Compensation discussion and analysis
This section describes TI’s compensation program for executive officers. It will provide insight into the following:

• The elements of the 2012 compensation program, why we selected them and how they relate to one another; and
• How we determined the amount of compensation for 2012.

     Currently, TI has 15 executive officers. These executives have the broadest job responsibilities and policy-making authority in the company. We hold them accountable for the company’s performance and for maintaining a culture of strong ethics. Details of compensation for our CEO, CFO and the three other highest paid individuals who were executive officers in 2012 (collectively called the “named executive officers”) can be found in the tables beginning on page 80.

Executive summary

• TI’s compensation program is structured to pay for performance and deliver rewards that encourage executives to think and act in both the short- and long-term interests of our shareholders. The majority of total compensation for our executives each year comes in the form of variable cash and equity compensation. Variable cash is tied to the short-term performance of the company, and the value of equity is tied to the long-term performance of the company. We believe our compensation program holds our executive officers accountable for the financial and competitive performance of TI.
• 2012 compensation decisions for the CEO:
  • Base salary was increased by 5 percent over 2011 to maintain it at a level below the estimated median of the CEOs in our pay comparator group. In 2011, base salary was unchanged from the prior year.
  • The grant date fair value of equity compensation awarded in 2012 was 8 percent lower than in 2011. The number of shares was 6 percent higher than in 2011.
  • The bonus decision was based primarily on the following performance results in 2012:

• Our executive compensation program is designed to encourage executive officers to pursue strategies that serve the interests of the company and shareholders, and not to promote excessive risk-taking by our executives. It is built on a foundation of sound corporate governance and includes:
• Executive officers do not have employment contracts and are not guaranteed salary increases or bonus amounts.
• We have never repriced stock options. We do not grant reload options. We grant equity compensation with double-trigger change-in-control terms, which accelerate the vesting of grants only if the grantee has been terminated involuntarily within a limited time after a change in control of the company.
• Bonus and equity compensation awards are subject to clawback under the committee’s policy described on page 77.
• We do not provide excessive perquisites. We provide no tax gross-ups for perquisites.
• We do not guarantee a return or provide above-market returns on compensation that has been deferred.
• Pension benefits are calculated on salary and bonus only; the proceeds earned on equity or other performance awards are not part of the pension calculation.

The committee’s strategy for setting cash and non-cash compensation is described in the table that follows immediately below. Its compensation decisions for the named executive officers for 2012 are discussed on pages 70-77. Benefit programs in which the executive officers participate are discussed on pages 78-79. Perquisites are discussed on page 79.

Detailed discussion

Compensation philosophy and elements
The Compensation Committee of TI’s board of directors is responsible for setting the compensation of all TI executive officers. The committee consults with the other independent directors and its compensation consultant, Pearl Meyer & Partners, before setting annual compensation for the executives. The committee chair regularly reports on committee actions at board meetings.
     The primary elements of our executive compensation program are as follows:

Near-term compensation, paid in cash

Comparator group
The Compensation Committee considers the market level of compensation when setting the salary, bonuses and equity compensation of the executive officers. The committee targets salary below market median in order to weight total compensation to performance-based elements. To estimate the market level of pay, the committee uses information provided by its compensation consultant and TI’s Compensation and Benefits organization about compensation paid to executives in similar positions at a peer group of companies (the “Comparator Group”).
     The committee sets the Comparator Group. In general, the Comparator Group companies (1) are U.S.-based, (2) engage in the semiconductor business or other electronics or information technology activities, (3) have executive positions comparable in complexity to those of TI and (4) use forms of executive compensation comparable to TI’s.

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Shown in the table below is the Comparator Group used for the compensation decisions for 2012.

The committee set the Comparator Group in July 2011 for the base salary and equity compensation decisions it made in January 2012. It also used this Comparator Group when it adjusted the base salary and awarded equity compensation for two officers (as discussed on pages 72-73) after they assumed new responsibilities in June 2012. For a discussion of the factors considered by the committee in setting the Comparator Group, please see page 71 of the company’s 2012 proxy statement.
     In July 2012, the committee conducted its regular review of the Comparator Group in terms of industry, revenue and market capitalization. With the advice of its compensation consultant, the committee removed three companies – Cisco and Google (both at the upper end of the revenue range) and Yahoo (at the lower end of that range) – from the Comparator Group to increase its overall comparability to TI. The committee used that Comparator Group for the bonus decisions in January 2013 relating to 2012 performance. The table below compares the group to TI in terms of revenue and market capitalization.

