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Notes to the Consolidated Balance Sheets

24. Share-Based Payment

The equity instruments made available for share-based payment programs are disclosed in Note 23 on Total Equity.

The expenses from stock options plans are recognized in other operating expenses. These amounted to €7.2 million in the year under review (PY: €17.3 million).

2004 variable stock option plan
Continental AG introduced a variable stock option plan (2004 stock option plan) with the approval of the Annual Shareholders' Meeting on May 14, 2004. This plan replaced the 1999 stock option plan and enabled the issue of up to 3.9 million subscription rights. Each option granted under this plan carries the right to subscribe for one share. These stock options can be exercised after a vesting period of three years, starting from the date on which the Executive Board (or the Supervisory Board) granted the options. Once vested, the options can be exercised, i.e. the corresponding number of Continental AG shares can be acquired, within certain exercise windows during the following two years.

Continental AG's variable stock option plans include a performance target as a prerequisite for the exercise of stock options. Subscription rights may be exercised only if the average market price of Continental shares in the XETRA closing auction on the Frankfurt Stock Exchange during the ten trading days prior to an exercise window is at least 15% (= exercise hurdle) above the average closing price during the ten trading days prior to the issue date.

The exercise price varies in accordance with an outperformance and performance discount. The outperformance discount is calculated on the basis of the performance of Continental's shares as against the MDAX. The performance discount is calculated as a function of the relative change in the corporation's EBIT margin.

The value of the issued stock options is determined using the Monte Carlo simulation model. This model ensures realistic allowances for the effects of the performance target as well as the performance and outperformance discount. Specifically, the model simulates the change in the price of Continental shares and the MDAX to reflect the outperformance of Continental shares as against the benchmark index and the increase in the average closing price of Continental shares as against the reference price. The measurement model also takes into account assumptions regarding fluctuation. The adjustment of the exercise price by the outperformance of Continental shares against the MDAX is a market condition under IFRS and is included only in measurement as of the issue date. The adjustment of the exercise price in line with the change in the return on sales (EBIT in % of sales) of the Continental Corporation is a performance condition under IFRS.

The model used also takes into account the possibility of an early exercise of the options in all cases where the adjusted exercise price falls below 50% of the reference price and the performance target is achieved during the exercise window. Further, the model assumes that, as experience has shown, option holders who have left the corporation exercise the option immediately after the vesting period.

The expected dividends recognized in the model for each year of the options' duration are based on estimates published by analysts.

The volatilities and correlation reflect historical trends, based on the closing prices for the Continental share and the MDAX as of the end of each reporting period corresponding to a period equivalent to the remaining duration of the option rights.

When calculating the exercise price, an allowance is possible if Continental's stock underperforms against the reference price, and that performance against the stock market index to which the Continental share belongs at the beginning of an exercise window is used as a basis to determine the outperformance. In addition, the plan features a cap on possible capital gain.

Stock option plan 2004
  2011 2010
  Number of subscription rights Average exercise price1 Number of subscription rights Average exercise price1
  1,000 units €/unit 1,000 units €/unit
Outstanding at January 1 1,283.2 105.73 1,767.6 95.72
Forfeited — — 3.3 118.65
Expired 602.3 91.13 481.1 68.87
Outstanding at December 31 680.9 118.65 1,283.2 105.73
Exercisable on December 312 680.9 118.65 1,283.2 105.73
1) The average exercise hurdle is given since no subscription rights were exercised in the period under review or in the previous year.
2) Of the subscription rights exercisable on December 31, 36,400 can still be exercised. The other subscription rights are assignable to the redemption offer for the previous periods.
Download Table (.xls)

No more stock options will be issued from the 2004 stock option plan when the 2008 stock option plan comes into effect.

A fair value of €36.18 was calculated for the options of the 2004 tranche for the last time at the end of the vesting period on July 3, 2010. The remaining term is equal to the exercise window still available. The weighted average remaining term is six months (PY: one year) and corresponds to the maximum remaining term of the entire 2004 stock option plan.

No stock options were issued in either the reporting period or the previous year's reporting period. The range of exercise prices for the 2007 tranche was from €51.59 to €118.65.

