Notice of 2007 Annual Meeting and Proxy Statement

March 5, 2007

Dear Shareholder:

You are cordially invited to attend our annual meeting of shareholders on Monday, April 16, 2007, at the Lilly Center Auditorium, Lilly Corporate Center, Indianapolis, Indiana, at 11:00 a.m. EDT.

The notice of meeting and proxy statement that follow describe the business we will consider at the meeting. Your vote is very important. I urge you to vote by mail, by telephone, or on the Internet in order to be certain your shares are represented at the meeting, even if you plan to attend.

Please note our procedures for admission to the meeting described on page 59.

I look forward to seeing you at the meeting.

Sidney Taurel
Chairman of the Board and Chief Executive Officer

Notice of Annual Meeting of Shareholders

April 16, 2007

The annual meeting of shareholders of Eli Lilly and Company will be held at the Lilly Center Auditorium, Lilly Corporate Center, Indianapolis, Indiana, on Monday, April 16, 2007, at 11:00 a.m. EDT for the following purposes:

	•		to elect four directors of the company to serve three-year terms
	•		to ratify the appointment by the audit committee of Ernst & Young LLP as principal independent auditors for the year 2007
	•		to approve amendments to the articles of incorporation to provide for the annual election of directors
	•		to reapprove performance goals for the company’s 2002 Lilly Stock Plan
	•		to consider and vote on a shareholder proposal requesting that the board of directors report on the feasibility of extending the company’s animal care and use policy to contract laboratories
	•		to consider and vote on a shareholder proposal requesting that the board of directors report on international outsourcing of animal research
	•		to consider and vote on a shareholder proposal requesting that the board of directors establish a policy separating the roles of chairman and chief executive officer
	•		to consider and vote on a shareholder proposal requesting that the company amend its articles of incorporation to allow shareholders to amend the company’s bylaws by majority vote
	•		to consider and vote on a shareholder proposal requesting that the board of directors adopt a simple majority vote standard for certain matters other than the election of directors

Shareholders of record at the close of business on February 15, 2007, will be entitled to vote at the meeting and at any adjournment of the meeting.

Attendance at the meeting will be limited to shareholders, those holding proxies from shareholders, and invited guests from the media and financial community. A page at the back of this proxy statement contains an admission ticket. If you plan to attend the meeting, please bring this ticket with you.

This combined proxy statement and annual report to shareholders and the proxy are being mailed on or about March 5, 2007.

By order of the board of directors,

James B. Lootens
Secretary

March 5, 2007
Indianapolis, Indiana

General Information

Why did I receive this proxy statement?

The board of directors of Eli Lilly and Company is soliciting proxies to be voted at the annual meeting of shareholders (the annual meeting) to be held on Monday, April 16, 2007, and at any adjournment of the annual meeting. When the company asks for your proxy, we must provide you with a proxy statement that contains certain information specified by law.

What will the shareholders vote on at the annual meeting?

Nine items:

	•		election of directors
	•		ratification of the appointment of principal independent auditors
	•		amending the company’s articles of incorporation to allow for annual election of directors
	•		reapproving performance goals for the company’s stock plan
	•		a shareholder proposal on extending the company’s animal care and use policy to contract laboratories
	•		a shareholder proposal on international outsourcing of animal research
	•		a shareholder proposal on separating the roles of chairman and chief executive officer
	•		a shareholder proposal on amending the company’s articles of incorporation
	•		a shareholder proposal on adopting a simple majority vote standard for matters other than election of directors

Will there be any other items of business on the agenda?

We do not expect any other items of business because the deadline for shareholder proposals and nominations has already passed. Nonetheless, in case there is an unforeseen need, the accompanying proxy gives discretionary authority to the persons named on the proxy with respect to any other matters that might be brought before the meeting. Those persons intend to vote that proxy in accordance with their best judgment.

Who is entitled to vote?

Shareholders as of the close of business on February 15, 2007 (the record date) may vote at the annual meeting. You have one vote for each share of common stock you held on the record date, including shares:

•		held directly in your name as the shareholder of record
•		held for you in an account with a broker, bank, or other nominee
•		attributed to your account in the Lilly Employee 401(k) Plan (the 401(k) plan).

What constitutes a quorum?

A majority of the outstanding shares, present or represented by proxy, constitutes a quorum for the annual meeting. As of the record date, ___ shares of company common stock were issued and outstanding.

How many votes are required for the approval of each item?

There are differing vote requirements for the various proposals.

	•		Each nominee for director will be elected if the votes for the director exceed the votes against the director. Abstentions will not be counted either for or against the director.
	•		The appointment of principal independent auditors, the management proposal regarding performance goals, and the shareholder proposals will be approved if the votes cast for the proposal exceed those cast against the proposal. Abstentions will not be counted either for or against the proposal.
	•		The management proposal to amend the articles of incorporation requires the vote of 80 percent of the outstanding shares. For this item, abstentions and broker non-votes have the same effect as a vote against the proposal.

Broker nonvotes. If your shares are held by a broker, the broker will ask you how you want your shares to be voted. If you give the broker instructions, your shares will be voted as you direct. If you do not give instructions, one of two things can happen, depending on the type of proposal. For the election of directors and the

ratification of auditors, the broker may vote your shares in its discretion. For all other proposals, the broker may not vote your shares at all. When that happens, it is called a “broker nonvote.”

How do I vote by proxy?

If you are a shareholder of record, you may vote your proxy by any one of the following methods.

By mail. Sign and date each proxy card you receive and return it in the prepaid envelope. Sign your name exactly as it appears on the proxy. If you are signing in a representative capacity (for example, as an attorney-in-fact, executor, administrator, guardian, trustee, or the officer or agent of a corporation or partnership), please indicate your name and your title or capacity. If the stock is held in custody for a minor (for example, under the Uniform Transfers to Minors Act), the custodian should sign, not the minor. If the stock is held in joint ownership, one owner may sign on behalf of all owners. If you return your signed proxy but do not indicate your voting preferences, we will vote on your behalf for the election of the nominees for director listed below, for the ratification of the appointment of the independent auditors, for the management proposals on amending the articles of incorporation and reapproving performance goals for the company’s stock plan, and against the shareholder proposals.

     Note that if you previously elected to receive these materials electronically, you did not receive a proxy card. If you wish to vote by mail, rather than by telephone or on the Internet as discussed below, you may request paper copies of these materials, including a proxy card, by calling 317-433-5112. Please make sure you give us the control number from the e-mail message that you received notifying you of the electronic availability of these materials, along with your name and mailing address.

By telephone. Shareholders in the United States, Puerto Rico, and Canada may vote by telephone by following the instructions on the enclosed proxy card or, if you received these materials electronically, by following the instructions in the e-mail message that notified you of their availability. Voting by telephone has the same effect as voting by mail. If you vote by telephone, do not return your proxy card. Telephone voting will be available until 11:59 p.m. EDT April 15, 2007.

By Internet. You may vote online at www.proxyvote.com. Follow the instructions on the enclosed proxy card or, if you received these materials electronically, the instructions in the e-mail message that notified you of their availability. Voting on the Internet has the same effect as voting by mail. If you vote on the Internet, do not return your proxy card. Internet voting will be available until 11:59 p.m. EDT April 15, 2007.

You have the right to revoke your proxy at any time before the meeting by (1) notifying the company’s secretary in writing or (2) delivering a later-dated proxy by telephone, on the Internet, or in writing. If you are a shareholder of record, you may also revoke your proxy by voting in person at the meeting.

How do I vote shares that are held by my broker?

If you have shares held by a broker or other nominee, you may instruct your broker or other nominee to vote your shares by following instructions that the broker or nominee provides for you. Most brokers offer voting by mail, telephone, and on the Internet.

How do I vote in person?

If you are a shareholder of record, you may vote your shares in person at the meeting. However, we encourage you to vote by proxy card, by telephone, or on the Internet even if you plan to attend the meeting.

How do I vote my shares in the 401(k) plan?

You may instruct the plan trustee on how to vote your shares in the 401(k) plan by mail, by telephone, or on the Internet as described above, except that, if you vote by mail, the card that you use will be a voting instruction card rather than a proxy card.

How many shares in the 401(k) plan can I vote?

You may vote all the shares allocated to your account on the record date. In addition, unless you decline, your vote will also apply to a proportionate number of other shares held in the 401(k) plan for which voting directions

are not received. These undirected shares include:

	•		shares credited to the accounts of participants who do not return their voting instructions (except for a small number of shares from a prior stock ownership plan, which can be voted only on the directions of the participants to whose accounts the shares are credited)
	•		shares held in the plan that are not yet credited to individual participants’ accounts.

     All participants are named fiduciaries under the terms of the 401(k) plan and under the Employee Retirement Income Security Act (ERISA) for the limited purpose of voting shares credited to their accounts and the portion of undirected shares to which their vote applies. Under ERISA, fiduciaries are required to act prudently in making voting decisions.

     If you do not want to have your vote applied to the undirected shares, you should check the box marked “I decline.” Otherwise, the trustee will automatically apply your voting preferences to the undirected shares proportionally with all other participants who elected to have their votes applied in this manner.

What happens if I do not vote my 401(k) plan shares?

Your shares will be voted by other plan participants who have elected to have their voting preferences applied proportionally to all shares for which voting instructions are not otherwise received.

What does it mean if I receive more than one proxy card?

It means that you hold shares in more than one account. To ensure that all your shares are voted, sign and return each card. Alternatively, if you vote by telephone or on the Internet, you will need to vote once for each proxy card and voting instruction card you receive.

Who tabulates the votes?

The votes are tabulated by an independent inspector of election, IVS Associates, Inc.

What should I do if I want to attend the annual meeting?

All shareholders as of the record date may attend by presenting the admission ticket that appears at the end of this proxy statement. Please fill it out and bring it with you to the meeting. The meeting will be held at the Lilly Center Auditorium. Please use the Lilly Center entrance to the south of the fountain at the intersection of Delaware and McCarty streets. You will need to pass through security, including a metal detector. Present your ticket to the usher at the meeting.

     Parking will be available on a first-come, first-served basis in the garage indicated on the map on page 60.

     If you have questions about admittance or parking, you may call 317-433-5112.

How do I contact the board of directors?

You can send written communications to one or more members of the board, addressed to:

Presiding Director, Board of Directors
Eli Lilly and Company
c/o Corporate Secretary
Lilly Corporate Center
Indianapolis, Indiana 46285

All such communications will be forwarded to the relevant director(s), except for solicitations or other matters unrelated to the company.

How do I submit a shareholder proposal for the 2008 annual meeting?

The company’s 2008 annual meeting is scheduled for April 21, 2008. If a shareholder wishes to have a proposal considered for inclusion in next year’s proxy statement, he or she must submit the proposal in writing so that we receive it by November 6, 2007. Proposals should be addressed to the company’s corporate secretary, Lilly Corporate Center, Indianapolis, Indiana 46285. In addition, the company’s bylaws provide that any shareholder wishing to propose any other business at the annual meeting must give the company written notice by November 6, 2007. That notice must provide certain other information as described in the bylaws. Copies of the bylaws are available online at http://investor.lilly.com/bylaws.cfm.

Does the company offer an opportunity to receive future proxy materials electronically?

Yes. If you are a shareholder of record or a member of the 401(k) plan, you may, if you wish, receive future proxy statements and annual reports online. If you elect this feature, you will receive an e-mail message notifying you when the materials are available along with a web address for viewing the materials and instructions for voting by telephone or on the Internet. If you have more than one account, you may receive separate e-mail notifications for each account.

     You may sign up for electronic delivery in two ways:

	•		If you vote online as described above, you may sign up for electronic delivery at that time.
	•		You may sign up at any time by visiting http://proxyonline.lilly.com.