Analysis of compensation determinations for 2012
Total compensation – Before finalizing the compensation of the executive officers, the committee reviewed all elements of compensation. The information included total cash compensation (salary, profit sharing and projected bonus), the grant date fair value of equity compensation, the impact that proposed compensation would have on other compensation elements such as pension, and a summary of benefits that the executives would receive under various termination scenarios. The review enabled the committee to see how various compensation elements relate to one another and what impact its decisions would have on the total earnings opportunity of the executives. In assessing the information, the committee did not target a specific level of total compensation or use a formula to allocate compensation among the various elements. Instead, it used its judgment in assessing whether the total was consistent with the objectives of the program. Based on this review, the committee determined that the level of compensation was appropriate.

Base salary – The committee set the 2012 rate of base salary for the named executive officers as follows:

The committee set the 2012 base-salary rate for each of the named executive officers in January 2012. In keeping with its strategy, the committee set the annual base-salary rates to be below the estimated median level of salaries expected to be paid to similarly situated executives of the Comparator Group in 2012.
     In June 2012, the committee increased the salary rate for Mr. Crutcher and Mr. Delagi as they assumed new leadership roles. The salary adjustment was consistent with the policy described in the preceding paragraph.
     The salary differences between the named executive officers were driven primarily by the market rate of pay for each officer, and not the application of a formula designed to maintain a differential between the officers.

Equity compensation – In 2012, the committee awarded equity compensation to each of the named executive officers. The grants are shown in the grants of plan-based awards in 2012 table on page 82. The grant date fair value of the awards is reflected in that table and in the “Stock Awards” and “Option Awards” columns of the summary compensation table on page 80. The table below is provided to assist the reader in comparing the number of shares, grant date fair values and “NQ Equivalent” levels for each of the years shown in the summary compensation table. NQ Equivalents are calculated by treating each restricted stock unit as 3 NQ Equivalents and each option share as 1 NQ Equivalent. This 3:1 ratio generally approximates the relative accounting expense of granting one restricted stock unit as compared with an option for one share.

    In January 2012, the committee awarded equity compensation to each of the named executive officers. The committee’s objective was to award to those officers equity compensation that had a grant date fair value at approximately the median market level, in this case the 40^th to 60^th percentile of the 3-year average of equity compensation (including an estimate of amounts for 2012) granted by the Comparator Group.
     In assessing the market level, the committee considered information presented by TI’s Compensation and Benefits organization (prepared using data provided by the committee’s compensation consultant) on the estimated value of the awards expected to be granted by the Comparator Group to similarly situated executives. The award value was estimated using the same methodology used for financial accounting.
     For each officer, the committee set a number of NQ Equivalents to achieve the desired grant value. The committee decided to allocate the NQ Equivalents for each officer equally between restricted stock units and options to give equal emphasis to promoting retention, motivating the executive and aligning his interests with those of shareholders.
     Before approving the grants, the committee reviewed the amount of unvested equity compensation held by the officers to assess its retention value. In making this assessment, the committee used its judgment and did not apply any formula, threshold or maximum. This review did not result in an increase or decrease of the awards from the levels described above.
     The exercise price of the options was the closing price of TI stock on January 26, 2012, the third trading day after the company released its annual and fourth quarter financial results for 2011. All grants were made under the 2009 Texas Instruments Long-Term Incentive Plan (the “2009 Plan”), which shareholders approved in April 2009. All grants have the terms described on page 85.
     The differences in the equity awards between the named executive officers were primarily the result of differences in the applicable estimated market level of equity compensation for their positions, and not the application of any formula designed to maintain differentials between the officers.
     In addition to the January 2012 awards described above, the committee awarded restricted stock units to Mr. Crutcher and Mr. Delagi as they assumed new and broader responsibilities in June 2012. The awards were intended to increase the retention value of their outstanding equity compensation. The number of restricted stock units was based on the committee’s judgment following a review of market data; no formula or threshold was applied.

