W.W. Grainger (GWW)

The Company annually provides long-term incentives to NEOs and other key managers in order to:

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Achieve specific business goals and objectives (including achieving financial performance that balances growth, profitability, and asset management);

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Reward management for results that create shareholder value;

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Attract qualified managers to join the Company; and

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Retain management through business cycles.

        The Company's long-term incentives consist of stock options, performance shares, and restricted stock units (RSUs) and are provided under the shareholder approved 2005 Incentive Plan. In 2008, the Company structured awards such that stock options represent approximately 40% of the total value of long-term incentive compensation, RSUs represent approximately 30% of the total value, and performance shares represent approximately 30% of the total value. This mix was chosen to achieve the program objectives noted above. This mix also reflected market practices for senior executives, which is to use a combination of awards to provide the desired level of long-term performance and retention.

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40% Stock Options.  The Company's stock options provide the right to purchase Company stock at a specified price over a ten-year term and vest 100% on the third anniversary of grant. They are intended to directly link management and shareholders' interests by tying a substantial portion of management's long-term incentives to stock price appreciation. The ten-year term is designed to focus management on long-term value creation. Three-year cliff vesting encourages meaningful retention before an employee can realize any value created by stock price appreciation. In all cases, stock options are awarded at an exercise price equal to the closing price of the Company's common stock reported for the business day before the grant. Stock option repricing is not permitted under the 2005 Incentive Plan.



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30% RSUs.  RSUs are intended to increase the retentive qualities of the compensation program through the four-year cliff vesting provision of the awards, to help build stock

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ownership, and to help meet stock ownership guidelines. The Company's RSUs are settled in Company stock if the executive is still employed with the Company on the fourth anniversary of the grant. The value of the RSUs increases or decreases with changes in the stock price, thus aligning the executives' interests with the shareholders'. Dividend equivalents are paid during the vesting period in order to simulate share ownership.

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30% Performance Shares.  Performance shares are intended to align compensation with the Company's business strategy and the long-term creation of shareholder value. The Company's performance shares provide the executive with a range of potential share payouts in three years only if specified performance criteria are met. The actual number of earned shares can range from 0% to 200% of the target number of shares, depending on one-year sales growth and continued ROIC achievement over three years.

        The target number of shares covered by long-term incentive awards is designed to provide an economic value that is generally at the median of the compensation comparator group for comparable jobs; the target can be adjusted up or down to reflect individual performance. The Committee annually establishes the target number of shares based on the executive's position. Individual awards are generally made at the December Board meeting for performance shares, while options and RSUs are awarded at the April Board meeting.

        The three-year performance cycle for the performance shares begins on January 1 of each year. The number of shares that could have been earned for the 2008 grant of performance shares ranged from 0% to 200% of the target award, depending on the Company's year-over-year growth in sales. The 2008 performance share program was structured as follows.

        If, during 2008, the Company had achieved less than 6 percent sales growth, 0% of the target award would be available, 6 percent growth would have yielded 50% of the target award, 9 percent growth would have yielded 100%, and 12% growth would have yielded 200%.

(1)

Amounts are interpolated, as necessary.

(2)

Vesting is contingent upon the achievement of a 3-year average 18% ROIC threshold.

        Given actual sales growth performance of 6.7%, the number of shares determined for the NEOs for 2008 was 71% of target. These shares will vest at the end of fiscal year 2010 only if the average ROIC performance over the three-year period from 2008 through 2010 is greater than or equal to 18%. The Committee selected these measures as they balance sales growth with long-term profitability, expense management, and asset management and are consistent with the short-term

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objectives established in the annual incentive program. The Committee may use different sales growth and ROIC objectives and target share numbers from year to year to maximize alignment with then-current business objectives. While outstanding performance share awards made prior to 2009 pay dividend equivalents after the end of the first year, those made in 2009 and for subsequent years will not pay dividend equivalents.

        The annual option and RSU awards fully vest upon death, disability, or retirement from the Company. Beginning in 2009, RSUs will no longer be granted to NEOs as part of the annual long term compensation program and only a fractional number of stock options will vest upon retirement, as described further in the paragraphs that follow. Performance share awards are subject to prorata vesting upon death, disability, or retirement from the Company. The definition of retirement eligibility is the same for all U.S. employees for the long-term incentive program, as well as the profit sharing program. Under this definition, an employee is retirement-eligible upon attaining any of the following:

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Age 60;



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Age 55 and 20 years of service; or



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25 years of service.

        Messrs. Chen, Keyser, Loux, and Ryan are currently retirement-eligible.

        The use of options and performance shares satisfies the requirements for qualified performance-based compensation under Section 162(m) of the Internal Revenue Code. The use of RSUs and performance shares also helps reduce share dilution, as compared with stock options. The Company historically makes stock option and RSU awards to current officers and employees each year on the date of the annual meeting of shareholders, and performance share awards no later than March 30 in order to qualify those awards as performance-based compensation under Section 162(m) of the Internal Revenue Code. The Company has not timed the grant of long-term incentive awards in respect of the release of material, non-public information nor for the purpose of affecting the value of executive compensation.

        In connection with their long-term incentive awards, the NEOs and all other recipients are required to sign an agreement containing confidentiality and non-competition obligations, designed to protect the Company's confidential and proprietary information and to preserve the Company's competitive advantages. Under these agreements, should an executive violate his or her confidentiality or non-compete obligations, any award is automatically forfeited. The agreements also require, in certain circumstances, that an executive who has breached the confidentiality and non-compete agreements must return vested shares and/or gains from disposition of shares to the Company.

        For 2009, the Company adjusted its long-term incentive program to include only stock options and non-dividend paying performance shares for NEOs and certain other officers. The Company believes its focus on pay for performance will be strengthened by eliminating RSUs as a component of long-term incentive compensation. In addition, in the Company changed the vesting structure for officers so that only a fractional amount will automatically vest upon retirement:

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Stock Options—In the year of retirement, a fraction of the award received in the year of retirement vests based on the number of months the retiree worked that year.

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Performance Shares—A fraction of the award vests after the end of the 36-month performance period based on the number of months the retiree worked in the performance period.