     If you received these materials electronically, you do not need to do anything to continue receiving materials electronically in the future.

     If you hold your shares in a brokerage account, you may also have the opportunity to receive proxy materials electronically. Please follow the instructions of your broker.

What are the benefits of electronic delivery?

Electronic delivery reduces the company’s printing and mailing costs. It is also a convenient way for you to receive your proxy materials and makes it easy to vote your shares online. If you have shares in more than one account, it is an easy way to avoid receiving duplicate copies of proxy materials.

What are the costs of electronic delivery?

The company charges nothing for electronic delivery. You may, of course, incur the usual expenses associated with Internet access, such as telephone charges or charges from your Internet service provider.

May I change my mind later?

Yes. You may discontinue electronic delivery at any time. For more information, call 317-433-5112.

What is “householding”?

We have adopted “householding,” a procedure under which shareholders of record who have the same address and last name and do not receive proxy materials electronically will receive only one copy of our annual report and proxy statement unless one or more of these shareholders notifies us that they wish to continue receiving individual copies. This procedure saves printing and postage costs by reducing duplicative mailings.

     Shareholders who participate in householding will continue to receive separate proxy cards. Householding will not affect dividend check mailings.

     Beneficial shareholders can request information about householding from their banks, brokers, or other holders of record.

What if I want to receive a separate copy of the annual report and proxy statement?

If you participate in householding and wish to receive a separate copy of the 2006 annual report and 2007 proxy statement, or if you wish to receive separate copies of future annual reports and proxy statements, please call us at 317-433-5112 or write to: Householding Department, 51 Mercedes Way, Edgewood, New York 11717. We will deliver the requested documents to you promptly upon your request.

Board of Directors

Directors’ Biographies

Class of 2007

The following four directors’ terms will expire at this year’s annual meeting. Each of these directors has been nominated and is standing for election to serve another term that will expire in 2010. See page 46 of this proxy statement for more information.

Sir Winfried Bischoff Chairman, Citigroup Europe
Director since 2000		Age 65
Sir Winfried Bischoff has served as chairman, Citigroup Europe, since April 2000. From 1995 to 2000, he was chairman of Schroders, plc. He joined the Schroder Group in 1966 and held a number of positions there, including chairman of J. Henry Schroder Co. and group chief executive of Schroders, plc. He is a nonexecutive director of The McGraw-Hill Companies, Inc., and Land Securities plc.
J. Michael Cook Retired Chairman and Chief Executive Officer, Deloitte and Touche LLP
Director since 2005		Age 64
Mr. Cook served as chairman and chief executive officer of Deloitte and Touche, LLP from 1989 until his retirement in 1999. He joined Deloitte, Haskins & Sells in 1964 and served as chairman and chief executive officer from 1986 through 1989. Mr. Cook is a member of the Advisory Council of the Public Company Accounting Oversight Board and is a trustee of The Scripps Research Institute. He serves on the boards of Comcast Corporation and International Flavors & Fragrances Inc. He is chairman of the Accountability Advisory Council to the Comptroller General of the United States. He was a member of the National Association of Corporate Directors Blue Ribbon Panel on Corporate Governance and was named the 62nd member of the Accounting Hall of Fame in 1999. He is past president of the Institute of Outstanding Directors.
Franklyn G. Prendergast, M.D., Ph.D. Edmond and Marion Guggenheim Professor of Biochemistry and Molecular Biology and Professor of Molecular Pharmacology and Experimental Therapeutics, Mayo Medical School, and Director, Mayo Clinic Cancer Center
Director since 1995		Age 61
Dr. Prendergast is the Edmond and Marion Guggenheim Professor of Biochemistry and Molecular Biology and Professor of Molecular Pharmacology and Experimental Therapeutics at Mayo Medical School and the director of the Center for Individualized Medicine. He has held several other teaching positions at the Mayo Medical School since 1975. Dr. Prendergast serves on the board of trustees of the Mayo Foundation and the Mayo Clinic Board of Governors.
Kathi P. Seifert Retired Executive Vice President, Kimberly-Clark Corporation
Director since 1995		Age 57
Ms. Seifert served as executive vice president for Kimberly-Clark Corporation until June 2004. She joined Kimberly-Clark in 1978 and served in several capacities in connection with both the domestic and international consumer products businesses, most recently leading the team that develops and manages global plans for branding and product positioning, R&D programs, and capital investment for personal care products. She also oversaw Kimberly-Clark’s U.S. and Canadian sales forces. Prior to joining Kimberly-Clark, Ms. Seifert held management positions at Procter & Gamble, Beatrice Foods, and Fort Howard Paper Company. She is chair of Pinnacle Perspectives, LLC. Ms. Seifert serves on the boards of Supervalu Inc.; Revlon Consumer Products Corporation; Lexmark International, Inc.; Appleton Papers Inc.; the U.S. Fund for UNICEF; and the Fox Cities Performing Arts Center.

Class of 2008

The following four directors will continue in office until 2008.

George M.C. Fisher Retired Chairman of the Board and Chief Executive Officer, Eastman Kodak Company
Director since 2000		Age 66
Mr. Fisher served as chairman of the board of Eastman Kodak Company from 1993 to December 2000. He also served as chief executive officer from 1993 to January 2000 and as president from 1993 until 1996. Prior to joining Kodak, he was an executive officer of Motorola, Inc., serving as chairman and chief executive officer from 1990 to October 1993, and president and chief executive officer from 1988 to 1990. Mr. Fisher is a senior advisor for Kohlberg Kravis Roberts & Company, and a director of General Motors Corporation and Visant Corporation. He is a former chairman of PanAmSat Corporation, and was chairman of the National Academy of Engineering from 2000 to 2004.
Alfred G. Gilman, M.D., Ph.D. Executive Vice President for Academic Affairs and Provost, The University of Texas Southwestern Medical Center; Dean, The University of Texas Southwestern Medical School; and Regental Professor of Pharmacology, The University of Texas Southwestern Medical Center
Director since 1995		Age 65
Dr. Gilman has served as executive vice president for academic affairs and provost of The University of Texas Southwestern Medical Center and dean of The University of Texas Southwestern Medical School since 2005 and professor of pharmacology at The University of Texas Southwestern Medical Center since 1981. He holds the Raymond and Ellen Willie Distinguished Chair in Molecular Neuropharmacology, the Nadine and Tom Craddick Distinguished Chair in Medical Science, and the Atticus James Gill, M.D. Chair in Medical Science at the university and was named a regental professor in 1995. Dr. Gilman was on the faculty of the University of Virginia School of Medicine from 1971 to 1981 and was named a professor of pharmacology there in 1977. He is a director of Regeneron Pharmaceuticals, Inc. Dr. Gilman was a recipient of the Nobel Prize in Physiology or Medicine in 1994.
Karen N. Horn, Ph.D. Retired President, Private Client Services, and Managing Director, Marsh, Inc.
Director since 1987		Age 63
Ms. Horn served as president of Private Client Services and managing director of Marsh, Inc., a subsidiary of MMC, from 1999 until her retirement in 2003. Prior to joining Marsh, she was senior managing director and head of international private banking at Bankers Trust Company; chair and chief executive officer of Bank One, Cleveland, N.A.; president of the Federal Reserve Bank of Cleveland; treasurer of Bell of Pennsylvania; and vice president of First National Bank of Boston. Ms. Horn serves as director of T. Rowe Price Mutual Funds; The U.S. Russia Investment Fund, a presidential appointment; Simon Property Group, Inc.; and Fannie Mae. Ms. Horn has been senior managing director of Brock Capital Group since 2004.
John C. Lechleiter, Ph.D. President and Chief Operating Officer
Director since 2005		Age 53
Dr. Lechleiter has served as president and chief operating officer of the company since October 2005. He joined Lilly in 1979 as a senior organic chemist and has held management positions in England and the U.S. He was named vice president of pharmaceutical product development in 1993 and vice president of regulatory affairs in 1994. In 1996, he was named vice president for development and regulatory affairs. Dr. Lechleiter became senior vice president of pharmaceutical products in 1998, and executive vice president, pharmaceutical products and corporate development in 2001. He was named executive vice president, pharmaceutical operations in 2004. He is a member of the American Chemical Society. In 2004, Dr. Lechleiter was appointed to the Visiting Committee of Harvard Business School and to the Health Policy and Management Executive Council of the Harvard School of Public Health. He also serves as a member of the Board of Trustees of Xavier University (Cincinnati, Ohio). In 2006, he became a member of the board of directors and executive committee of the Fairbanks Institute, and also a member of the United Way of Central Indiana board of directors. In addition, he serves as a distinguished advisor to The Children’s Museum of Indianapolis and as a member of the Dean’s External Advisory Board at the Indiana University School of Medicine.

Class of 2009

The following four directors will continue in office until 2009.

Martin S. Feldstein, Ph.D. President and Chief Executive Officer, National Bureau of Economic Research, and George F. Baker Professor of Economics, Harvard University
Director since 2002		Age 67
Dr. Feldstein is president and chief executive officer of the National Bureau of Economic Research and the George F. Baker Professor of Economics at Harvard University. He became an assistant professor at Harvard in 1967 and an associate professor in 1968. From 1982 through 1984, he served as chairman of the Council of Economic Advisers and President Ronald Reagan’s chief economic adviser. He is a member of the American Philosophical Society, a corresponding fellow of the British Academy, a fellow of the Econometric Society, and a fellow of the National Association for Business Economics. Dr. Feldstein is a member of the executive committee of the Trilateral Commission and a director of the Council on Foreign Relations; American International Group, Inc.; and Economic Studies, Inc. He is a member of the American Academy of Arts and Sciences and past president of the American Economic Association.
J. Erik Fyrwald Group Vice President, DuPont Agriculture & Nutrition
Director since 2005		Age 47
Mr. Fyrwald has been group vice president of DuPont Agriculture & Nutrition since 2003. He was previously vice president and general manager of DuPont’s nutrition and health businesses, which included The Solae Company, DuPont Qualicon, Liqui-Box, and DuPont Food Industry Solutions. Mr. Fyrwald joined DuPont in 1981 as a production engineer, and held a variety of sales and management positions in a number of areas. In 1990, he became the leader of the DuPont Engineering Polymers and DuPont™ Butacite® businesses for the Asia Pacific region, a position he held until 1994. He was named leader of the DuPont Nylon Plastics business for the Americas until 1996, when he became head of global sales and marketing for engineering polymers. In 1998, he was appointed vice president of corporate plans and business development and then vice president of e-commerce. Mr. Fyrwald serves on the boards of the Biotechnology Industry Organization (BIO); CropLife International President’s Advisory Group; Des Moines Art Center; 8th Continent L.L.C.; and The Solae Company.
Ellen R. Marram President, The Barnegat Group LLC
Director since 2002		Age 60
Ms. Marram is president of The Barnegat Group LLC, a firm that provides business advisory services. She was a managing director at North Castle Partners, LLC from 2000 to 2005 and is currently an advisor to the firm. Prior to joining North Castle, she served as the chief executive officer of a start-up B2B exchange for the food and beverage industry. From 1993 through 1998, Ms. Marram was president and chief executive officer of Tropicana and the Tropicana Beverage Group. From 1988 to 1993, she was president and chief executive officer of the Nabisco Biscuit Company, an operating unit of Nabisco, Inc.; from 1987 to 1988, she was president of Nabisco’s Grocery Division; and from 1970 to 1986, she held a series of marketing positions at Nabisco/Standard Brands, Johnson & Johnson, and Lever Brothers. Ms. Marram is a member of the board of directors of Ford Motor Company and The New York Times Company as well as several private companies. She serves on the boards of The New York-Presbyterian Hospital, Lincoln Center Theater, Families and Work Institute, and Citymeals-on-Wheels.
Sidney Taurel Chairman of the Board and Chief Executive Officer
Director since 1991		Age 58
Mr. Taurel has been the company’s chief executive officer since July 1998 and chairman of the board since January 1999. He also served as president from February 1996 through September 2005. He joined the company in 1971 and has held management positions in the company’s international operations based in São Paulo, Vienna, Paris, and London. Mr. Taurel served as president of Eli Lilly International Corporation from 1986 to 1991, executive vice president of the pharmaceutical division from 1991 to 1993, and executive vice president of the company from 1993 to 1996. He is a member of the boards of IBM Corporation and The McGraw-Hill Companies, Inc. He is also a member of the executive committee of the board of directors of Pharmaceutical

Research and Manufacturers of America (PhRMA), a member of the board of overseers of the Columbia Business School, a trustee at the Indianapolis Museum of Art, a director of the RCA Tennis Championships, and a member of The Business Council and The Business Roundtable. In early 2003, he was appointed to the President’s Export Council to provide advice on international trade issues. He is an officer of the French Legion of Honor.

Highlights of the Company’s Corporate Governance Guidelines

The board of directors has established guidelines that it follows in matters of corporate governance. The following summary provides highlights of those guidelines. A complete copy of the guidelines is available online at http://investor.lilly.com/guidelines.cfm or in paper form upon request to the company’s corporate secretary.

I. Role of the Board

The directors are elected by the shareholders to oversee the actions and results of the company’s management. Their responsibilities include:

	•		providing general oversight of the business
	•		approving corporate strategy
	•		approving major management initiatives
	•		providing oversight of legal and ethical conduct
	•		overseeing the company’s management of significant business risks
	•		selecting, compensating, and evaluating directors
	•		evaluating board processes and performance
	•		selecting, compensating, evaluating, and, when necessary, replacing the chief executive officer, and compensating other executive officers
	•		ensuring that a succession plan is in place for all senior executives.

II. Composition of the Board

Mix of Independent Directors and Officer-Directors

There should always be a substantial majority (75 percent or more) of independent directors. The chief executive officer should be a board member. Other officers may, from time to time, be board members, but no officer other than the chief executive officer should expect to be elected to the board by virtue of his or her office.

Selection of Director Candidates

The board is responsible for selecting candidates for board membership and for establishing the criteria to be used in identifying potential candidates. The board delegates the screening process to the directors and corporate governance committee. For more information on the director nomination process, including the current selection criteria, see Directors and Corporate Governance Committee Matters on pages 19-20.

Independence Determinations

The board annually determines the independence of directors based on a review by the directors and corporate governance committee. No director is considered independent unless the board has determined that he or she has no material relationship with the company, either directly or as a partner, shareholder, or officer of an organization that has a material relationship with the company. Material relationships can include commercial, industrial, banking, consulting, legal, accounting, charitable, and familial relationships, among others. To evaluate the materiality of any such relationship, the board has adopted categorical independence standards consistent with the New York Stock Exchange listing guidelines.

     Specifically, a director is not considered independent if (i) the director or an immediate family member is a current partner of Lilly’s independent auditor (currently Ernst & Young LLP); (ii) the director is a current employee of such firm; (iii) the director has an immediate family member who is a current employee of such firm and who participates in the firm’s audit, assurance, or tax compliance (but not tax planning) practice; or (iv) the director or immediate family member was within the last three years (but is no longer) a partner or employee of such firm and personally worked on the listed company’s audit within that time.

     In addition, a director is not considered independent if any of the following relationships existed within the previous three years:

	•		a director who is an employee of Lilly, or whose immediate family member is an executive officer of Lilly. Temporary service by an independent director as interim chairman or chief executive officer will not disqualify the director from being independent following completion of that service.
	•		a director who receives any direct compensation from Lilly other than the director’s normal director compensation, or whose immediate family member receives more than $100,000 per year in direct compensation from Lilly other than for service as a non-executive employee.
	•		a director who is employed (or whose immediate family member is employed as an executive officer) by another company where any Lilly executive officer serves on that company’s compensation committee.
	•		a director who is employed by, who is a 10 percent shareholder of, or whose immediate family member is an executive officer of a company that makes payments to or receives payments from Lilly for property or services that exceed the greater of $1 million or 2 percent of that company’s gross revenues in a single fiscal year.
	•		a director who is an executive officer of a nonprofit organization that receives grants or contributions from Lilly in a single fiscal year exceeding the greater of $1 million or 2 percent of that organization’s gross revenues in a single fiscal year.

     Members of the audit, compensation, and directors and corporate governance committees must meet all applicable independence tests of the New York Stock Exchange, Securities and Exchange Commission, and Internal Revenue Service.

     In February 2007, the directors and corporate governance committee reviewed directors’ responses to a questionnaire asking about their relationships with the company (and those of their immediate family members) and other potential conflicts of interest, as well as material provided by management related to transactions, relationships, or arrangements between the company and the directors or parties related to the directors. The committee determined that all 10 non-employee directors listed below are independent, and that the members of the audit, compensation, and directors and corporate governance committees also meet the independence tests referenced above. The committee recommended this conclusion to the board and explained the basis for its decision, and this conclusion was adopted by the full board. The committee and the board determined that none of the 10 directors listed below has had during the last three years (i) any of the relationships listed above or (ii) any other material relationship with the company that would compromise his or her independence. The table below includes a description of categories or types or transactions, relationships, or arrangements considered by the board (in addition to those listed above) in reaching its determination that the directors are independent.

	Name			Independent			Transactions/Relationships/Arrangements
	Sir Winfried Bischoff			Yes
	Mr. Cook			Yes
	Dr. Feldstein			Yes
	Mr. Fisher			Yes
	Mr. Fyrwald			Yes
	Dr. Gilman			Yes
	Ms. Horn			Yes
	Ms. Marram			Yes
	Dr. Prendergast			Yes
	Ms. Seifert			Yes

Director Tenure

Subject to the company’s charter documents, the governance guidelines establish the following expectations for director tenure:

•

A company officer-director, including the chief executive officer, will resign from the board at the

			time he or she retires or otherwise ceases to be an active employee of the company.
	•		Nonemployee directors will retire from the board not later than the annual meeting of shareholders that follows their seventy-second birthday.
	•		Directors may stand for reelection even though the board’s retirement policy would prevent them from completing a full three-year term.
	•		A nonemployee director who retires or changes principal job responsibilities will offer to resign from the board. The directors and corporate governance committee will assess the situation and recommend to the board whether to accept the resignation.

Voting for Directors

In an uncontested election, any nominee for director who receives a greater number of votes against his or her election than votes for such election will not be elected. Under Indiana law, that director would remain in office as a “holdover director” until the next annual meeting of shareholders, unless he or she resigns, is removed, or dies prior to the next annual meeting. Under the company’s bylaws, an unelected holdover director is required to promptly tender his or her resignation following certification of the shareholder vote. The directors and corporate governance committee will consider the resignation offer and recommend to the board whether to accept it. The board will act on the committee’s recommendation within 90 days following certification of the shareholder vote. Board action on the matter will require the approval of a majority of the independent directors.

     The company will disclose the board’s decision on a Form 8-K furnished to the Securities and Exchange Commission within four business days after the decision, including a full explanation of the process by which the decision was reached and, if applicable, the reasons why the board rejected the directors’ resignation. If the resignation is accepted, the directors and corporate governance committee will recommend to the board whether to fill the vacancy or reduce the size of the board.

     Any director who tenders his or her resignation under to this provision will not participate in the committee or board deliberations regarding whether to accept the resignation offer. If each member of the directors and corporate governance committee receives a greater number of votes against his or her election than votes for such election, then the independent directors who did not receive a majority of votes against their election will appoint a committee amongst themselves to consider the resignation offers and recommend to the board whether to accept them.

III. Director Compensation and Equity Ownership

The directors and corporate governance committee annually reviews board compensation. Any recommendations for changes are made to the full board by the committee.

     Directors should hold meaningful equity ownership positions in the company; accordingly, a significant portion of overall director compensation is in the form of company equity.

IV. Key Responsibilities of the Board

Selection of Chairman and Chief Executive Officer; Succession Planning

The board customarily combines the roles of chairman and chief executive officer, believing this generally provides the most efficient and effective leadership model for the company. The board anticipates that, in certain occasional circumstances, and particularly during relatively short periods of leadership transition, these roles could be assigned to two different persons for a period of time. The presiding director recommends to the board an appropriate process by which a new chairman and chief executive officer will be selected.

     The independent directors are responsible for overseeing succession and management development programs for senior leadership. The chief executive officer develops and maintains a process for advising the board on succession planning for the chief executive officer and other key leadership positions. He or she reviews this plan with the independent directors at least annually.

Evaluation of Chief Executive Officer

The presiding director leads the independent directors annually in assessing the performance of the chief executive officer. The results of this review are discussed with the chief executive officer and considered by the compensation committee in establishing his or her compensation for the next year.

Corporate Strategy

Once each year, the board devotes an extended meeting to an update from management regarding the strategic issues and opportunities facing the company, allowing the board an opportunity to provide direction for the corporate strategic plan. Throughout the year, significant corporate strategy decisions are brought to the board for approval.

Code of Ethics

The board approved the company’s code of ethics, which complies with the requirements of the New York Stock Exchange and Securities and Exchange Commission. This code is set out in:

	•		The Red Book, a comprehensive code of ethical and legal business conduct applicable to all employees worldwide and to our board of directors
	•		the company’s Code of Ethical Conduct for Lilly Financial Management, a supplemental code for our chief executive officer, chief operating officer, and all members of financial management that recognizes the unique responsibilities of those individuals in assuring proper accounting, financial reporting, internal controls, and financial stewardship.

     Both documents are available online at http://investor.lilly.com/code_business_conduct.cfm or in paper form upon request to the company’s corporate secretary.

     The audit committee and public policy and compliance committee assist in the board’s oversight of compliance programs with respect to matters covered in the code of ethics.

V. Functioning of the Board

Executive Session of Directors

The independent directors meet alone in executive session at every regularly scheduled board meeting. In addition, at least twice a year, the independent directors meet in executive session with the chief executive officer.

Presiding Director

The board appoints a presiding director from among the independent directors (currently Ms. Horn). The presiding director:

	•		leads the board’s process for selecting and evaluating the chief executive officer;
	•		presides at all meetings of the board at which the chairman is not present, including executive sessions of the independent directors unless the directors decide that, due to the subject matter of the session, another independent director should preside;
	•		serves as a liaison between the chairman and the independent directors;
	•		generally approves information sent to the board and meeting agendas and schedules; and
	•		has the authority to call meetings of the independent directors.

Conflicts of Interest

Occasionally a director’s business or personal relationships may give rise to an interest that conflicts, or appears to conflict, with the interests of the company. Directors must disclose to the company all relationships that create a conflict or an appearance of a conflict. The board, after consultation with counsel, takes appropriate steps to ensure that all directors voting on an issue are disinterested. In appropriate cases, the affected director will be excused from discussions on the issue.

     To avoid any conflict or appearance of a conflict, board decisions on certain matters of corporate governance are made solely by the independent directors. These include executive compensation and the selection, evaluation, and removal of the chief executive officer.

Review and Approval of Transactions with Related Persons

The board has adopted a policy and procedures for review, approval and monitoring of transactions involving the company and “related persons” (directors and executive officers or their immediate family members, or shareholders owning five percent or greater of the company’s outstanding stock). The policy covers any related person transaction that meets the minimum threshold for disclosure in the proxy statement under the relevant

SEC rules (generally, transactions involving amounts exceeding $120,000 in which a related person has a direct or indirect material interest).