Bonus – In January 2013, the committee set the 2012 bonus compensation for executive officers based on its assessment of 2012 performance. In setting the bonuses, the committee used the following performance measures to assess the company:

• The relative one-year and three-year performance of TI as compared with competitor companies, as measured by
• revenue growth,
• operating profit as a percentage of revenue,
• total shareholder return; and
• The absolute one-year and three-year performance of TI on the above measures.

In addition, the committee considered our strategic progress by reviewing how competitive we are in key markets with our core products and technologies, as well as the strength of our relationships with key customers.
     One-year relative performance on the three measures and one-year strategic progress were the primary considerations in the committee’s assessment of the company’s 2012 performance. In assessing performance, the committee did not use formulas, thresholds or multiples. Because market conditions can quickly change in our industry, thresholds established at the beginning of a year could prove irrelevant by year-end. The committee believes its approach, which assesses the company’s relative performance in hindsight after year-end, gives it the insight to most effectively and critically judge results and encourages executives to pursue strategies that serve the long-term interests of the company and its shareholders.
     In the comparison of relative performance, the committee used the following companies (the “competitor companies”):²

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These companies include both broad-based and niche suppliers that operate in our key markets or offer technology that competes with our products. The committee considers annually whether the list is still appropriate in terms of revenue, market capitalization and changes in business activities of the companies. In July 2012, the committee decided to add Freescale, a TI competitor that had its initial public offering in 2011, to increase the overall comparability of the group to TI.

Assessment of 2012 performance

The committee spent extensive time in December and January assessing TI’s results and strategic progress for 2012. The committee considered both quantitative and qualitative data, and it applied judgment in its assessment. Overall, the committee determined that TI’s performance was about the same as the prior year, with absolute performance slightly down and relative performance again above median in most competitor comparisons (see list of competitor companies above). The committee also noted the continued strength of TI’s strategic position. Commensurate with this performance, the committee set bonuses for executive officers generally at the same level as the prior year. Below are details of the committee’s performance assessment.

Revenue and margin

• TI revenue declined 7 percent, which was slightly below the median growth rate of competitor companies. This included an $800 million decline in revenue from wireless baseband operations, for which the company has had a publicly stated exit plan for a number of years. Without these wireless operations, TI’s revenue declined 1 percent, better than the median rate of competitors.³ Revenue for the company’s core businesses of Analog and Embedded Processing was up 10 percent and down 7 percent, respectively. This resulted in a strong share gain in Analog and a slight share decline in Embedded Processing.
• Operating profit margin was 15 percent, above median as compared with competitors. Return on invested capital was 11 percent, above the company’s cost of capital.
• Three-year metrics were 7 percent compounded annual revenue growth and 23 percent average operating profit margin, below and well above the median, respectively, as compared with competitors. (Without the impact of the wireless operations mentioned above, three-year compounded revenue growth was 13 percent, above the median comparison with competitors.)

Total shareholder return (TSR)

• TSR increased 9 percent, which was slightly better than the median performance of competitors.
• The company again generated strong cash, with free cash flow at 23 percent of revenue.⁴ Ninety percent of free cash flow was returned to shareholders in 2012 through share repurchases and dividends. Share repurchases of $1.8 billion reduced outstanding shares by 3 percent (net of stock issuances during the year), and the quarterly dividend rate increased 24 percent (the tenth increase in nine years).
• The balance sheet remained robust, ending the year with cash and short-term investments of $4 billion, up 35 percent from the prior year.
• Three-year TSR increased 8 percent, about the median performance of competitors.

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Strategic progress

• The company reached a milestone in 2012, with 70 percent of its revenue now coming from its core businesses of Analog and Embedded Processing semiconductors. These businesses serve markets that are among the best in the industry, with thousands of possible applications and dependable long-term growth opportunities.
• Also of note was the successful integration of National Semiconductor, which was acquired in September 2011; the readiness of low-cost capacity for revenue growth; the increasing diversity of the customer base, especially in the industrial sector; and the company’s strong customer and market share position in China.
• In all, the committee concluded that the strategic condition of the company continues to provide a sustainable competitive advantage.

