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Notes to the Consolidated Financial Statements

25. Share-based payments

The Group recognised the following charges in the income statement in respect of its equity-settled share-based payment plans:

All figures in millions 2007 2006
Pearson plans 23 18
Interactive Data plans 7 7
Total share-based payment costs 30 25

The Group operates the following equity-settled employee option and share plans:

Worldwide Save for Shares Plan – Since 1994, the Group has operated a Save-As-You-Earn plan for UK employees. In 1998, the Group introduced a Worldwide Save for Shares Plan. Under these plans, employees can save a portion of their monthly salary over periods of three, five or seven years. At the end of this period, the employee has the option to purchase ordinary shares with the accumulated funds at a purchase price equal to 80% of the market price prevailing at the time of the commencement of the employee’s participation in the plan. Options that are not exercised within six months of the third, fifth or seventh anniversary after grant lapse unconditionally.

Employee Stock Purchase Plan – In 2000, the Group established an Employee Stock Purchase Plan which allows all employees in the US to save a portion of their monthly salary over six month periods. At the end of the period, the employee has the option to purchase ADRs with their accumulated funds at a purchase price equal to 85% of the lower of the market price prevailing at the beginning or end of the period.

Long-Term Incentive Plan – This plan was introduced in 2001 and renewed in 2006 and consists of two parts: share options and/or restricted shares.

Options were granted under this plan in 2001 based on a pre-grant earnings per share growth test and are not subject to further performance conditions on exercise. The options became exercisable in tranches and lapse if they remain unexercised at the tenth anniversary of the date of grant.

The vesting of restricted shares is normally dependent on continuing service and/or upon the satisfaction of corporate performance targets over a three-year period. These targets may be based on market and/or non-market performance criteria. Restricted shares awarded to senior management in October 2006 and July 2007 vest dependent on relative shareholder return, return on invested capital and earnings per share growth. The award was split equally across all three measures. Other restricted shares awarded in 2006 and 2007 vest depending on continuing service over a three-year period.

Annual Bonus Share Matching Plan – This plan permits executive directors and senior executives around the Group to invest up to 50% of any after tax annual bonus in Pearson shares. If these shares are held and the Group meets an earnings per share growth target, the Company will match them on a gross basis of up to one share for every one held.

In addition to the above, share options remain outstanding under Executive Share Option, Reward and Special Share Option Plans. These are legacy plans which were replaced with the introduction of the Long-Term Incentive Plan in 2001.

The number and weighted average exercise prices of share options granted under the Group’s plans are as follows:

2007 2006
Number of
share options
000s
Weighted
average
exercise
price
Number of
share options
000s
Weighted
average
exercise
price
Outstanding at beginning of year 18,861 13.36 21,677 13.15
Granted during the year 773 6.90 837 6.30
Exercised during the year (1,326) 5.80 (1,396) 5.36
Forfeited during the year (1,434) 19.63 (1,828) 15.39
Expired during the year (93) 7.68 (429) 6.72
Outstanding at end of year 16,781 13.15 18,861 13.36
Options exercisable at end of year 13,999 14.63 15,595 14.14

Options were exercised regularly throughout the year. The weighted average share price during the year was 8.02 (2006: 7.45). Early exercises arising from redundancy, retirement or death are treated as an acceleration of vesting and the Group therefore recognises in the income statement the amount that otherwise would have been recognised for services received over the remainder of the original vesting period.

The options outstanding at the end of the year have weighted average remaining contractual lives and exercise prices as follows:

Range of exercise prices
2007 2006
Number of
share options
000s
Weighted
average
contractual
life
Years
Number of
share options
000s
Weighted
average
contractual
life
Years
0 – 5 930 1.56 1,649 1.94
5 – 10 4,909 3.22 5,254 3.85
10 – 15 7,257 2.62 7,638 3.63
15 – 20 980 1.85 1,050 2.88
20 – 25 400 2.19 424 3.19
>25 2,305 2.19 2,846 3.22
16,781 2.62 18,861 3.42

In 2007 and 2006 options were granted under the Worldwide Save for Shares Plan. The weighted average estimated fair value for the options granted was calculated using a Black-Scholes option pricing model.

The weighted average estimated fair values and the inputs into the Black-Scholes model are as follows:

2007
2006
Weighted
average
Weighted
average
Fair value 2.53 1.92
Weighted average share price 8.91 7.66
Weighted average exercise price 6.90 6.30
Expected volatility 19.72% 23.12%
Expected life 4.0 years 4.0 years
Risk free rate 5.34% 4.42%
Expected dividend yield 3.29% 3.52%
Forfeiture rate 3.5% 5.0%

The expected volatility is based on the historic volatility of the Company’s share price over the previous three to seven years depending on the vesting term of the options.