Policy

	•		Related person transactions must be approved by the board or by a committee of the board consisting solely of independent directors, who will approve the transaction only if they determine that it is in the best interests of the company. In considering the transaction, the board or committee will consider all relevant factors, including as applicable (i) the company’s business rationale for entering into the transaction; (ii) the alternatives to entering into a related person transaction; (iii) whether the transaction is on terms comparable to those available to third parties, or in the case of employment relationships, to employees generally; (iv) the potential for the transaction to lead to an actual or apparent conflict of interest and any safeguards imposed to prevent such actual or apparent conflicts; and (vi) the overall fairness of the transaction to the company.
	•		The board or relevant committee will periodically monitor the transaction to ensure that there are no changed circumstances that would render it advisable for the company to amend or terminate the transaction.

Procedures

	•		Management or the affected director or executive officer will bring the matter to the attention of the chairman, the presiding director, the chair of the directors and corporate governance committee, or the secretary.
	•		The chairman and the presiding director shall jointly determine (or if either is involved in the transaction, the other shall determine in consultation with the chair of the directors and corporate governance committee) whether the matter should be considered by the board or by one of its existing committees consisting only of independent directors.
	•		If a director is involved in the transaction, he or she will be recused from all discussions and decisions about the transaction.
	•		The transaction must be approved in advance whenever practicable, and if not practicable, must be ratified as promptly as practicable.
	•		The board or relevant committee will review the transactions annually to determine whether it continues to be in the company’s best interests.

     Currently the only related person transaction is the time-share arrangement for Mr. Taurel’s personal use of the corporate aircraft, as described on page 44-45. The compensation committee approved and continues to monitor this arrangement consistent with the above policy.

Orientation and Continuing Education

A comprehensive orientation process is in place for new directors. In addition, directors receive ongoing continuing education through educational sessions at meetings, the annual strategy retreat, and periodic mailings between meetings. We hold periodic mandatory training sessions for the audit committee, to which other directors and executive officers are invited. We also afford directors the opportunity to attend external director education programs.

Director Access to Management and Independent Advisers

Independent directors have direct access to members of management whenever they deem it necessary. The independent directors and the committees are also free to retain their own independent advisers, at company expense, whenever they feel it would be desirable to do so. In accordance with New York Stock Exchange listing standards, the audit, compensation, and directors and corporate governance committees have sole authority to retain independent advisers to their respective committees.

Assessment of Board Processes and Performance

The directors and corporate governance committee annually assesses the performance of the board, its

committees, and board processes based on inputs from all directors. The committee also considers the contributions of individual directors at least every three years when considering whether to recommend nominating the director to a new three-year term.

VI. Board Committees

Number, Structure, and Independence

The duties and membership of the six board-appointed committees are described below. Only independent directors may serve on the audit, compensation, directors and corporate governance, and public policy and compliance committees. Only independent directors may chair any committee.

     Committee membership and selection of committee chairs are recommended to the board by the directors and corporate governance committee after consulting the chairman of the board and after considering the desires of the board members.

Functioning of Committees

Each committee reviews and approves its own charter annually, and the directors and corporate governance committee reviews and approves all committee charters annually. The board may form new committees or disband a current committee (except the audit, compensation, and directors and corporate governance committees) as it deems appropriate. The chair of each committee determines the frequency and agenda of committee meetings. In addition, the audit and compensation committees meet alone in executive session on a regular basis; all other committees meet in executive session as needed.

     All six committee charters are available online at http://investor.lilly.com/board-committees.cfm or in paper form upon request to the company’s corporate secretary.

Committees of the Board of Directors

Audit Committee

The duties of the audit committee are described in the audit committee report found on page 20 of this proxy statement.

Directors and Corporate Governance Committee

The duties of the directors and corporate governance committee are described on pages 19-20.

Compensation Committee

	•		evaluates and establishes compensation for executive officers
	•		oversees the deferred compensation plan, the company’s management stock plans, and other management incentive programs.

     The compensation committee report is shown on page 31 of this proxy statement.

Public Policy and Compliance Committee

	•		oversees the processes by which the company conducts its business so that the company will do so in a manner that complies with laws and regulations and reflects the highest standards of integrity
	•		reviews and makes recommendations regarding policies, practices, and procedures of the company that relate to public policy and social, political, and economic issues that may affect the company.

Finance Committee

•

reviews and makes recommendations regarding capital structure and strategies, including dividends, stock repurchases, capital expenditures, financings and borrowings, and significant business development projects.

Science and Technology Committee

•

reviews and makes recommendations regarding the company’s strategic research goals and objectives

•

reviews new developments, technologies, and trends in pharmaceutical research and development.

Membership and Meetings of the Board and Its Committees

In 2006, each director attended more than 90 percent of the total number of meetings of the board and the committees on which he or she serves. In addition, all board members are expected to attend the annual meetings of shareholders, and all attended in 2006. Current committee membership and the number of meetings of the full board and each committee in 2006 are shown in the table below.

Directors and

Public Policy and

Science and

Board

Audit

Compensation

Corporate Governance

Finance

Compliance

Technology

Sir Winfried Bischoff

Member

Member

Member

Mr. Cook

Member

Chair

Member

Dr. Feldstein

Member

Member

Chair

Member

Mr. Fisher

Member

Member

Chair

Member

Mr. Fyrwald

Member

Member

Member

Dr. Gilman

Member

Member

Chair

Mr. Golden1

Member

Ms. Horn

Member

Chair

Member

Dr. Lechleiter

Member

Member

Ms. Marram

Member

Member

Member

Dr. Prendergast

Member

Member

Member

Member

Ms. Seifert

Member

Member

Member

Chair

Mr. Taurel

Chair

Number of 2006 Meetings

7

10

5

4

2

4

3

1		Mr. Golden retired from the board of directors as of April 24, 2006.

Directors’ Compensation

Directors who are employees receive no additional compensation for serving on the board or its committees.

In 2006, we provided the following annual compensation to directors who are not employees:

				Fees Earned															All Other
				or Paid in Cash					Stock Awards					Stock Option Awards					Compensation					Total
	Name			($) (1)					($) (2)					($) (3)					($) (4)					($) (5)
	Sir Winfried Bischoff			$	97,000				$	139,228				$	27,647				$	18,823	(6)			$	282,698
	Mr. Cook			$	108,000				$	139,228					0					0				$	247,228
	Dr. Feldstein			$	103,000				$	139,228				$	27,647					0				$	269,875
	Mr. Fisher			$	102,000				$	139,228				$	27,647				$	663				$	269,538
	Mr. Fyrwald			$	91,000				$	139,228					0				$	641				$	230,869
	Dr. Gilman			$	96,000				$	139,228				$	27,647				$	1,253				$	264,128
	Ms. Horn			$	122,000				$	139,228				$	27,647				$	1,044				$	289,919
	Ms. Marram			$	92,000				$	139,228				$	27,647				$	743				$	259,618
	Dr. Prendergast			$	102,000				$	139,228				$	27,647					0				$	268,875
	Ms. Seifert			$	109,000				$	139,228				$	27,647					0				$	275,875

(1)		The following directors deferred 2006 cash compensation into their deferred share account under the Lilly Directors’ Deferral Plan (further described below):

	Name			2006 Cash Deferred					Shares
	Mr. Cook			$	108,000					1,971
	Mr. Fisher			$	51,000					926

(2)		Each nonemployee director received an award of stock with a grant date fair value of $145,000 (2,672 shares). This stock award and all prior stock awards are fully vested in that they are not subject to forfeiture; however, the shares are not issued until the director ends his or her service on the board, as further described below under Lilly Directors’ Deferral Plan. The table shows the expense recognized by the company for each director’s stock award.
(3)		No stock options were granted in 2006, as the stock option program for directors was discontinued in 2005. The amounts in this column reflect the expenses related to options granted in 2003 and 2004 recognized in our 2006 financial statements. Aggregate total numbers of stock option awards outstanding are shown below. All outstanding options were vested as of February 17, 2007.

																			Outstanding
																			Stock Options
	Name			Grant Date					Expiration Date					Exercise Price					(Exercisable)
	Sir Winfried Bischoff				2/20/2001					2/18/2011				$	73.98					2,800
					2/19/2002					2/17/2012				$	75.92					2,800
					2/18/2003					2/18/2013				$	57.85					2,800
					2/17/2004					2/17/2014				$	73.11					2,800
	Mr. Cook				—					—					—					0
	Dr. Feldstein				2/19/2002					2/17/2012				$	75.92					2,800
					2/18/2003					2/18/2013				$	57.85					2,800
					2/17/2004					2/17/2014				$	73.11					2,800
	Mr. Fisher				2/20/2001					2/18/2011				$	73.98					2,800
					2/19/2002					2/17/2012				$	75.92					2,800
					2/18/2003					2/18/2013				$	57.85					2,800
					2/17/2004					2/17/2014				$	73.11					2,800
	Mr. Fyrwald				—					—					—					0
	Dr. Gilman				4/20/2000					4/19/2010				$	75.94					2,800
					2/20/2001					2/18/2011				$	73.98					2,800
					2/19/2002					2/17/2012				$	75.92					2,800
					2/18/2003					2/18/2013				$	57.85					2,800
					2/17/2004					2/17/2014				$	73.11					2,800
	Ms. Horn				4/20/2000					4/19/2010				$	75.94					2,800
					2/20/2001					2/18/2011				$	73.98					2,800
					2/19/2002					2/17/2012				$	75.92					2,800
					2/18/2003					2/18/2013				$	57.85					2,800
					2/17/2004					2/17/2014				$	73.11					2,800
	Ms. Marram				2/18/2003					2/18/2013				$	57.85					2,800
					2/17/2004					2/17/2014				$	73.11					2,800
	Dr. Prendergast				4/20/2000					4/19/2010				$	75.94					2,800
					2/20/2001					2/18/2011				$	73.98					2,800
					2/19/2002					2/17/2012				$	75.92					2,800
					2/18/2003					2/18/2013				$	57.85					2,800
					2/17/2004					2/17/2014				$	73.11					2,800
	Ms. Seifert				4/20/2000					4/19/2010				$	75.94					2,800
					2/20/2001					2/18/2011				$	73.98					2,800
					2/19/2002					2/17/2012				$	75.92					2,800
					2/18/2003					2/18/2013				$	57.85					2,800
					2/17/2004					2/17/2014				$	73.11					2,800

(4)		For all directors other than Sir Winfried Bischoff, these amounts consist of tax reimbursements for income imputed to him or her for use of the corporate aircraft, or commercial flights, by his or her spouse to attend board functions that included spouse participation.
(5)		Directors do not participate in a Lilly pension plan or non-equity incentive plan.
(6)		This amount includes expenses for Sir Winfried Bischoff’s spouse to travel to and participate in board functions which included spouse participation.

Cash Compensation

The company provides directors the following cash compensation:

	•		retainer of $80,000 per year (payable monthly)
	•		$1,000 for each committee meeting attended
	•		$2,000 to the committee chairpersons for each committee meeting conducted as compensation for the chairperson’s preparation time
	•		retainer of $20,000 per year to the presiding director
	•		reimbursement for customary and usual travel expenses.

Stock Compensation

Stock compensation for directors consists of:

•

Shares of Lilly stock equaling $145,000, deposited annually in a deferred stock account in the Lilly Directors’ Deferral Plan (as described below), payable after service on the board has ended.

Lilly Directors’ Deferral Plan

This plan allows directors to defer receipt of all or part of their retainer and meeting fees until after their service on the board has ended. Each director can choose to invest the funds in either of two accounts:

	•		Deferred Share Account. This account allows the director, in effect, to invest his or her deferred cash compensation in Lilly stock. In addition, the annual award of shares to each director noted above (2,672 shares in 2006) is credited to this account. Funds in this account are credited as hypothetical shares of Lilly stock based on the market price of the stock at the time the compensation would otherwise have been earned. Hypothetical dividends are “reinvested” in additional shares based on the market price of the stock on the date dividends are paid. All shares in the deferred share accounts are hypothetical and are not issued or transferred until the director ends his or her service on the board.
	•		Deferred Compensation Account. Funds in this account earn interest each year at a rate of 120 percent of the applicable federal long-term rate, compounded monthly, as established the preceding December by the U.S. Treasury Department under Section 1274(d) of the Internal Revenue Code. The rate for 2007 is 5.7 percent. The aggregate amount of interest that accrued in 2006 for the participating directors was $182,102 at a rate of 5.6 percent.

     Both accounts may be paid in a lump sum or in annual installments for up to 10 years. Amounts in the deferred share account are paid in shares of Lilly stock.

Lilly Matching Gift Program

     Directors are eligible to participate in the Eli Lilly and Company Foundation, Inc. matching gift program, which is generally available to U.S. employees. Under this program, the foundation matches 100 percent of charitable donations over $25 made to eligible charities up to a maximum of $90,000 per year for each individual. These limits apply to active employees and directors.

Directors and Corporate Governance Committee Matters

Overview

The directors and corporate governance committee recommends candidates for membership on the board and board committees. The committee also oversees matters of corporate governance, director independence, director compensation, and board performance. The committee’s charter is available online at http://investor.lilly.com/board-committees.cfm or in paper form upon request to the company’s corporate secretary.

     All committee members are independent as defined in the New York Stock Exchange listing requirements.

Director Nomination Process

The board seeks independent directors who represent a mix of backgrounds and experiences that will enhance the quality of the board’s deliberations and decisions. Candidates shall have substantial experience with one or more publicly traded national or multinational companies or shall have achieved a high level of distinction in their chosen fields.

Board membership should reflect diversity in its broadest sense, including persons diverse in geography, gender, and ethnicity. The board is particularly interested in maintaining a mix that includes the following backgrounds:

	•		active or retired chief executive officers and senior executives, particularly those with experience in operations, finance or banking, and marketing or sales
	•		international business
	•		medicine and science
	•		government and public policy
	•		information technology.

     The board delegates the screening process to the directors and corporate governance committee, which receives direct input from other board members. Potential candidates are identified by recommendations from several sources, including:

	•		incumbent directors
	•		management
	•		shareholders
	•		an independent executive search firm retained by the committee to assist in locating candidates meeting the board’s selection criteria.

     The committee employs the same process for evaluating all candidates, including those submitted by shareholders. The committee initially evaluates the candidate based on publicly available information and any additional information supplied by the party recommending the candidate. If the candidate appears to satisfy the selection criteria and the committee’s initial evaluation is favorable, the committee, assisted by management, gathers additional data on the candidate’s qualifications, availability, probable level of interest, and any potential conflicts of interest. If the committee’s subsequent evaluation continues to be favorable, the candidate is contacted by the chairman of the board and one or more of the independent directors for direct discussions to determine the mutual levels of interest in pursuing the candidacy. If these discussions are favorable, the committee makes a final recommendation to the board to nominate the candidate for election by the shareholders (or to select the candidate to fill a vacancy, as applicable).

Process for Submitting Recommendations and Nominations

A shareholder who wishes to recommend a director candidate for evaluation by the committee pursuant to this process should forward the candidate’s name and information about the candidate’s qualifications to the chairman of the directors and corporate governance committee, in care of the corporate secretary, at Lilly Corporate Center, Indianapolis, Indiana 46285. The candidate must meet the selection criteria described above and must be willing and expressly interested in serving on the board.

     Under Section 1.9 of the company’s bylaws, a shareholder who wishes to directly nominate a director

candidate at the 2008 annual meeting (i.e., to propose a candidate for election who is not otherwise nominated by the board through the recommendation process described above) must give the company written notice by November 6, 2007. The notice should be addressed to the corporate secretary at Lilly Corporate Center, Indianapolis, Indiana 46285. The notice must contain prescribed information about the candidate and about the shareholder proposing the candidate as described in more detail in Section 1.9 of the bylaws. A copy of the bylaws is available online at http://investor.lilly.com/bylaws.cfm. The bylaws will also be provided by mail without charge upon request to the corporate secretary.

Audit Committee Matters

Audit Committee Membership

All members of the audit committee are independent as defined in the New York Stock Exchange listing standards applicable to audit committee members. The board of directors has determined that Mr. J. Michael Cook is an audit committee financial expert as defined in the rules of the Securities and Exchange Commission.

Audit Committee Report

The audit committee (“we” or “the committee”) reviews the company’s financial reporting process on behalf of the board. Management has the primary responsibility for the financial statements and the reporting process, including the systems of internal controls and disclosure controls. In this context, we have met and held discussions with management and the independent auditors. Management represented to us that the company’s consolidated financial statements were prepared in accordance with generally accepted accounting principles, and we have reviewed and discussed the audited financial statements and related disclosures with management and the independent auditors, including a review of the significant management judgments underlying the financial statements and disclosures.

     The independent auditors report to us and to the board. We have sole authority to appoint (subject to shareholder ratification) and to terminate the engagement of the independent auditors.

     We have discussed with the independent auditors matters required to be discussed by Statement on Auditing Standards No. 61 (Communication with Audit Committees), including the quality, not just the acceptability, of the accounting principles, the reasonableness of significant judgments, and the clarity of the disclosures in the financial statements. In addition, we have received the written disclosures and the letter from the independent auditors required by the Independence Standards Board Standard No. 1 (Independence Discussions with Audit Committees) and have discussed with the independent auditors the auditors’ independence from the company and its management. In concluding that the auditors are independent, we determined, among other things, that the nonaudit services provided by Ernst & Young LLP (as described below) were compatible with their independence. Consistent with the requirements of the Sarbanes-Oxley Act of 2002, we have adopted policies to avoid compromising the independence of the independent auditors, such as prior committee approval of nonaudit services and required audit partner rotation.

     We discussed with the company’s internal and independent auditors the overall scope and plans for their respective audits including internal control testing under Section 404 of the Sarbanes-Oxley Act. We periodically meet with the internal and independent auditors, with and without management present, and in private sessions with members of senior management (such as the chief financial officer, the chief accounting officer, and the general auditor) to discuss the results of their examinations, their evaluations of the company’s internal controls, and the overall quality of the company’s financial reporting. We also periodically meet in executive session.

     In reliance on the reviews and discussions referred to above, we recommended to the board (and the board subsequently approved the recommendation) that the audited financial statements be included in the company’s annual report on Form 10-K for the year ended December 31, 2006, for filing with the Securities and Exchange Commission. We have also appointed the company’s independent auditors, subject to shareholder ratification, for 2007.

Audit Committee

J. Michael Cook, Chair
Martin S. Feldstein, Ph.D.
Franklyn G. Prendergast, M.D., Ph.D.
Kathi P. Seifert

Services Performed by the Independent Auditor

The audit committee preapproves all services performed by the independent auditor, in part to assess whether the provision of such services might impair the auditor’s independence. The committee’s policy and procedures are as follows:

	•		The committee approves the annual audit services engagement and, if necessary, any changes in terms, conditions, and fees resulting from changes in audit scope, company structure, or other matters. The committee may also preapprove other audit services, which are those services that only the independent auditor reasonably can provide. Since 2004, audit services have included internal controls attestation work under Section 404 of the Sarbanes-Oxley Act.
	•		Audit-related services are assurance and related services that are reasonably related to the performance of the audit, and that are traditionally performed by the independent auditor. The committee believes that the provision of these services does not impair the independence of the auditor.
	•		Tax services. The committee believes that, in appropriate cases, the independent auditor can provide tax compliance services, tax planning, and tax advice without impairing the auditor’s independence.
	•		The committee may approve other services to be provided by the independent auditor if (i) the services are permissible under SEC and Public Company Accounting Oversight Board rules, (ii) the committee believes the provision of the services would not impair the independence of the auditor, and (iii) management believes that the auditor is the best choice to provide the service.
	•		Process. At the beginning of each audit year, management requests prior committee approval of the annual audit, statutory audits, and quarterly reviews for the upcoming audit year as well as any other engagements known at that time. Management will also present at that time an estimate of all fees for the upcoming audit year. As specific engagements are identified thereafter, they are brought forward to the committee for approval. To the extent approvals are required between regularly scheduled committee meetings, preapproval authority is delegated to the committee chair.

     For each engagement, management provides the committee with information about the services and fees sufficiently detailed to allow the committee to make an informed judgment about the nature and scope of the services and the potential for the services to impair the independence of the auditor.

     After the end of the audit year, management provides the committee with a summary of the actual fees incurred for the completed audit year.

Independent Auditor Fees

The following table shows the fees incurred for services rendered on a worldwide basis by Ernst & Young LLP, the company’s independent auditor, in 2006 and 2005. All such services were preapproved by the committee in accordance with the preapproval policy.

				2006 (millions)					2005 (millions)
	Audit Fees
	• Annual audit of consolidated and subsidiary financial statements, including Sarbanes-Oxley 404 attestation   • Reviews of quarterly financial statements   • Other services normally provided by the auditor in connection with statutory and regulatory filings				$5.8					$5.8
	Audit-Related Fees
	• Assurance and related services reasonably related to the performance of the audit or reviews of the financial statements:
	—2006 and 2005: primarily related to employee benefit plan and other ancillary audits, and accounting consultations				$0.4					$1.0
	Tax Fees
	• 2006 and 2005: primarily related to tax planning and various compliance services				$1.5					$1.8
	All Other Fees
	• 2006: primarily related to compliance services outside the U.S.
	• 2005: primarily related to upgrading and maintaining on-line training programs				$0.1					$0.1
	Total				$7.8					$8.7

Compensation Committee Matters

Scope of Authority

The compensation committee acts on behalf of the board of directors and by extension the shareholders to establish the compensation of executive officers of the company and provides oversight of the company’s global compensation philosophy. The committee also acts as the oversight committee with respect to the company’s deferred compensation plans, management stock plans, and bonus plans covering executive officers and other senior management. In overseeing those plans, the committee may delegate authority for day-to-day administration and interpretation of the plan, including selection of participants, determination of award levels within plan parameters, and approval of award documents, to officers of the company. However, the committee may not delegate any authority under those plans for matters affecting the compensation and benefits of the executive officers.

The Committee’s Processes and Procedures

The committee’s primary processes for establishing and overseeing executive compensation can be found in the Compensation Discussion and Analysis section under “The Committee’s Processes” on page 24. Additional processes and procedures include:

	•		Meetings. The committee meets several times each year (5 times in 2006). Committee agendas are established in consultation with the committee chair and the committee’s independent compensation consultant. The committee meets in executive session following each regular meeting.
	•		Role of Independent Consultant. The committee has retained Frederic W. Cook and his firm, Frederic W. Cook & Co., as its independent compensation consultant to assist the committee in evaluating executive compensation programs and in setting executive officers’ compensation. The use of an independent consultant provides additional assurance that the company’s executive compensation programs are reasonable and consistent with company objectives. The consultant reports directly to the committee and does not perform any services for management. The consultant regularly participates in committee meetings and advises the committee with respect to compensation trends and best practices, plan design, and the reasonableness of individual compensation awards. In addition, with respect to the chief executive officer, the consultant prepares the specific compensation recommendations for the committee’s consideration; the CEO does not participate in the development of the recommendations and has no knowledge of the recommendations when they are presented to the committee.
	•		Role of Executive Officers and Management. With the oversight of the CEO, chief operating officer, and the senior vice president of human resources, the company’s global compensation group formulates recommendations on matters of compensation philosophy, plan design, and the specific compensation recommendations for executive officers (other than the CEO as noted above). The CEO gives the committee a performance assessment and compensation recommendation for each of the other named executive officers. Those recommendations are then considered by the committee with the assistance of its compensation consultant. The CEO and the senior vice president of human resources generally attend committee meetings but are not present for the executive sessions or for any discussion of their own compensation.

     Directors’ compensation is established by the board of directors upon the recommendation of the directors and corporate governance committee.

Compensation Committee Interlocks and Insider Participation

None of the compensation committee members

	•		has ever been an officer or employee of the company
	•		is or was a participant in a “related person” transaction in 2006 (see pages 13-14 for a description of our policy on related person transactions)
	•		is an executive officer of another entity, at which one of our executive officers serves on the board of directors

Executive Compensation

Compensation Discussion and Analysis

Executive Compensation Policy

As a research-based pharmaceutical company, our long-term success depends on our ability to discover, develop, and market a stream of innovative medicines that address important medical needs. In addition, the intense global pressures on health care costs require us to continually improve productivity in all that we do. To achieve these goals, it is critical that we be able to attract, motivate, and retain highly talented individuals at all levels of the organization who are committed to the company’s core values of excellence, integrity, and respect for people.

     The compensation committee bases its executive compensation programs on the same objectives that guide the company in establishing all its compensation programs:

	•		Compensation should be based on the level of job responsibility, individual performance, and company performance. As employees progress to higher levels in the organization, an increasing proportion of their pay should be linked to company performance and shareholder returns, because they are more able to affect the company’s results.
	•		Compensation should reflect the value of the job in the marketplace. To attract and retain a highly skilled work force, we must remain competitive with the pay of other premier employers who compete with us for talent.
	•		Compensation should reward performance. Our programs should deliver top-tier compensation given top-tier individual and company performance; likewise, where individual performance falls short of expectations and/or company performance lags the industry, the programs should deliver lower-tier compensation. In addition, the objectives of pay-for-performance and retention must be balanced. Even in periods of temporary downturns in company performance, the programs should continue to ensure that successful, high-achieving employees will remain motivated and committed to Lilly.
	•		Compensation should foster the long-term focus required for success in the pharmaceutical industry. While all employees receive a mix of both annual and longer-term incentives, employees at higher levels have an increasing proportion of their compensation tied to longer-term performance because they are in a position to have greater influence on longer-term results.
	•		To be effective, performance-based compensation programs should enable employees to easily understand how their efforts can affect their pay, both directly through individual performance accomplishments and indirectly through contributing to the company’s achievement of its strategic and operational goals. No matter how elegant a performance measure may be in theory, if in practice employees cannot easily understand how it works or how it relates to their daily jobs, it will not be an effective motivator.
	•		Compensation and benefit programs should be egalitarian. While the programs and individual pay levels will always reflect differences in job responsibilities, geographies, and marketplace considerations, the overall structure of compensation and benefit programs should be broadly similar across the organization. Perquisites for executives should be rare and limited to those that are important to the executive’s ability to safely and effectively carry out his or her responsibilities.
	•		Compensation and benefit programs should attract employees who are interested in a career at Lilly. The company’s nationally recognized benefit programs provide a competitive advantage by helping the company attract and retain highly talented employees who are looking for the opportunity to build a career. These programs include a strong retirement program, flexible health care coverage options for active employees and retirees, and leading-edge work/life programs to help employees manage the sometimes conflicting demands of career and family.

The Committee’s Processes

The compensation committee has established a number of processes to assist it in ensuring that the company’s executive compensation program is achieving its objectives. Among those are:

	•		Assessment of Company Performance. The committee uses company performance measures in two ways. First, in establishing total compensation ranges, the committee considers various measures of company and industry performance, including sales, earnings per share, return on assets, return on equity, and total shareholder return. The committee does not apply a formula or assign these performance measures relative weights. Instead, it makes a subjective determination after considering such measures collectively. Second, as described in more detail below, the committee has established specific company performance measures that determine the size of payouts under the company’s three formula-based incentive programs – the Eli Lilly and Company Bonus Plan, the performance award program and, beginning in 2007, the shareholder value award which replaces the stock option program (the shareholder value award is discussed on page 31.)
	•		Assessment of Individual Performance. Individual performance has a strong impact on the compensation of all employees, including the CEO and the other executive officers. With respect to the CEO, the independent directors, under the direction of the presiding director, meet with the CEO in executive session annually at the beginning of the year to agree upon the CEO’s performance objectives (both individual and company objectives) for the year. At the end of the year, the independent directors meet in executive session under the direction of the presiding director to conduct a performance review of the CEO based on his or her achievement of the agreed-upon objectives, contribution to the company’s performance, and other leadership accomplishments. This evaluation is shared with the CEO by the presiding director and is provided to the compensation committee for its consideration in setting the CEO’s compensation.
			For the other named executive officers, the committee receives a performance assessment and compensation recommendation from the CEO and also exercises its judgment based on the board’s interactions with the executive officer. As with the CEO, the performance evaluation of these executives is based on achievement of pre-agreed objectives by the executive and his or her organization, his or her contribution to the company’s performance, and other leadership accomplishments.
	•		Benchmarking. The committee benchmarks the company’s programs with a peer group of global pharmaceutical companies. Pharmaceutical companies’ needs for scientific and sales/marketing talent are unique to the industry and as such, Lilly must compete with these companies for talent: Abbott Laboratories; Amgen; Bristol-Myers Squibb Company; GlaxoSmithKline; Johnson & Johnson; Merck & Co.; Pfizer, Inc.; Schering-Plough Corporation; and Wyeth Laboratories. The committee compares the companies’ executive compensation programs as a whole, and also compares the pay of individual executives if the jobs are sufficiently similar to make the comparison meaningful. The committee uses the peer group data primarily to ensure that the executive compensation program as a whole is competitive, meaning generally within the broad middle range of comparative pay of the peer group companies when the company achieves the targeted performance levels. The individual’s relative position is driven by individual and company performance.
	•		Total Compensation Review. The committee reviews each executive’s base pay, bonus, and equity incentives annually with the guidance of the committee’s independent consultant. In addition to these primary compensation elements, the committee reviews the deferred compensation program, perquisites and other compensation, and payments that would be required under various severance and change-in-control scenarios. Following the 2006 review, the committee determined that these elements of compensation were reasonable in the aggregate. In response to evolving corporate governance trends, the committee recommended to the board, and it approved, amendments to the change-in-control severance pay programs in 2006 to reduce the severance benefit for executive officers from three times to two times annual base salary plus bonus. This change aligns the executive officers’ benefit with that of all other executives. See “Severance Benefits” below.

Components of Executive Compensation for 2006

For 2006, the compensation of executives consisted of the same four primary components as were provided to other levels of management – base salary, a cash incentive bonus award under the Eli Lilly and Company Bonus Plan, equity grants of a performance award (a performance-based stock incentive award under the 2002 Lilly Stock Plan) and stock options, and a benefits package. The committee believes that this program balances both the mix of cash and equity compensation, the mix of currently-paid and longer-term compensation, and the security of foundational benefits in a way that furthers the compensation objectives discussed above. Following is a discussion of the committee’s considerations in establishing each of the components for the executive officers.

Base Salary

Base salary is the guaranteed element of employees’ annual cash compensation. The value of base salary reflects the employee’s long-term performance, skill set and the market value of that skill set. In setting base salaries for 2006, the committee considered the following factors:

	•		The corporate “merit budget,” meaning the company’s overall budget for base salary increases. The aggregate increases for the executive officers were within the corporate merit budget. The corporate merit budget was established based on company performance for 2005, planned performance for 2006, and peer group data. The objective of the merit budget is to allow salary increases to retain and motivate successful performers while maintaining affordability within the company’s business plan.
	•		Internal relativity, meaning the relative pay differences for different job levels.
	•		Individual performance. As described above under “The Committee’s Processes,” base salary increases were driven by individual performance assessments.

     In establishing Mr. Taurel’s base salary for 2006, the committee applied the principles described above under “The Committee’s Processes.” In an executive session including all independent directors, the committee assessed Mr. Taurel’s 2005 performance. They considered the company’s and Mr. Taurel’s accomplishment of objectives that had been established at the beginning of the year and its own subjective assessment of his performance. They noted that under Mr. Taurel’s leadership, in 2005 the company achieved 6 percent sales growth, with strong growth of several recently launched products offsetting declines in Zyprexa and Strattera sales. The company's successful implementation of Six Sigma exceeded objectives in its first year, as did other productivity initiatives. Through strict headcount control, the company was able to reduce its headcount through attrition by nearly 2,000 employees. Improved productivity led to a 9 percent increase in reported earnings per share and an 11 percent increase in adjusted earnings per share. The company also made significant strides in brand equity/customer satisfaction, compliance and enterprise risk management, and diversity. In recognition of his continued strong leadership in 2005, the committee increased Mr. Taurel’s annual salary by 4.4 percent effective March 2006.

     The committee reviewed similar considerations for each of the other named executives. In addition, with regard to Dr. Lechleiter’s performance, the committee considered his leadership in increasing the productivity of the sales and marketing, manufacturing, and other operational functional areas of the company. The committee had increased Dr. Lechleiter’s annual salary by 18 percent in recognition of his promotion to president and chief operating officer in October 2005, and therefore did not increase his annual salary in 2006.

     With regard to Dr. Paul’s performance, the committee gave particular weight to his leadership of the company’s research and development efforts, noting that Lilly Research Laboratories improved productivity in all phases of discovery and development, increasing the number and success of early phase candidates, and more quickly identifying compounds likely to be unsuccessful. The committee increased Dr. Paul’s annual salary by 4 percent effective March 2006.

     In establishing Mr. Armitage’s annual salary (an 8 percent increase), the committee noted his leadership in implementing successful litigation strategies, enhancing the company’s compliance programs, and improving productivity within the law division.

     Mr. Rice’s base salary was raised upon his promotion to chief financial officer in May 2006.

•

Peer group data specific to the executive’s position, where applicable. As noted above, we used the

			peer group data to test for reasonableness and competitiveness of base salaries, but we also exercised subjective judgment in view of our compensation objectives.
	•		Consideration of the mix of overall compensation. Consistent with our compensation objectives, as employees progress to higher levels in the organization, a greater proportion of overall compensation is directly linked to company performance and shareholder returns. Thus, for example, Mr. Taurel’s overall compensation is more heavily weighted toward incentive compensation and equity compensation than that of the other executive officers.

Cash Incentive Bonuses

The company has established an annual cash bonus program in order to align employees’ goals with the company’s sales and earnings growth objectives for the current year. Cash incentive bonuses for all management employees worldwide, as well as all non-management employees in the U.S. other than sales representatives, were determined under the Eli Lilly and Company Bonus Plan, a shareholder-approved formula-based incentive plan adopted in 2004. The bonuses paid for 2006 appear in the Summary Compensation Table under the “Nonequity Incentive Plan Compensation” column. Under the plan, bonus target amounts, expressed as a percentage of base salary, are established for participants at the beginning of each year. Bonus payouts for the year are then determined by the company’s financial results for the year relative to predetermined performance measures. Satisfactory individual performance is a condition to payment. At the end of the performance period, the committee has discretion to adjust an award payout downward, but not upward, from the amount yielded by the formula. The committee considered the following when establishing the awards for 2006:

	•		Bonus Targets. Bonus targets were based on job responsibilities, internal relativity, and peer group data. Our objective was to set bonus targets such that total annual cash compensation was within the broad middle range of peer group companies and a substantial portion of that compensation was linked to company performance. Consistent with our executive compensation policy, individuals with greater job responsibilities had a greater proportion of their total cash compensation tied to company performance through the bonus plan. Thus, the committee established the following bonus targets for 2006 (expressed as a percentage of base salary): Mr. Taurel, 125 percent; Dr. Lechleiter, 100 percent; Dr. Paul, 85 percent; Mr. Golden, 85 percent; Mr. Rice, 75 percent; and Mr. Armitage, 75 percent.
	•		Company performance measures. For all participants in the plan, including the executive officers, the committee established 2006 company performance measures based 25 percent on sales growth (target of 5 percent growth) and 75 percent on earnings per share (EPS) growth adjusted for certain items as described below under “Adjustments for Certain Items” (target of 7 percent growth). The measures were determined in January 2006. The committee believes that this mix of performance measures will encourage employees to focus appropriately on improving both top-line sales and bottom-line earnings. Special emphasis is given to bottom line earnings so that employees can be directly rewarded for their productivity improvements. The measures are also effective motivators because they are easy to track and clearly understood by employees. Under the plan formula, payouts can range from zero to 200 percent of target depending on company performance. In establishing the target growth rates for both sales and EPS (that is, the growth rates at which the payouts would be 100 percent of target), the committee considered the expected 2006 performance of companies in our peer group, based on published investment analyst estimates. Consistent with the compensation objectives discussed above, the target growth percentages represented approximately the median expected growth for our peer group; accordingly, Lilly performance exceeding the peer group would result in above-target payouts and Lilly performance lagging the peer group would result in below-target payouts. The bonuses paid to executive officers for 2006 were 134 percent of target as a result of above-target growth in both sales (7 percent) and adjusted earnings per share (11 percent). (Adjustments for certain items are discussed on page 30.)

Equity Incentives – Total Equity Program

Through 2006, we employed two forms of equity incentives granted under the 2002 Lilly Stock Plan: stock options and performance awards. These incentives foster the long-term perspective necessary for continued success in our business. They also ensure that our leaders are properly focused on shareholder value. Stock options and performance awards have traditionally been granted broadly and deeply within the organization,

with approximately 4,900 management and professional employees now participating. In determining the value of grants for executives, the committee’s overall objective was to set combined grant values of stock options and performance awards that were competitive within the broad middle range of peer company long-term incentive grant amounts. The committee approves grant values (expressed in U.S. dollars) prior to the pre-established grant date. The committee’s process for setting grant dates is discussed on page 28. Then, on the grant date those values are converted to the equivalent number of shares using the same valuation methodology as the company uses to determine the accounting expense of the grants under Statement of Financial Accounting Standards (SFAS) 123R.

     For 2005, the committee had lowered grant values significantly at all levels consistent with marketplace trends, and had also shifted the mix of awards to increase emphasis on performance awards and decrease emphasis on stock options. For 2006, the committee maintained the same total grant values but continued to place greater emphasis on performance-based equity incentives by increasing the performance award portion of executive officers’ equity grants from 40 percent to 50 percent of the total grant value. In making this determination, the committee reviewed available peer group data but found it provided only limited insight because of rapidly changing equity grant practices. Grant values for individuals were determined by individual performance and internal relativity. Consistent with the company’s compensation philosophy, individuals at higher levels received a greater proportion of total pay in the form of equity. The values for 2006 grants for the named executives were as follows:

	Name			Stock Options					Performance Awards
	Current
	Sidney Taurel			$	3,600,000				$	3,600,000
	John C. Lechleiter, Ph.D.			$	2,340,000				$	2,340,000
	Steven M. Paul, M.D.			$	1,200,000				$	1,200,000
	Robert A. Armitage			$	900,000				$	900,000
	Derica W. Rice (1)			$	450,000				$	450,000
	Retired
	Charles E. Golden (2)			$	1,100,000				$	1,100,000

Equity Incentives – Performance Awards

Performance awards provide employees with shares of Lilly stock if certain company performance goals are achieved, aligning employees with shareholder interests and providing an ownership stake in the company. The awards, normally granted annually, are structured as a schedule of shares of Lilly stock based on the company’s achievement of specific earnings-per-share (EPS) levels over specified time periods of one or more years. We granted performance awards for 2006 to executive officers with possible payouts ranging from zero to 200 percent of the target amount, depending on 2006 EPS growth as adjusted based on predetermined criteria. No dividends are paid on the awards during the performance period. At the end of the performance period, the committee has discretion to adjust an award payout downward, but not upward, from the amount yielded by the formula. For executive officers, the payout was in the form of restricted stock, as noted below. The committee approved the terms of the 2006 performance awards in January 2006, and took into consideration the following:

	•		Target grant size. As noted above, following a substantial reduction in total equity grant values in 2005, the committee decided to maintain the same grant values in 2006 but increased the performance award portion of the total grant value from 40 to 50 percent.
	•		Company performance measure. As in previous years, the committee established the performance measure as EPS growth (adjusted as described below under “Adjustments for Certain Items”) over a one-year period. The committee believes EPS growth is an effective motivator because it is closely

			linked to shareholder value and it is easily understood by employees. In setting the target growth percentage of 7 percent, the committee considered the expected earnings performance of companies in our peer group. Consistent with the compensation objectives discussed above, the target growth percentage represented approximately the median expected growth for our peer group; accordingly, Lilly performance exceeding the peer group would result in above-target payouts and Lilly performance lagging the peer group would result in below-target payouts. Above-target growth in adjusted earnings per share (11 percent) resulted in a 2006 performance award payout at 150 percent of target.
	•		Longer-term focus and retention considerations. To enhance the performance awards’ incentives for longer-term focus and retention, the awards to executive officers for 2006 are payable in restricted stock that is subject to forfeiture if the executive leaves the company prior to February 2008, except by reason of death, disability, retirement, or by consent of the committee. The additional one-year restriction period is consistent with our share retention guidelines discussed on page 30.

Equity Incentives – Stock Options

Stock options align employee incentives with shareholders because options have value only if the stock price increases over time. The company’s 10-year options, granted at the market price on the date of grant, help focus employees on long-term growth. In addition, options are intended to help retain key employees because they typically cannot be exercised for three years and, if not exercised, are forfeited if the employee leaves the company before retirement. The three-year vesting also helps keep employees focused on long-term performance. The company does not reprice options; likewise, if the stock price declines after the grant date, we do not replace options.

     The committee considered the following in establishing the 2006 option grants to executive officers:

	•		Grant size. As noted above under “Equity Incentives – Total Equity Program,” stock option grants were 50 percent of the total equity grant values (measured in accordance with SFAS 123R) established by the committee. The total equity grant values were unchanged from 2005; however, we decreased the stock option portion of the total grant value from 60 to 50 percent.
	•		Grant Timing and Price. The committee’s procedure for timing of equity grants (performance awards and stock options) provides assurance that grant timing is not being manipulated to result in a price that is favorable to employees. The annual equity grant date for all eligible employees, including executive officers (more than 4,900 employees), is in mid-February. This date is established by the committee well in advance – typically at the committee’s October meeting or in December when there is no meeting in October. The mid-February grant date timing is driven by three considerations:

	o		It coincides with the company’s calendar-year-based performance management cycle, allowing supervisors to deliver the equity awards close in time to performance appraisals, which increases the impact of the awards by strengthening the link between pay and performance.
	o		It is within about two weeks after release of quarterly earnings, so that the stock price at that time can reasonably be expected to fairly represent the market’s collective view of our then-current results and prospects.
	o		To take advantage of favorable local tax laws for stock options in certain jurisdictions outside the U.S., options may not be granted within a specified number of days before or after announcing earnings or filing financial reports.

In the event of grants to new hires, the grants are effective on the first trading day of the month following hire.

Our process for establishing the grant date well in advance provides assurance that grant timing is not being manipulated for employee gain.

Employee and Post-Employment Benefits

The company offers core employee benefits coverage in order to:

	•		provide our global workforce with a reasonable level of financial support in the event of illness or injury, and
	•		enhance productivity and job satisfaction through programs that focus on work/life balance.

     The benefits available are the same for all U.S. employees and executive officers and include medical and dental coverage, disability insurance, and life insurance. In addition, the Lilly 401(k) Savings Plan and the Lilly

Retirement Plan provide a reasonable level of retirement income reflecting employees’ careers with the company. All U.S. employees, including executive officers, participate in these plans. To the extent that any employee’s retirement benefit exceeds IRS limits for amounts that can be paid through a qualified plan, Lilly also offers a non-qualified retirement plan and savings plan. These plans provide only the difference between the calculated benefits and the IRS limits.

     The cost of both employee and post-employment benefits is partially borne by the employee, including each executive officer.

Perquisites

The company does not provide significant perquisites or personal benefits to executive officers, except that the company aircraft is made available for the personal use of Mr. Taurel and Dr. Lechleiter, where the committee believes the security and efficiency benefits to the company clearly outweigh the expense. Mr. Taurel’s only use of the corporate aircraft for personal flights in 2006 was to attend outside board meetings for the two public companies at which he serves as an independent director. The compensation committee believes that Mr. Taurel’s service on these boards, and his ability to conduct company business while traveling to board meetings, provides clear benefits to the company. As described on pages 44-45, Mr. Taurel has entered into a time share arrangement for the corporate aircraft under which he pays the company a lease fee for personal use. This amount offsets part of the company’s incremental cost of providing the aircraft. Dr. Lechleiter did not use the corporate aircraft for personal flights. In addition, depending on seat availability, family members of executive officers may travel on the company aircraft to accompany executives who are traveling on business. There is no incremental cost to the company for these trips.

Deferred Compensation Program

Executives may defer receipt of part or all of their cash compensation under the company’s deferred compensation program. The program allows executives to save for retirement in a tax-effective way at minimal cost to the company. Under this unfunded program, amounts deferred by the executive are credited at an interest rate of 120 percent of the applicable federal long-term rate, as described in more detail following the Nonqualified Deferred Compensation in 2006 Table on page 41.

Severance Benefits

Except in the case of a change in control of the company, the company is not obligated to pay severance or other enhanced benefits to named executive officers upon termination of their employment.

     The company has adopted a change-in-control severance pay program for nearly all employees of the company, including the executive officers. The program is intended to preserve employee morale and productivity and encourage retention in the face of the disruptive impact of an actual or rumored change in control of the company. In addition, for executives, the program is intended to align executive and shareholder interests by enabling executives to consider corporate transactions that are in the best interests of the shareholders and other constituents of the company without undue concern over whether the transactions may jeopardize the executives’ own employment.

     Although there are some differences in benefit levels depending on the employee’s job level and seniority, the basic elements of the program are comparable for all employees:

	•		Double trigger. Unlike “single trigger” plans that pay out immediately upon a change in control, the Lilly program requires a “double trigger” – a change in control followed by an involuntary loss of employment within two years thereafter. This is consistent with the purpose of the program, which is to provide employees with a guaranteed level of financial protection upon loss of employment. The only exception is performance awards, a portion of which would be paid out upon change in control, based on time worked prior to the change in control and the target or forecasted payout level at the time of the change in control. The committee believes this partial payment is appropriate because of the difficulties in converting the Lilly EPS targets into an award based on the surviving company’s EPS.
	•		Covered terminations. Employees are eligible for payments if, within two years of the change in control, their employment is terminated (i) without cause by the company or (ii) for good reason by the employee, each as is defined in the program. See pages 42-44 for a more detailed discussion.
	•		Severance payment. Eligible terminated employees would receive a severance payment ranging from

			six months’ to two years’ base salary Executives are all eligible for two years’ base salary plus cash bonus (with bonus established as the higher of the then-current year’s target bonus or the last bonus paid prior to the change in control).
	•		Benefit continuation. Basic employee benefits such as health and life insurance would be continued for up to two years following termination of employment. All executives, including named executive officers are entitled to two years’ benefit continuation.
	•		Pension supplement. Under the portion of the program covering executives, a terminated employee would be entitled to a supplement of two years of age credit and two years of service credit for purposes of calculating eligibility and benefit levels under the company’s defined benefit pension plan.
	•		Accelerated vesting of equity awards. Any unvested equity awards at the time of termination of employment would become vested.
	•		Excise tax. In the event the payments made to the employee, or the value of other benefits received by the employee, in connection with a change in control exceed certain limits, Section 280G of the Internal Revenue Code imposes an excise tax on the employee. The costs of this excise tax, including related tax gross-ups, would be borne by the company.

Other Matters

Share Retention Guidelines; Hedging Prohibition

Share retention guidelines help to foster a focus on long-term growth. We expect our executive officers to retain all net shares received from stock options and performance awards, net of taxes, for at least one year. Consistent with this objective, performance award shares earned for 2006 performance were issued in the form of restricted stock that is subject to forfeiture if the executive leaves the company prior to February 2008, except by reason of death, disability, or retirement. Employees are not permitted to hedge their economic exposures to the Lilly stock that they own.

Adjustments for Certain Items

Consistent with past practice and based on criteria established at the beginning of the performance period, the committee adjusted the earnings results on which 2006 bonuses and performance awards were determined to eliminate the effect of certain items. The adjustments are intended to ensure that award payments represent the underlying growth of the core business and are not artificially inflated or deflated due to such items either in the award year or the previous (comparator) year. For the 2006 awards calculation, the committee adjusted EPS to eliminate the effect in both 2005 and 2006 of product liability charges, major asset impairments, restructuring and other special charges. In addition, the committee eliminated the 2005 cumulative effect of an accounting change relating to the adoption of FIN 47 (conditional asset retirement obligations).

Deductibility Cap on Executive Compensation

U.S. federal income tax law prohibits the company from taking a tax deduction for certain compensation paid in excess of $1,000,000 to the named executive officers listed in the summary compensation table below. However, performance-based compensation, as defined in the tax law, is fully deductible if the programs are approved by shareholders and meet other requirements. Our policy is to qualify our incentive compensation programs for full corporate deductibility to the extent feasible and consistent with our overall compensation goals as reflected in the summary compensation table below.

     The company has taken steps to qualify compensation under the Eli Lilly and Company Bonus Plan, as well as stock options and performance awards under its management stock plans, for full deductibility as “performance-based compensation.” The committee may make payments that are not fully deductible if, in its judgment, such payments are necessary to achieve the company’s compensation objectives and to protect shareholder interests. For 2006, the non-deductible compensation under this law was essentially the portion of Mr. Taurel’s and Dr. Lechleiter’s base salary that exceeded $1,000,000 as shown in the Summary Compensation Table.

Executive Compensation Recovery Policy

The committee has adopted an executive compensation recovery policy applicable to executive officers. Under this policy, the company may recover incentive compensation (cash or equity) that was based on achievement of financial results that were subsequently the subject of a restatement if an executive officer engaged in intentional misconduct that caused or partially caused the need for the restatement and the effect of the wrongdoing was to increase the amount of bonus or incentive compensation. This policy covers income related to cash bonuses and performance awards.

2007 Compensation Decisions

Beginning in 2007, the company is implementing a new equity program, the shareholder value award (SVA), which replaces our stock option program going forward. The SVA pays out shares of stock based on the growth of the company’s stock price over a three-year going forward performance period. Payouts are based on individual target grids, which range from 60 percent of target (zero for executive officers) to 140 percent of target. Targets are set based on an expected investment return for large cap companies. Because the SVA pays in shares, it has stronger retention power.

     The performance award program remains in place, and executive officers received 50 percent of their total equity grant value for 2007 in performance award shares and 50 percent in SVA shares. All other compensation programs are unchanged from 2006.

     The following table summarizes the compensation committee’s 2007 equity compensation decisions for named executive officers:

				Shareholder Value Awards
	Name			($)					Performance Awards ($)
	Sidney Taurel				3,060,000					3,060,000
	John C. Lechleiter, Ph.D.				1,989,000					1,989,000
	Steven M. Paul, M.D.				1,200,000					1,200,000
	Robert A. Armitage				855,000					855,000
	Derica W. Rice				855,000					855,000

Compensation Committee Report

The compensation committee (“we” or “the committee”) evaluates and establishes compensation for executive officers and oversees the deferred compensation plan, the company’s management stock plans, and other management incentive, benefit and perquisite programs. Management has the primary responsibility for the company’s financial statements and reporting process, including the disclosure of executive compensation. With this in mind, we have reviewed and discussed with management the Compensation Discussion and Analysis found on pages 23-31 of this report. The committee is satisfied that the Compensation Discussion and Analysis fairly and completely represents the philosophy, intent, and actions of the committee with regard to executive compensation. We recommended to the board of directors that the Compensation Discussion and Analysis be included in this proxy statement for filing with the Securities and Exchange Commission.

Karen N. Horn, Ph.D., Chair
George M.C. Fisher
J. Erik Fyrwald
Ellen R. Marram

Summary Compensation Table (1)

																								Non-equity
																								Incentive Plan					Change in					All Other					Total
	Name and								Salary					Stock Awards					Option Awards					Compensation					Pension Value					Compensation					Compensation
	Principal Position			Year					($)					(2)($)					(2)($)					(3)($)					(4)($)					(5)($)					($)
	Current
	Sidney Taurel Chairman of the Board and Chief Executive Officer				2006				$	1,650,333				$	5,400,000				$	3,805,333				$	2,764,308				$	1,417,434				$	192,409				$	15,229,817
	John C. Lechleiter, Ph.D. President and Chief Operating Officer				2006				$	1,112,000				$	3,510,000				$	3,967,976				$	1,490,080				$	156,247				$	68,790				$	11,305,093
	Steven M. Paul, M.D. Executive Vice President, Science and Technology				2006				$	916,167				$	1,864,460				$	1,240,000				$	1,043,514				$	607,463				$	55,789				$	5,727,393
	Robert A. Armitage Senior Vice President and General Counsel				2006				$	701,657				$	1,394,053				$	1,339,911				$	705,165				$	231,862				$	42,691				$	4,415,339
	Derica W. Rice Senior Vice President and Chief Financial Officer				2006				$	615,000				$	675,000				$	590,928				$	580,466				$	168,627				$	37,722				$	2,667,743
	Retired
	Charles E. Golden Retired Executive Vice President and Chief Financial Officer				2006				$	285,900				$	550,000				$	619,167	(6)			$	325,640				$	134,878				$	473,441				$	2,389,026

(1)		No bonus was paid to a named executive officer except as part of a non-equity incentive plan.
(2)		A discussion of the assumptions used in calculating these values may be found in Note 7 to our 2006 audited financial statements on pages        of our annual report.
(3)		Payment for 2006 performance made in March 2007 under the Lilly Bonus Plan.
(4)		The amounts in this column are the change in pension value for each individual. No named executive officer received preferential or above-market earnings on deferred compensation.
(5)		The table below shows the components of this column, which include the company match for each individual’s 401(k) plan contributions, tax gross-ups, perquisites, and the cost of Mr. Golden’s retiree medical and dental coverage. We calculate the incremental cost to the company of any personal use of the corporate aircraft based on the cost of fuel, trip-related maintenance, crew travel expenses, on-board catering, landing fees, trip-related hangar and parking costs, and smaller variable costs, offset by any time share lease payments by the executive. Since the company-owned aircraft are used primarily for business travel, we do not include the fixed costs that do not change based on usage, such as pilots’ salaries, the purchase costs of the company-owned aircraft, and the cost of maintenance not related to trips.

																								Total “All
																			Retiree Medical					Other
	Name			401(k) Match					Tax Gross-ups					Perquisites					Expense					Compensation”
	Mr. S. Taurel			$	99,020				$	1,382	(a)			$	92,007	(d)				0				$	192,409
	Dr. J. Lechleiter			$	66,720				$	2,070	(b)				0					0				$	68,790
	Dr. S. Paul			$	54,970				$	819	(b)				0					0				$	55,789
	Mr. R. Armitage			$	42,099				$	592	(b)				0					0				$	42,691
	Mr. D. Rice			$	36,900				$	822	(b)				0					0				$	37,722
	Mr. C. Golden			$	17,154				$	359,863	(c)				0				$	96,424				$	473,441

	(a)		Tax reimbursements on income imputed to Mr. Taurel for his use of the corporate aircraft to attend outside board meetings and for travel by his wife on the corporate aircraft to attend certain company functions involving spouse participation.
	(b)		Tax reimbursements for travel by the executives’ spouses on the corporate aircraft to attend certain company functions involving spouse participation.
	(c)		Tax reimbursements on income imputed to Mr. Golden for FICA tax payments made by the company on his benefits accrued under the company’s non-qualified pension plan. All participants in the non-qualified pension plan are eligible for this one-time reimbursement upon retirement.
	(d)		Includes $91,069, representing the incremental cost to the company of use of the corporate aircraft to attend outside board meetings. The amount in this column also includes Mrs. Taurel’s expenses to attend board functions that included spouse participation. In addition, Mr. Taurel’s family members have occasionally accompanied him on business trips, at no incremental cost to the company.

(6)

This amount reflects expense to the company for options granted to Mr. Golden in 2004 and 2005. There was no expense for Mr. Golden’s 2006 stock option award, which was forfeited on his retirement according to its terms.

We have no employment agreements with our named executive officers.

     The compensation plans under which the grants in the following table were made are generally described in the Compensation Discussion and Analysis, beginning on page 23, and include the Eli Lilly and Company Bonus Plan, a non-equity incentive plan, and the 2002 Lilly Stock Plan, which provides for performance awards, stock options, restricted stock grants, and restricted stock units.

Grants of Plan-Based Awards During 2006

																																												All Other
																																												Option
																																												Awards:
																																												Number of					Exercise or
									Compensa-					Estimated Future Payouts Under Non-															Estimated Possible Payouts Under Equity															Securities					Base Price of					Grant Date Fair
									tion					Equity Incentive Plan Awards (1)															Incentive Plan Awards (2)															Underlying					Option					Value of Equity
									Committee					Threshold					Target					Maximum					Threshold					Target					Maximum					Options (3)					Awards					Awards
	Name			Grant Date					Action Date					($)					($)					($)					(# shares)					(# shares)					(# shares)					(#)					($/share)					($)
	Current
	Sidney Taurel				—					—					0				$	2,062,917				$	4,125,834
					2/10/06					12/19/05																				0					64,080					128,160														$	3,600,000
					2/10/06					12/19/05																																			216,867				$	56.18				$	3,600,000
	John C. Lechleiter,				—					—					0				$	1,112,000				$	2,224,000
	Ph.D.				2/10/06					12/19/05																				0					41,652					83,304														$	2,340,000
					2/10/06					12/19/05																																			140,964				$	56.18				$	2,340,000
	Steven M. Paul, M.D.				—					—					0				$	778,742				$	1,557,484
					2/10/06					12/19/05																				0					21,360					42,720														$	1,200,000
					2/10/06					12/19/05																																			72,289				$	56.18				$	1,200,000
	Robert A. Armitage				—					—					0				$	526,243				$	1,052,486
					2/10/06					12/19/05																				0					16,020					32,040														$	900,000
					2/10/06					12/19/05																																			54,217				$	56.18				$	900,000
	Derica W. Rice				—					—					0				$	433,183				$	966,366
					2/10/06					(4	)																																											$	450,000
					2/10/06					(4	)																			0					8,010					16,020					27,108				$	56.18				$	450,000
					5/1/06	(5)				1/20/06																																			30,000				$	52.54				$	471,900
	Retired
	Charles E. Golden				—					—					0				$	729,045	(6)			$	1,458,090	(6)
					2/10/06					12/19/05																				0					19,580	(7)				39,160	(7)													$	1,100,000	(9)
					2/10/06					12/19/05																																			66,265	(8)			$	56.18				$	1,100,000