2008 variable stock option plan
With the approval of the Annual Shareholders' Meeting on April 25, 2008, Continental AG adopted another variable stock option plan (2008 stock option plan) for senior executives and the Executive Board to take account of the new management structure after the acquisition of Siemens VDO. Its main features are the same as those of the 2004 stock option plan. Each stock option granted as part of the stock option plan carries the right to subscribe for one share. In total, up to 7.8 million stock options can be issued as part of the 2008 stock option plan. The issue of the stock options of a tranche takes place on the eleventh working day following the publication of the interim report for the first quarter of the relevant year (issue date). The stock options can be exercised only after a three-year period has elapsed since the issue date (vesting period) and then within a further period of two years commencing immediately upon expiration of the vesting period (exercise period). The stock options can be exercised only within certain time periods (exercise windows) during an exercise period.

The exercise is also linked to the attainment of a "performance target". Accordingly, an exercise is possible only if the average closing price of Continental shares in XETRA trading (average closing price) during the last ten trading days before the respective exercise window is at least 15% (= exercise hurdle) above the average closing price during the last ten days of trading before the issue date. The issue amount for shares subscribed on the basis of an exercise of subscription rights derived from the 2008 stock option plan ("exercise price") corresponds to the average closing price during the last ten trading days prior to the issue date (issue price), plus a premium, minus a performance-oriented reduction and adjusted by an outperformance-oriented reduction or surcharge. The performance discount is calculated as a function of the relative change in the corporation's EBIT margin. The outperformance discounts and premiums are determined on the basis of the development of Continental's shares in comparison with the development of the DAX or the stock market index to which the Continental shares belong at the beginning of the exercise window.

The value of the issued stock options is determined using the Monte Carlo simulation model, which is explained in detail in the description of the 2004 stock option plan. In accordance with the 2004 stock option plan, a ceiling has been imposed on the achievable capital gain.

A fair value of €32.43 was calculated for the options of the 2008 tranche for the last time at the end of the vesting period on May 16, 2011. The remaining term is equal to the exercise window still available. The weighted average remaining term is one year and four months (PY: two years and four months) and corresponds to the maximum remaining term of the entire 2008 stock option plan.

Stock option plan 2008
  2011 2010
  Number of subscription rights Average exercise price1 Number of subscription rights Average exercise price1
  1,000 units €/unit 1,000 units €/unit
Outstanding at January 1 1,173.8 89.95 1,183.7 89.95
Forfeited — — 9.9 89.95
Expired 8.3 89.95 — —
Outstanding at December 31 1,165.5 89.95 1,173.8 89.95
Exercisable on December 312 1,165.5 89.95 — —
1) The average exercise hurdle is given since no subscription rights were exercised in the period under review or in the previous year.
2) Of the subscription rights exercisable on December 31, 47,900 can still be exercised. The other subscription rights are assignable to the redemption offer for the previous periods.
Download Table (.xls)

In December 2008, a compensation offer for granted and not yet exercised stock options was made to the senior executive management of the corporation to whom stock options were granted from the stock option plans of 2004 and 2008. The reason for the compensation offer was the limited free float of Continental AG's shares, which meant that the share price performance could be subject to coincidental fluctuations which do not reflect Continental's economic development. The stock option plan thus lost its effectiveness as a long-term remuneration instrument geared towards the company's performance.

The compensation offer was based on the fair value of the stock options as of October 31, 2008. The average weighted fair value of the 2005 to 2008 tranches was €3.13 per stock option. Based on this evaluation, a provision was made for the payments in the years 2010 and 2011 for the first time in fiscal 2008. The acceptance period ran until mid-January 2009. The majority of the stock option plan beneficiaries accepted the offer.

2009 and 2010 remuneration plans
As a component of Executive Board remuneration, a decision was made at the end of 2010 as in 2009 to convert part of the variable element into virtual shares. The total bonus amount of €5.6 million (PY: €1.2 million) was recognized as a provision as of the end of the reporting period. Information on Executive Board remuneration can be found in the Remuneration Report.

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Continental Value Contribution (CVC). The CVC represents the absolute amount of additional value created, and the Delta CVC represents the change in absolute value creation over the prior year. This change in the absolute contribution measured by Delta CVC allows us to monitor the extent to which management units generate value-creating growth or resources must be employed more efficiently. The CVC is measured by subtracting the weighted average cost of capital (WACC) from the ROCE and multiplying this by the average operating assets for the fiscal year. The weighted average cost of capital calculated for the Continental Corporation corresponds to the required minimum return. The cost of capital is calculated as the weighted average ratio of the cost of equity and borrowing costs.

Currency swap. Swap of principal payable or receivable in one currency into similar terms in another currency. Often used when issuing loans denominated in a currency other than that of the lender.

Defined Benefit Obligation (DBO). DBO is defined as the present value of all vested and non-vested benefits calculated on the basis of estimated salary levels at retirement. The only actuarial method that may be used to calculate the DBO is the projected unit credit method. DBO corresponds to PBO (projected benefit obligation).

Derivative financial instruments. Transactions used to manage interest rate and/or currency risks.

Dividend payout ratio. The dividend payout ratio is the ratio between the dividend for the fiscal year and the earnings per share.

EBIT. Earnings Before Interest and Taxes. EBIT represents the results of operations. Since 2002, when the amortization of goodwill was discontinued, EBITDA has been equal to EBIT.

EBITA. EBIT before scheduled goodwill amortization.

EBITDA. Earnings before interest, taxes, depreciation and amortization.

Finance lease. Under a finance lease, the lessor transfers the investment risk to the lessee. This means that the lessor bears only the credit risk and any agreed services. The lessee is the beneficial owner of the leased asset. Finance leases are characterized by a fixed basic term during which the lease may not be terminated by the lessee.

Gearing ratio. The gearing ratio represents the net indebtedness divided by total equity, expressed as a percentage.

Hedging. Securing a transaction against risks, such as fluctuations in exchange rates, by entering into an offsetting hedge transaction, typically in the form of a forward contract.

IAS. International Accounting Standards.

IASB. International Accounting Standards Board. The authority that defines the International Financial Reporting Standards.

IFRIC. International Financial Reporting Interpretations Committee. Committee that reviews and determines appropriate treatment of accounting issues within the context of IFRS and IAS.

IFRS. International Financial Reporting Standards. The accounting standards issued by the IASB.

Interest rate cap. An interest rate cap sets an upper limit for a variable interest rate in relation to a notional debt amount. To the extent that the variable interest due on the underlying debt exceeds the cap amount, the holder of the cap receives income as compensation in the amount of the difference to the cap. An up-front premium is paid as consideration for the cap.

Interest rate swap. An interest rate swap is the exchange of interest payments between two parties. For example, this allows variable interest to be exchanged for fixed interest, or vice versa.

Net indebtedness. The net amount of interest-bearing liabilities as recognized in the balance sheet, cash and cash equivalents, the positive fair values of the derivative financial instruments as well as other interest-bearing investments.

Operating assets. Operating assets are the assets less liabilities as reported in the balance sheet, without recognizing the net indebtedness, discounted trade bills, deferred tax assets, income tax receivable and payable, as well as other financial assets and debts.

Operating lease. A form of lease that is largely similar to rental. Leased assets are recognized in the lessor's balance sheet and capitalized.

PPA. Purchase Price Allocation. PPA is the process of breaking down the purchase price and assigning the values to the identified assets, liabilities, and contingent liabilities following a business combination. Subsequent adjustments to the opening balance sheet – resulting from differences between the preliminary and final fair values at the date of initial consolidation – are recognized as "PPA adjustments".

Rating. Standardized indicator for the international finance markets that assesses and classifies the creditworthiness of a debtor. The classification is the result of an economic analysis of the debtor by specialist rating companies.

ROCE. Return On Capital Employed. We define ROCE as the ratio of EBIT to average operating assets for the fiscal year.

SIC. Standing Interpretations Committee (predecessor to the IFRIC).

US GAAP. United States Generally Accepted Accounting Principles. These principles are subdivided into binding and guiding principles.

Weighted Average Cost of Capital (WACC). The WACC represents the weighted average cost of the required return on equity and net interest-bearing liabilities.