Notice of 2009 Annual Meeting and Proxy Statement

March 9, 2009

Dear Shareholder:

You are cordially invited to attend our annual meeting of shareholders on Monday, April 20, 2009, 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 5.

     I look forward to seeing you at the meeting.

John C. Lechleiter, Ph.D.
Chairman of the Board, President, and Chief Executive Officer

Important notice regarding the availability of proxy materials for the shareholder meeting to be held April 20, 2009: The annual report and proxy statement are available at ____________

Notice of Annual Meeting of Shareholders

April 20, 2009

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 20, 2009, 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 auditor for the year 2009
	•		to approve amendments to the articles of incorporation to provide for annual election of all directors
	•		to reapprove the material terms of performance goals for the Eli Lilly and Company Bonus Plan
	•		to consider and vote on a shareholder proposal requesting that the board eliminate all supermajority voting provisions from the company’s articles of incorporation and bylaws
	•		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 policy of asking shareholders to ratify the compensation of named executive officers at the annual meeting of shareholders.

     Shareholders of record at the close of business on February 13, 2009, 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 9, 2009.

By order of the board of directors,

James B. Lootens
Secretary

March 9, 2009
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 20, 2009, 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?
Seven items:

	•		election of directors
	•		ratification of the appointment of principal independent auditor
	•		amending the company’s articles of incorporation to provide for annual election of all directors
	•		reapproving performance goals for the company’s cash bonus plan
	•		a shareholder proposal on eliminating supermajority voting provisions from the company’s articles of incorporation and bylaws
	•		a shareholder proposal on allowing shareholders to amend the company’s bylaws
	•		a shareholder proposal on shareholder ratification of executive compensation.

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 13, 2009 (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.

	•		The four nominees for director will be elected if they receive a majority of the votes cast. Abstentions will not count as votes cast either for or against a nominee.
	•		The following items of business will be approved if the votes cast for the proposal exceed those cast against the proposal:

			—the appointment of principal independent auditor
			—the management proposal to reapprove performance goals for the company’s bonus plan
			—the shareholder proposals.

     Abstentions will not be counted either for or against these proposals.

•

The management proposal to amend the articles of incorporation to provide for annual election of directors requires the vote of 80 percent of the outstanding shares. For this item, abstentions and broker nonvotes 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, the ratification of auditors, and the management proposal on reapproving performance goals of the company’s bonus plan, 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 auditor, for the management proposals on amending the articles of incorporation and reapproving performance goals for the company’s bonus 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 19, 2009.

On the Internet. You may vote online at www.proxyvote.com. Follow the instructions on the enclosed proxy card or, if you received these materials electronically, follow 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 19, 2009.

     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 by mail. 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 mail, 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 66. If you have questions about admittance or parking, you may call 317-433-5112.

How do I contact the board of directors?
You may 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 2010 annual meeting?
The company’s 2010 annual meeting is scheduled for April 19, 2010. 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 9, 2009. 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 9, 2009. That notice must provide certain other information as described in the bylaws. Copies of the bylaws are available online at http://investor.lilly.com/governance.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://investor.lilly.com/services.cfm.

     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.

Can 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 2008 annual report and 2009 proxy statement, or if you wish to receive separate copies of future annual reports and proxy statements, please call 1-800-542-1061 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 2009
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 a term that will expire in 2012. See pages 53–54 of this proxy statement for more information.

Martin S. Feldstein, Ph.D.		Age 69		Director since 2002

George F. Baker Professor of Economics, Harvard University

Dr. Feldstein is president emeritus 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, an associate professor in 1968, and a professor in 1969. 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 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		Age 49		Director since 2005

Chairman, President, and Chief Executive Officer, Nalco Holding Company

Mr. Fyrwald joined Nalco Holding Company (a leading integrated water treatment and process improvement company) as chairman, president, and chief executive officer in February 2008. From 2003 to 2008, Mr. Fyrwald served as group vice president of the agriculture and nutrition division at E.I. du Pont de Nemours and Company. From 2000 until 2003, he was vice president and general manager of DuPont’s Nutrition and Health business. In 1999, Mr. Fyrwald was vice president for corporate strategic planning and business development. At DuPont, Mr. Fyrwald held a broad variety of assignments in a number of divisions covering many industries. He has worked in several locations throughout North America and Asia.

