british american tobacco p.l.c. annual report 2008 - Notes on the accounts: 27 of 31

ANNUAL REPORT 2009

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27 Share-based payments

During the period ended 31 December 2009, the following material share-based payment arrangements existed, which are described below:

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Notes:

(a) The granting of options under this scheme ceased with the last grant made in March 2004. Eligible individuals are entitled to participate in the Long-Term Incentive Plan and Deferred Share Bonus Scheme.

(b) Nil-cost options exercisable three years from date of grant, with payout subject to performance conditions based on earnings per share relative to inflation (50 per cent of grant) and total shareholder return, combining the share price and dividend performance of the Company by reference to two comparator groups (50 per cent of grant). Participants are not entitled to dividends prior to the exercise of the options. For grants made in 2005 and thereafter, a cash equivalent dividend will accrue through the vesting period and will be paid on vesting.

(c) Free shares released three years from date of grant and may be subject to forfeit if participant leaves employment before the end of the three year holding period. Participants receive a separate payment equivalent to a proportion of the dividend during the holding period.

(d) Options granted by invitation at a 20 per cent discount to the market price. Options are exercisable at the end of a three year or five year savings contract. Participants are not entitled to dividends prior to the exercise of the options. The maximum amount that can be saved by a participant in this way is £3,000 in any tax year.

(e) Options exercisable three years from date of grant and subject to earnings per share performance condition relative to inflation. Participants are not entitled to receive dividends in the period prior to the exercise of the options.

(f) Free shares granted (maximum £3,000 in any year) subject to a three year holding period and may be subject to forfeit if the employee leaves within this period. Participants are entitled to receive dividends during the holding period which are reinvested to buy further shares.

During the period, the Company operated a Partnership Share Scheme, which was open to all eligible employees, where employees can allocate part of their pre-tax salary to purchase shares in British American Tobacco p.l.c. The maximum amount that can be allocated in this way to any individual is £1,500 in any tax year. The shares purchased are held in a UK-based trust and are normally capable of transfer to participants tax free after a five year holding period.

Further details on the operation of share-based payment arrangements can be found in the Remuneration report.

Share option schemes

Details of the movements for equity-settled share option schemes during the years ended 31 December 2009 and 31 December 2008 covering the Share Option and Sharesave Schemes were as follows:

In addition to the above options, the movement in nil-cost equity-settled options from the Long-Term Incentive Plan was as follows:

*During 2009, equity-settled awards in respect of 1,230 (2008: 5,282) options were modified to a cash-settled basis.

The weighted average British American Tobacco p.l.c. share price at the date of exercise for share options exercised during the period was £17.58 (2008: £18.77). A detailed breakdown of the range of exercise prices for options outstanding for the years ended 31 December 2009 and 31 December 2008 is shown in the table below:

The weighted average fair value of equity-settled share option schemes shares granted during 2009 was £10.58 (2008: £11.96).

Assumptions used in the Black-Scholes models to determine the fair value of share options at grant date were as follows:

*Where two figures have been quoted for the Long-Term Incentive Plan, the first number represents the March award and the second number the May award.

**Where two figures have been quoted for the Sharesave Schemes, the first number represents the assumptions for the three-year savings contract and the second number for the five-year savings contract.

Market condition features were incorporated into the Monte Carlo models for the total shareholder return elements of the Long-Term Incentive Plan, in determining fair value at grant date. Assumptions used in these models were as follows:

*Where two figures have been quoted for the Long-Term Incentive Plan, the first number represents the March award and the second number the May award.

The expected British American Tobacco p.l.c. share price volatility was determined taking account of the daily share price movements over a five year period. The respective FMCG and FTSE 100 share price volatility and correlations were also determined over the same periods. The average expected term to exercise used in the models has been adjusted, based on management’s best estimate, for the effects of non-transferability, exercise restrictions and behavioural conditions, forfeiture and historical experience.

The risk-free rate has been determined from market yield curves for government gilts with outstanding terms equal to the average expected term to exercise for each relevant grant. The expected dividend yield was determined by calculating the yield from the last two declared dividends divided by the grant share price, adjusted for the Group’s announced change in dividend policy.

For grants containing earnings per share performance conditions, the payout calculation is based on the expectations published in analysts’ forecasts.

Other equity share-based payment arrangements (other than share options)

Details of the movements of other equity share-based payment arrangements during the years ended 31 December 2009 and 31 December 2008, covering the Deferred Share Bonus and Share Reward Schemes, were as follows:

*Equity-settled awards in respect of 8,376 (2008: 905) shares were modified to a cash-settled basis.

The shares outstanding for the year ended 31 December 2009 had a weighted average contractual life of 1.4 years (2008: 1.1 years).

The fair value for other equity share-based payment arrangements granted during the period was determined using the Black-Scholes model with the following input assumptions at their grant date:

The weighted average fair value of other equity share-based payment arrangements granted during 2009 was £13.67 (2008: £17.24).

Cash-settled share-based payment arrangements

The Group issues to certain employees cash-settled share-based payments that require the Group to pay the intrinsic value of these share-based payments to the employee at the date of exercise. The Group has recorded liabilities at the end of 2009 of £25.7 million (2008: £23.1 million) of which £5.7 million (2008: £5.0 million) was in respect of vested grants. Fair value was determined from the Black-Scholes and Monte Carlo models, using assumptions revised at the balance sheet date for cash-settled share-based payment arrangements. The Group recorded total expenses of £14.0 million in 2009 (2008: £12.4 million).

Details of movements for cash-settled arrangements in respect of the Share Option Scheme during the years ended 31 December 2009 and 31 December 2008, were as follows:

In addition to the above, the movement in other nil-cost cash-settled arrangements during the years ended 31 December 2009 and 31 December 2008, covering the Long-Term Incentive Plan and Deferred Share Bonus Scheme, were as follows:

*As explained in the sections for Share Option Schemes and Other equity share-based payment arrangements, 9,606 (2008: 6,187) awards in respect of shares were changed from an equity-settled to a cash-settled basis.

Assumptions used to determine the fair value of cash-settled share-based payment arrangements at date of grant, can be found in the sections relating to share option schemes and other equity share-based payment arrangements.

The weighted average British American Tobacco p.l.c. share price at the date of exercise for cash-settled share-based arrangements exercised during the period was £17.17 (2008: £18.86). A detailed breakdown of the range of exercise prices for cash-settled share-based payment arrangements outstanding for the years ended 31 December 2009 and 31 December 2008 are shown in the table below:

Share-based payment expense

The amounts recognised in the income statement in respect of share-based payments were as follows: