the likelihood of excessive risk-taking:

 —Maximum payout levels for bonuses and performance awards are capped at 200 percent of target.

 —All regular U.S. employees participate in the same bonus plan.

 

 

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 —Bonus and equity programs have minimum payout levels for nonexecutive officers.

 —The company currently does not grant stock options.

 —The compensation committee has downward discretion over incentive program payouts.

 —Executive officers are subject to share ownership and retention guidelines.

 

The committee determined that, for all employees, the company’s compensation programs do not encourage excessive risk and instead encourage behaviors that support sustainable value creation. Nonetheless, as a result of the review, the committee is implementing certain changes to the bonus and equity incentive plan designs for 2010 to further reduce incentives to incur excessive risk as follows:

 

Compensation Committee Interlocks and Insider Participation

None of the compensation committee members:

 

 

 

 

 

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Executive Compensation

 

Compensation Discussion and Analysis

 

Summary

Executive compensation for 2009 aligned well with the objectives of our compensation philosophy and with our performance, driven by these factors:

	•	Strong growth in operating results drove strong annual bonus and performance award (PA) payouts. As described below, strong operating performance included 5.3 percent pro-forma adjusted revenue growth and 15.7 percent adjusted EPS growth, both of which were more than double our peer group average. This resulted in above-target cash bonus and PA payouts for all participants.

	•	Lagging stock price resulted in no payout of shareholder value awards (SVAs). Total shareholder return for 2007-2009 failed to meet the threshold for the SVA; as a result, awards granted to executive officers did not pay out.

	•	Cost-effective equity design maintained for 2009, with more emphasis on long-term performance. In 2009, we shifted our PA program from a one-year to a two-year performance period, in response to shareholder input and the board’s emphasis on strong corporate governance. We continued our SVA program and maintained a 50/50 mix of PAs and SVAs for all members of senior management, including executive officers. We improved the overall cost structure of our equity program in 2007, while maintaining its competitiveness and motivational impact, by eliminating stock options in favor of SVAs.
	•	A balanced program fosters employee achievement, retention, and engagement. We delivered a total compensation package composed of salary, performance-based cash and equity incentives, and a competitive employee benefits program. Together these elements reinforced pay-for-performance, provided a balanced focus on both long- and short-term performance, and encouraged employee retention and engagement.

 

In addition:

 

 

 

 

Executive Compensation Philosophy

Our strategy is to create value by accelerating the flow of innovative new medicines that provide improved outcomes for individual patients. We aim to discover, develop, or acquire innovative new therapies—medicines that make a real difference for patients and deliver clear value for payers. In addition, we must continually improve productivity in all that we do. To achieve these goals, we must attract, engage, and retain highly-talented

 

 

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individuals who are committed to the company’s core values of integrity, excellence, and respect for people. Our compensation and benefits programs are based on these objectives:

 

	•	Compensation should reflect individual and company performance. We link all employees’ pay to individual and company performance.

	—	As employees assume greater responsibilities, more of their pay is linked to company performance and shareholder returns.

	—	We seek to deliver above-market compensation given top-tier individual and company performance, but below-market compensation where individual performance falls short of expectations and/or company performance lags the industry.
	—	We design our programs to be simple and clear, so that employees can easily understand how their efforts affect their pay.
	—	Our incentive programs use hard metrics (sales, earnings, and total shareholder return) that can be objectively measured against our peer companies.

	—	We balance the objectives of pay-for-performance and employee retention. Even during downturns in company performance, the program should continue to motivate and engage successful, high-achieving employees.

 

 

 

 

The Committee’s Processes and Analyses

The compensation committee uses several tools to help it structure compensation programs that meet company objectives. Among those are:

	•	Assessment of individual performance. Individual performance has a strong impact on compensation.

	—	The independent directors, under the direction of the lead director, meet with the CEO in private session at the beginning of the year to agree upon the CEO’s performance objectives for the year. At the end of the year, the independent directors meet in executive session to review the performance of the CEO based on his or her achievement of the agreed-upon objectives, contribution to the company’s performance, ethics and integrity, and other leadership accomplishments. This evaluation is shared with the CEO by the lead director and is used by the compensation committee in setting the CEO’s compensation.

	—	For the other executive officers, the committee receives a performance assessment and compensation recommendation from the CEO and also exercises its judgment based on the board’s interactions with the executive officer. As with the CEO, the executive’s performance evaluation is based on the executive’s achievement of objectives established between the executive and his or her supervisor, the executive’s contribution to the company’s performance, ethics and integrity, and other leadership attributes and accomplishments.

 

 

 

 

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The peer group is reviewed for appropriateness at least every three years. The group was reviewed in June 2008, and the new group was used for purposes of 2009 compensation decisions. The committee added four new companies (AstraZeneca plc, Hoffmann-La Roche Inc., Novartis AG, and Sanofi-Aventis) because over time the number of comparator companies had decreased due to industry consolidation. The committee desired an expanded peer group to have a better representation of companies that are direct competitors for our products, operate in a similar business model, and employ people with the unique skills required to operate an established biopharmaceutical company. The committee also considered market cap as of December 31, 2007 and 2007 revenue as measures of size; with the exception of Johnson & Johnson, all peer companies were between one-half to three times Lilly with regard to both measures. The committee included Johnson & Johnson, despite its size, because it competes directly with Lilly for talent at all management levels.

 

 

Executive Compensation for 2009

 

Overview—Establishment of Overall Pay

In making its pay decisions for 2009, the committee reviewed 2008 company performance data and peer group data as discussed above, and also considered expected competitive trends in executive pay. That review showed:

 

 

 

The committee determined the following:

 

 

 

 

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2009 Target Compensation

The graphs below show the balance of target compensation determined by the committee.

 

 

 

2009 Actual Compensation

The graphs below show the ratio of pay elements in actual compensation received for 2009.

 

 

Base salary and bonus amounts are shown in the Summary Compensation Table. The PA payout for 2009 performance is shown in the table on page 44. The SVA payout for 2007-2009 performance was zero for all named executive officers except Mr. Carmine, who was not an officer when the award was granted. Mr. Carmine’s payout is shown in the Options Exercised and Stock Vested in 2009 table.

 

Base Salary

In setting base salaries for 2009, the committee considered the following:

	•	The corporate budget. The corporate budget for salary increases was established based on company performance for 2008, expected performance for 2009, and a reference to general external trends. The objective of the budget is to allow salary increases to retain, motivate, and reward successful performers while maintaining affordability within the company’s business plan. Individual pay increases can be more or less than the budget amount depending on individual performance, but aggregate increases must stay within the budget. The aggregate increases for the named executive officers and the other executive officers were within the corporate budget of four percent.

	•	Internal relativity, meaning the relative pay differences between different job levels.

	•	Peer group data specific to certain positions in which the jobs were viewed as comparable in content and importance. We used the peer-group data as a market check for reasonableness and competitiveness. The salaries, as determined by the other factors, were within the broad middle range of expected competitive pay and, therefore, no further adjustments were necessary for competitiveness.

	•	Individual performance. As described above under “The Committee’s Processes and Analyses,” base salary increases were driven largely by individual performance assessments.

	—	In assessing Dr. Lechleiter’s 2008 performance, the independent directors considered the company’s and Dr. Lechleiter’s accomplishment of objectives that had been established at the beginning of the year and their own subjective assessment of his performance. They noted that under Dr. Lechleiter’s leadership in 2008, the company:

	•	exceeded sales and earnings targets

 

 

 

In establishing Dr. Lechleiter’s base salary, the committee also considered his assumption of the additional role of chairman of the board in 2009.

 

 

Change in base salary ($000‘s)

 

 

   In establishing the 2009 target growth rates, the committee considered the expected 2009 performance of our peer group, based on published investment analyst estimates. The target growth rates of three percent for sales and seven percent for adjusted EPS were slightly above the median expected growth rates for our peer group. These targets were aligned with our compensation objectives of producing above-target payouts if the company outperformed the peer group and below-target payouts if company performance lagged the peer group. Payouts were determined by this formula:

 

2009 sales and adjusted EPS multiples are illustrated by these charts:

 

 

2009 pro forma sales of $21,836 million represented 5.3 percent growth over 2008 pro forma sales of $20,732 million and resulted in a sales multiple of 1.23.

 

 

2009 pro forma adjusted EPS of $4.42 represented growth of 15.7 percent over 2008 pro forma adjusted EPS of $3.82 and resulted in an EPS multiple of 1.87.

 

Together, the sales multiple and the adjusted EPS multiple yielded a bonus multiple of 1.71.

 

(0.25 x 1.23) + (0.75 x 1.87) = 1.71 bonus multiple

 

 

See page 37 for a reconciliation of 2009 reported and pro forma sales and adjusted EPS.

 

Equity Incentives—Total Equity Program

We employ two forms of equity incentives granted under the 2002 Lilly Stock Plan: performance awards (PAs) and shareholder value awards (SVAs). These incentives are designed to focus our leaders on long-term shareholder value: SVAs have a three-year performance period and PAs, beginning in 2009, have a two-year performance period. For executive officers, PAs pay out in restricted stock units that vest one year after the

 

 

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performance period. Executive officers are required to hold net shares they earn from SVAs for one year after payout. The following chart shows the holding periods for PA and SVA grants over time:

 

	•	Target grant values. For 2009, the committee increased aggregate grant values for three named executives based on internal relativity, individual performance, and aggregated peer-group data suggesting that the 2008 grant values were below the broad middle range compared to those of peers. Consistent with the company’s compensation objectives, individuals at higher levels received a greater proportion of total compensation in the form of equity. The committee determined that for members of senior management, a 50/50 split between PAs and SVAs appropriately balances the company financial performance and shareholder equity return metrics of the two programs. Target values for 2009 equity grants for the named executive officers were as follows:

 

Target grant values ($000’s)

 

 