CAGR = compound annual growth rate

ROIC = operating margin x (1 – tax rate) / (assets – non-debt liabilities)

Before setting the bonuses for the named executive officers, the committee considered the officers’ individual performance. The performance of the CEO was judged according to the performance of the company. For the other officers, the committee considered the factors described below in assessing individual performance. In making this assessment, the committee did not apply any formula or performance targets.
     Mr. March is the chief financial officer. The committee noted the financial management of the company.
     Mr. Crutcher was responsible for the company’s embedded processing and custom product lines until June 2012, when he became responsible for the company’s analog semiconductor product lines. The committee noted the financial performance and strategic position of the product lines.
     Mr. Delagi is responsible for the company’s wireless semiconductor product lines. In addition, beginning in June 2012 he became responsible for its embedded processing and custom product lines. The committee noted the financial performance and strategic position of the product lines.
     Mr. Ritchie is responsible for the company’s semiconductor manufacturing operations. The committee noted the performance of those operations, including their cost-competitiveness and inventory management.
     The bonuses awarded for 2012 performance are shown in the table on page 76. The differences in the amounts awarded to the named executive officers were primarily the result of differences in the officers’ level of responsibility and the applicable market level of total cash compensation expected to be paid to similarly situated officers in the Comparator Group. The increase in Mr. Crutcher’s bonus for 2012 as compared to 2011 reflects the substantial increase in his level of responsibility during 2012. The bonus of each named executive officer was paid under the Executive Officer Performance Plan described on pages 79 and 82.

Results of the compensation decisions – Results of the compensation decisions made by the committee relating to the named executive officers for 2012 are summarized in the following table. This table is provided as a supplement to the summary compensation table on page 80 for investors who may find it useful to see the data presented in this form. Although the committee does not target a specific level of total compensation, it considers information similar to that in the table to ensure that the sum of these elements is, in its judgment, in a reasonable range. The principal differences between this table and the summary compensation table are explained in footnote 5 below.⁵

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     The compensation decisions shown above resulted in the following 2012 compensation mix for the named executive officers:

	* Average data for the named executive officers other than Mr. Templeton. Salary includes the annual rate for Mr. Crutcher and Mr. Delagi as of June 2012. Totals may not equal 100 percent, due to rounding.

Equity dilution
The Compensation Committee’s goal is to keep net annual dilution from equity compensation under 2 percent. “Net annual dilution” means the number of shares under equity awards granted by the committee each year to all employees (net of award forfeitures) as a percentage of the shares of the company’s outstanding common stock. Equity awards granted in 2012 under the company’s equity-compensation program resulted in 1.2 percent net annual dilution.

Process for equity grants
The Compensation Committee makes grant decisions for equity compensation at its January meeting each year. The dates on which these meetings occur are generally set three years in advance. The January meetings of the board and the committee generally occur in the week or two before we announce our financial results for the previous quarter and year.
     On occasion, the committee may grant stock options or restricted stock units to executives at times other than January. For example, it has done so in connection with job promotions and for purposes of retention.
     We do not back-date stock options or restricted stock units. We do not accelerate or delay the release of information due to plans for making equity grants.
     Under the committee’s policy, if the committee meeting falls in the same month as the release of the company’s financial results, the grants approved at the meeting will be made effective on the later of (i) the meeting day or (ii) the third trading day after the release of results. Otherwise they will be made effective on the day of committee action. The exercise price of stock options is the closing price of TI stock on the effective date of the grant.

Recoupment policy
The committee has a policy concerning recoupment (“clawback”) of executive bonuses and equity compensation. Under the policy, in the event of a material restatement of TI’s financial results due to misconduct, the committee will review the facts and circumstances and take the actions it considers appropriate with respect to the compensation of any executive officer whose fraud or willful misconduct contributed to the need for such restatement. Such action may include (a) seeking reimbursement of any bonus paid to such officer exceeding the amount that, in the judgment of the committee, would have been paid had the financial results been properly reported and (b) seeking to recover profits received by such officer during the twelve months after the restated period under equity compensation awards. All determinations by the committee with respect to this policy are final and binding on all interested parties.

Most recent stockholder advisory vote on executive compensation
In April 2012, our shareholders cast an advisory vote on the company’s executive compensation decisions and policies as disclosed in the proxy statement issued by the company in March 2012. Approximately 95 percent of the shares voted on the matter were cast in support of the compensation decisions and policies as disclosed. The committee considered this result and determined that it was not necessary at this time to make any material changes to the company’s compensation policies and practices in response to the advisory vote.

Benefits

Retirement plans
The executive officers participate in our retirement plans under the same rules that apply to other U.S. employees. We maintain these plans to have a competitive benefits program and for retention.
     Like other established U.S. manufacturers, we have had a U.S. qualified defined benefit pension plan for many years. At its origin, the plan was designed to be consistent with those offered by other employers in the diverse markets in which we operated, which at the time included consumer and defense electronics as well as semiconductors and materials products. In order to limit the cost of the plan, we closed the plan to new participants in 1997. We gave U.S. employees as of November 1997 the choice to remain in the plan, or to have their plan benefits frozen (i.e., no benefit increase attributable to years of service or change in eligible earnings) and begin participating in an enhanced defined contribution plan. Mr. Templeton and Mr. Crutcher chose not to remain in the defined benefit plan. As a result, their benefits under that plan were frozen in 1997 and they participate in the enhanced defined contribution plan. The other named executive officers have continued their participation in the defined benefit pension plan.
     The Internal Revenue Code (IRC) imposes certain limits on the retirement benefits that may be provided under a qualified plan. To maintain the desired level of benefits, we have non-qualified defined benefit pension plans for participants in the qualified pension plan. Under the non-qualified plans, participants receive benefits that would ordinarily be paid under the qualified pension plan but for the limitations under the IRC. For additional information about the defined benefit plans, please see pages 86-89.
     Employees accruing benefits in the qualified pension plan, including the named executive officers other than Mr. Templeton and Mr. Crutcher, also are eligible to participate in a qualified defined contribution plan that provides employer matching contributions. The enhanced defined contribution plan, in which Mr. Templeton and Mr. Crutcher participate, provides for a fixed employer contribution plus an employer matching contribution.
     In general, if an employee who participates in the pension plan (including an employee whose benefits are frozen as described above) dies after having met the requirements for normal or early retirement, his or her beneficiary will receive a benefit equal to the lump-sum amount that the participant would have received if he or she had retired before death. In 2011, having reached the age of 55 with at least 20 years of employment, Mr. Ritchie met the requirements for early retirement under the pension plans. In 2012, none of the other named executive officers was retirement-eligible under the plans. 
     Because benefits under the qualified and non-qualified defined benefit pension plans are calculated on the basis of eligible earnings (salary and bonus), an increase in salary or bonus may result in an increase in benefits under the plans. Salary or bonus increases for Mr. Templeton and Mr. Crutcher do not result in greater benefits for them under the company’s defined benefit pension plans because their benefits under those plans were frozen in 1997. The committee considers the potential effect on the executives’ retirement benefits when it sets salary and performance bonus levels.

Deferred compensation
Any U.S. employee whose base salary and management responsibility exceed a certain level may defer the receipt of a portion of his or her salary, bonus and profit sharing. Rules of the U.S. Department of Labor require that this plan be limited to a select group of management or highly compensated employees. The plan allows employees to defer the receipt of their compensation in a tax-efficient manner. Eligible employees include, but are not limited to, the executive officers. We have the plan to be competitive with the benefits packages offered by other companies.
     The executive officers’ deferred compensation account balances are unsecured and all amounts remain part of the company’s operating assets. The value of the deferred amounts tracks the performance of investment alternatives selected by the participant. These alternatives are a subset of those offered to participants in the defined contribution plans described above. The company does not guarantee any minimum return on the amounts deferred. In accordance with SEC rules, no earnings on deferred compensation are shown in the summary compensation table on page 80 for 2012 because no “above market” rates were earned on deferred amounts in that year.

Employee stock purchase plan
     Our shareholders approved the TI Employees 2005 Stock Purchase Plan in April 2005. Under the plan, all employees in the U.S. and certain other countries may purchase a limited number of shares of the company’s common stock at a 15 percent discount. The plan is designed to offer the broad-based employee population an opportunity to acquire an equity interest in the company and thereby align their interests with those of shareholders. Consistent with our general approach to benefit programs, executive officers are also eligible to participate.

Health-related benefits
Executive officers are eligible under the same plans as all other U.S. employees for medical, dental, vision, disability and life insurance. These benefits are intended to be competitive with benefits offered in the semiconductor industry.

Other benefits
Executive officers receive only a few benefits that are not available to all other U.S. employees. The CEO is eligible for a company-paid physical and financial counseling. In addition, the board of directors has determined that for security reasons, it is in the company’s interest to require the CEO to use company aircraft for personal air travel. Please see pages 81 (footnote 6) and 90 for further details. The company provides no tax gross-ups for perquisites to any of the executive officers.

Compensation following employment termination or change in control
None of the executive officers has an employment contract. Executive officers are eligible for benefits on the same terms as other U.S. employees upon termination of employment or a change in control of the company. The current programs are described under the heading Potential Payments upon Termination or Change in Control beginning on page 89. None of the few additional benefits that the executive officers receive continue after termination of employment, except the amount for financial counseling is provided in the following year in the event of retirement. The committee reviews the potential impact of these programs before finalizing the annual compensation for the named executive officers. The committee did not raise or lower compensation for 2012 based on this review.
     The Texas Instruments 2009 Long-Term Incentive Plan generally establishes double-trigger change-in-control terms for grants made in 2010 and later years. Under those terms, options become fully exercisable and shares are issued under restricted stock unit awards (to the extent permitted by Section 409A of the IRC) if the grantee is involuntarily terminated within 24 months after a change in control of TI. These terms are intended to encourage employees to remain with the company through a transaction while reducing employee uncertainty and distraction in the period leading up to any such event.

Stock ownership guidelines and policy against hedging
Our board of directors has established stock ownership guidelines for executive officers. The guideline for the CEO is four times base salary or 125,000 shares, whichever is less. The guideline for other executive officers is three times base salary or 25,000 shares, whichever is less. Executive officers have five years from their election as executive officers to reach these targets. Directly owned shares and restricted stock units count toward satisfying the guidelines.
     Short sales of TI stock by our executive officers are prohibited. It is against TI policy for any employee, including an executive officer, to engage in trading in “puts” (options to sell at a fixed price on or before a certain date), “calls” (similar options to buy), or other options or hedging techniques on TI stock.

Consideration of tax and accounting treatment of compensation
Section 162(m) of the IRC generally denies a deduction to any publicly held corporation for compensation paid in a taxable year to the company’s CEO and four other highest compensated officers to the extent that the officer’s compensation (other than qualified performance-based compensation) exceeds $1 million. The Compensation Committee considers the impact of this deductibility limit on the compensation that it intends to award. The committee exercises its discretion to award compensation that does not meet the requirements of Section 162(m) when applying the limits of Section 162(m) would frustrate or be inconsistent with our compensation policies and/or when the value of the foregone deduction would not be material. The committee has exercised this discretion when awarding restricted stock units that vest over time, without performance conditions to vesting. The committee believes it is in the best interest of the company and its shareholders that restricted stock unit awards provide for the retention of our executive officers in all market conditions.
     The Texas Instruments Executive Officer Performance Plan is intended to ensure that performance bonuses under the plan are fully tax deductible under Section 162(m). The plan, which shareholders approved in 2002, is further described on page 82. The committee’s general policy is to award bonuses within the plan, although the committee reserves the discretion to pay a bonus outside the plan if it determines that it is in our shareholders’ best interest to do so. The committee set the bonuses of the named executive officers for 2012 performance at the levels described on pages 74 and 76. The bonuses were awarded within the plan.
     When setting equity compensation, the committee considers the estimated cost for financial reporting purposes of equity compensation it intends to grant. Its consideration of the estimated cost of grants made in 2012 is discussed on page 73 above.