The following shares were granted under restricted share arrangements:

2007 2006
Number
of shares
000s
Weighted
average
fair value
Number
of shares
000s
Weighted
average
fair value
Annual Bonus Share Matching Plan 143 7.67 90 6.27
Long-Term Incentive Plan 3,377 7.12 3,585 6.96

Restricted shares granted under the Annual Bonus Share Matching Plan are valued using the share price at the date of grant discounted by the dividend yield (2007: 3.26%; 2006: 3.66%) to take into account any dividends foregone. The fair value of shares granted under the Long-Term Incentive Plan that vest unconditionally is determined using the share price at the date of grant. Participants of the Long-Term Incentive Plan are entitled to dividends during the vesting period. The number of shares to vest has been adjusted, based on historical experience, to account for any potential forfeitures. Restricted shares with a market performance condition were valued by an independent actuary using a Monte Carlo model. Restricted shares with a non-market performance condition were fair valued based on the share price at the date of grant. Non-market performance conditions were considered by adjusting the number of shares expected to vest based on the most likely outcome of the relevant performance criteria.

Subsidiary share option plans

Interactive Data, a 62% subsidiary of the Group, operates the following share-based payment plans:

2001 Employee Stock Purchase Plan

The 2001 Employee Stock Purchase Plan allows all eligible employees worldwide to purchase stock at a discounted price at specific times.

2000 Long-Term Incentive Plan

Under this plan, the Compensation Committee of the Board of Directors can grant share-based awards representing up to 20% of the total number of shares of common stock outstanding at the date of grant. The plan provides for the discretionary issuance of share-based awards to directors, officers and employees of Interactive Data, as well as persons who provide consulting or other services to Interactive Data. The exercise price for all options granted to date has been equal to the market price of the underlying shares at the date of grant. Options expire ten years from the date of grant and generally vest over a three to four year period without any performance criteria attached.

In addition, grants of restricted stock can be made to certain executives and members of the Board of Directors of Interactive Data. The awarded shares are available for distribution, at no cost, at the end of a three-year vesting period. No performance criteria are attached to shares granted under this plan.

Interactive Data employees purchased 186,343 shares (2006: 206,324) under the 2001 Employee Stock Purchase Plan at an average share price of $17.77 (8.93) (2006: $15.58; 7.96). The weighted average fair value at the date of grant was $4.76 (2.39) (2006: $3.98; 2.03).

The number and weighted average exercise prices of share options granted under the 2000 Long-Term Incentive Plan are as follows:

2007 2006
Number of share options
000s
Weighted average exercise price
$
Weighted average exercise price
Number of share options 000s Weighted average exercise price
$
Weighted average exercise price
Outstanding at beginning of year 10,506 16.33 8.34 10,068 15.16 8.37
Granted during the year 1,560 27.17 13.65 1,835 20.58 10.52
Exercised during the year (1,935) 14.88 7.48 (1,252) 12.88 6.58
Forfeited during the year (293) 20.38 10.24 (139) 19.02 9.72
Expired during the year (11) 18.12 9.10 (6) 11.46 5.86
Outstanding at end of year 9,827 18.21 9.15 10,506 16.33 8.34
Options exercisable at end of year 6,199 15.27 7.67 6,547 14.11 7.21

The options outstanding at the end of the year have a weighted average remaining contractual life and exercise price as follows:

Range of exercise prices
$
2007 2006
Number of
share options
000s
Weighted
average
contractual
life
Years
Number of
share options
000s
Weighted
average
contractual
life
Years
0 – 4.4 30 3.1
4.4 – 7.5 72 2.1 157 2.3
7.5 – 12 1,745 3.4 2,164 4.4
12 – 20 3,464 5.6 4,640 6.4
> 20 4,546 8.5 3,515 9.0
9,827 6.6 10,506 6.8

The fair value of the options granted under the Long-Term Incentive Plan and of the shares awarded under the 2001 Employee Stock Purchase Plan was estimated using a Black-Scholes model. The weighted average estimated fair values and the inputs into the Black-Scholes model are as follows:

Long-Term Incentive Plan Employee Stock Purchase Plan
2007 2006 2007 2006
Weighted
average
Weighted
average
Weighted
average
Weighted
average
Fair value $6.60 $6.57 $4.76 $3.98
Weighted average share price $27.17 $20.58 $17.77 $15.58
Weighted average exercise price $27.17 $20.58 $17.77 $15.58
Expected volatility 23.40% 25.90% 20.50% 18.32%
Expected life 5.0 years 4.7 years 0.5 years 0.5 years
Risk free rate 4.2% to 4.9% 4.6% to 5.1% 4.3% to 5.1% 3.7% to 5.2%
Expected dividend yield 1.9% 0.0% 2.0% 0.0%
Forfeiture rate 0.0% 0.0% 0.0% 0.0%

The expected volatility is based on the historic volatility of Interactive Data’s share price over the vesting term of the options.

During the year Interactive Data granted the following shares under restricted share arrangements:

2007 2006
Number
of shares 000s
Weighted
average fair value
$
Weighted
average fair value
Number
of shares 000s
Weighted
average fair value
$
Weighted
average fair value
2000 Long-Term Incentive Plan 185 27.07 13.60 196 20.82 10.64

Shares awarded under the 2000 Long-Term Incentive Plan were valued based on the share price prevailing at the date of grant.

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