Eli Lilly and Company provided the following information in the notes
(excerpts) to its 1997 financial statements:
Note 8: Stock Plans
Stock options and performance awards have been granted to officers and other
executive and key employees. Stock options are granted at exercise prices
equal to the fair market value of the company's stock at the dates of grant.
Generally, options vest 100 percent after three years from the grant date and
have a term of 10 years.
In October \(1995,\) the company issued its second grant under the GlobalShares
program. Essentially all employees were given an option to buy 400 shares of
the company's common stock at a price equal to the fair market value of the
company's stock at the date of grant. Options to purchase approximately 10.3
million shares were granted as part of the program. Individual grants
generally become exercisable on or after the third anniversary of the grant
date and have a term of 10 years.
The company has elected to follow Accounting Principles Board Opinion (APB)
No. \(25,\) "Accounting for Stock Issued to Employees" and related
interpretations in accounting for its stock options. Under APB No. \(25,\)
because the exercise price of the company's employee stock options equals the
market price of the underlying stock on the date of grant, no compensation
expense is recognized. Total compensation expense for stock-based awards
reflected in income on a pretax basis was \(\$ 242.1\) million, \(\$ 164.2\)
million, and \(\$ 93.1\) million in \(1997,1996,\) and \(1995,\) respectively.
However, SFAS No. \(123,\) "Accounting for Stock-Based Compensation," requires
presentation of pro forma information as if the company had accounted for its
employee stock options granted subsequent to December \(31,1994,\) under the
fair value method of that statement. For purposes of pro forma disclosure, the
estimated fair value of the options is amortized to expense over the vesting
period. Under the fair value method, the company's net income (loss) and
earnings (loss) per share would have been as follows:
Note 9: Shareholders' Equity
On September \(15,1997,\) the company's board of directors declared a two-forone
stock split to be effected in the form of a 100 percent stock dividend payable
to shareholders of record at the close of business on September 24 1997. The
outstanding and weighted-average number of shares of common stock and per-
share data in these financial statements have been adjusted to reflect the
impact of the stock split for all periods presented. The company now has
1,111,521,927 issued shares of common stock without par value, including
554,331,485 shares issued October \(15,1997,\) as a result of the stock split.
Treasury shares held by the company were not split.
The company has an Employee Stock Ownership Plan (ESOP) as a funding vehicle
for the existing employee savings plan. The ESOP used the proceeds of a loan
from the company to purchase shares of common stock from the treasury. In
\(1991,\) the ESOP issued \(\$ 200\) million of third-party debt, repayment of
which was guaranteed by the company (see Note 7). The proceeds were used to
purchase shares of the company's common stock on the open market. Shares of
common stock held by the ESOP will be allocated to participating employees
annually through 2006 as part of the company's savings plan contribution. The
fair value of shares allocated each period is recognized as compensation
expense.
Under the terms of the company's Shareholder Rights plan, all shareholders of
common stock received for each share owned a preferred stock purchase right
entitling them to purchase from the company one four-hundredth of a share of
Series A Participating Preferred Stock at an exercise price of \(\$ 40.63\) The
rights are not exercisable until after the date on which the company's right
to redeem has expired. The company may redeem the rights for \(\$ .00125\) per
right up to and including the tenth business day after the date of a public
announcement that a person (the "Acquiring Person") has acquired ownership of
stock having 20 percent or more of the company's general voting power (the
"Stock Acquisition Date").
The plan provides that, if the company is acquired in a business combination
transaction at any time after a stock acquisition date, generally each holder
of a right will be entitled to purchase at the exercise price a number of the
acquiring company's shares having a market value of twice the exercise price
The plan also provides that, in the event of certain other business
combinations, certain self-dealing transactions or the acquisition by a person
of stock having 25 percent or more of the company's general voting power,
generally each holder of a right will be entitled to purchase at the exercise
price a number of shares of the company's common stock having a market value
of twice the exercise price. Any rights beneficially owned by an acquiring
person shall not be entitled to the benefit of the adjustments with respect to
the number of shares described above. The rights will expire on July 28,1998
unless redeemed earlier by the company.
a Review Lilly's notes. Identify any unusual terms.
b. Reconstruct each of the transactions described by Lilly. Use the accounting
equation to summarize these transactions.
c. Indicate how each of these transactions may affect Lilly's (a) EPS and (b)
ROE.
d. Discuss the possible impact of Lilly's preferred rights issue.
e. Discuss the implications of Lilly's stock option plan.
f. Identify whether Lilly's disclosures are favorable or unfavorable for
existing shareholders. Are they advantageous for future shareholders? Why?
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