Equity Incentives—Performance Awards

PAs provide employees with shares of company stock if certain company performance goals are achieved. The awards are structured as a schedule of shares of company stock based on growth in adjusted EPS over specified time periods of one or more years. In 2009, the company granted both a one-year and a two-year award to all global management as a transition to a two-year performance period for all PAs granted beginning in 2010. (This design change was implemented in response to shareholder feedback.) The two grants in 2009 provided the opportunity for participants to receive one and only one PA payout each year—without skipping a year. The 2009 PA paid in February 2010, while the 2009-2010 PA will pay out in February 2011, assuming performance targets are met (see Holding Periods for PAs and SVAs chart above). The fair market value at grant for both awards was the same. Possible payouts for both PAs range from zero to 200 percent of the target amount, depending on adjusted EPS growth over the performance period. No dividends are paid on the awards during the performance period. At the end of the performance period, the committee has discretion to adjust an award payout downward (but not upward) from the amount yielded by the formula. For the 2009 grants, the committee considered the following:

 

	•	Company performance measure. The committee established the performance measure as adjusted EPS growth. The committee believes adjusted EPS growth is an effective motivator because it is closely linked to shareholder value, is broadly communicated to the public, is easily understood by employees, and allows for objective comparisons to peer-group performance. The target growth percentage of seven percent was slightly above the median expected adjusted earnings performance of companies in our peer group over both a one-year and two-year period, based on published investment analyst estimates. Accordingly,

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Payouts for 2009 PAs were determined according to this schedule:

 

2009 PA

 

 

2009 pro forma adjusted EPS of $4.42 represented a growth over 2008 pro forma adjusted EPS ($3.82) of 15.7 percent. This top-tier growth within the peer group resulted in a 2009 PA payout at 200 percent of target. See page 37 for a reconciliation of 2009 reported and pro forma adjusted EPS.

 

Payouts for 2009-2010 PAs will be determined in 2011 based on the schedule below:

 

2009-2010 PA

 

 

Equity Incentives—Shareholder Value Awards

In 2007, the company replaced its stock option program with the SVA program. SVAs are structured as a schedule of shares of company stock based on the performance of the company’s stock over a three-year period. No dividends are paid on the awards during the performance period. Payouts range from zero to 140 percent of the target amount, depending on stock performance over the period. At the end of the performance period, the committee has discretion to adjust an award payout downward (but not upward) from the amount yielded by the formula. The SVA program delivers equity compensation that is strongly linked to long-term total shareholder returns. It is more cost-effective than the stock option program it replaced because the SVA program delivers, at a lower cost to the company, an equity incentive that is equally or more effective in aligning employee interests with long-term shareholder returns. For the 2009 grants, the committee considered the following:

	•	Company performance measure. The SVA is designed to pay above target if company stock outperforms an expected compounded annual rate of return for large-cap companies and below target if company stock underperforms that rate of return. The expected rate of return used in this calculation was determined considering total return that a reasonable investor would consider appropriate for investing in a large-cap U.S. company, less the company’s current dividend yield, based on input from external money managers. Executive officers receive no payout if the stock price, less three years of dividends at the current rate, does not grow over the three-year performance period—in other words, if total shareholder return for the three-year period is zero or negative.

 

The starting price for the 2009-2011 SVAs was $34.74 per share, representing the average of the closing prices of company stock for all trading days in November and December 2008. The ending price to determine payouts will be the average of the closing prices of company stock for all trading days in November and December 2011.

 

Payouts of the 2009-2011 SVA to executive officers will be determined by this schedule when they are paid out in early 2012:

 

2009-2011 SVA

 

 

 

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Stock Options

The company stopped granting stock options in 2007. All outstanding stock options are currently “under water,” meaning they have no realizable value. The stock option granted in 1999 expired in 2009, and all of the named executive officers forfeited the award having realized no value. These awards (and other expired stock options) were not replaced.

 

Adjustments for Certain Items

Consistent with past practice, the committee adjusted the results on which 2009 bonuses and PAs were determined to eliminate the distorting effect of certain unusual income or expense items on year-over-year growth percentages. The adjustments are intended to:

 

 

 

To assure the integrity of the adjustments, the committee establishes adjustment guidelines at the beginning of the year. These guidelines are consistent with the company guidelines for reporting adjusted earnings to the investment community, which are reviewed by the audit committee of the board. The adjustments apply equally to income and expense items. The compensation committee reviews all adjustments and retains “downward discretion”—i.e., discretion to reduce compensation below the amounts that are yielded by the adjustment guidelines.

For the 2009 awards calculation, the committee made these adjustments to EPS:

 

 

 

 

In addition, to eliminate the distorting effect of the acquisition of ImClone Systems Incorporated (completed in late November 2008) on year-over-year growth rates, the committee adjusted sales and EPS for 2008 on a pro forma basis as if the acquisition had been completed at the beginning of 2008.

The adjustments were intended to align award payments more closely with underlying business growth trends and eliminate volatile swings (up or down) caused by the unusual items. This is demonstrated by the 2007, 2008, and 2009 adjustments:

 

 

Reconciliations of the adjustments to our reported sales and earnings per share are below. The bolded numbers are the growth percentages used to calculate payouts under the compensation programs.

 

 

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