Ellen R. Marram		Age 62		Director since 2002

President, The Barnegat Group LLC

Ms. Marram is the 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 to 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, the largest 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 Institute for the Future, The New York-Presbyterian Hospital, Lincoln Center Theater, Families and Work Institute, and Citymeals-on-Wheels.

Douglas R. Oberhelman		Age 56		Director since 2008

Group President, Caterpillar Inc.

Mr. Oberhelman is a group president of Caterpillar Inc. He joined Caterpillar in 1975 and has held a variety of positions, including senior finance representative based in South America for Caterpillar Americas Co; region finance manager and district manager for the company’s North American Commercial Division; and managing director and vice general manager for strategic planning at Shin Caterpillar Mitsubishi, Caterpillar’s affiliated company in Tokyo, Japan. Mr. Oberhelman was elected a vice president in 1995, serving as Caterpillar’s chief financial officer with administrative responsibility for the corporation’s accounting, information services, tax, treasury, investor relations and marketing support services areas from 1995 to November 1998. In 1998, he became vice president with responsibility for the engine products division, including the market development, strategic planning, supplier management, electric power generation and worldwide marketing and administration for Caterpillar’s engine business. He was elected a group president and member of Caterpillar’s executive office in 2002. Mr. Oberhelman serves on the boards of Ameren Corporation, The Nature Conservancy — Illinois Chapter, the Association of Equipment Manufacturers, the National Association of Manufacturers, the Manufacturing Institute, Easter Seals, and the Wetlands America Trust. Mr. Oberhelman has been serving under interim election since December 2008.

Class of 2010
The following four directors will continue in office until 2010.

Sir Winfried Bischoff		Age 67		Director since 2000

Chairman, Citigroup Inc.

Sir Winfried Bischoff is chairman of Citigroup Inc. He served as chairman of Citigroup Europe from 2000 to 2007. 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 Prudential plc.

J. Michael Cook		Age 66		Director since 2005

Retired Chairman and Chief Executive Officer, Deloitte & Touche LLP

Mr. Cook served as chairman and chief executive officer of Deloitte & Touche LLP from 1989 until his retirement in 1999. He joined Deloitte, Haskins & Sells in 1964 and served as chairman and chief executive from 1986 through 1989. Mr. Cook is an emeritus 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 and is chairman of the Department of Defense Audit Advisory Committee. 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.		Age 63		Director since 1995

Edmond and Marion Guggenheim Professor of Biochemistry and Molecular Biology and Professor of Molecular Pharmacology and Experimental Therapeutics, Mayo Medical School; Director, Mayo Clinic Center for Individualized Medicine; and Director Emeritus, Mayo Clinic Cancer Center

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 Mayo Clinic 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		Age 59		Director since 1995

Retired Executive Vice President, Kimberly-Clark Corporation

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. Prior to joining Kimberly-Clark, Ms. Seifert held management positions at Procter & Gamble, Beatrice Foods, and Fort Howard Paper Company. She is chairman of Katapult, 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 2011
The following four directors will continue in office until 2011.

Michael L. Eskew		Age 59		Director since 2008

Former Chairman and Chief Executive Officer, United Parcel Service, Inc.

Mr. Eskew served as chairman and chief executive officer of United Parcel Service, Inc., from January 2002 until December 2007. He continues to serve on the UPS board of directors. Mr. Eskew began his UPS career in 1972 as an industrial engineering manager and held various positions of increasing responsibility, including time with UPS’s operations in Germany and with UPS Airlines. In 1993, Mr. Eskew was named corporate vice president for industrial engineering. Two years later he became group vice president for engineering. In 1998, he was elected to the UPS board of directors. In 1999, Mr. Eskew was named executive vice president and a year later was given the additional title of vice chairman. Mr. Eskew serves as chairman of the board of trustees of the Annie E. Casey Foundation. He also serves on the boards of 3M Corporation and IBM Corporation.

Alfred G. Gilman, M.D., Ph.D.		Age 67		Director since 1995

Executive Vice President for Academic Affairs and Provost, The University of Texas Southwestern Medical Center at Dallas; Dean, Southwestern Medical School; and Regental Professor of Pharmacology and Director of the Cecil and Ida Green Center for Molecular, Computational, and Systems Biology, The University of Texas Southwestern Medical Center

Dr. Gilman has served as executive vice president for academic affairs and provost of the University of Texas Southwestern Medical Center at Dallas 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 of 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.		Age 65		Director since 1987

Retired President, Private Client Services, and Managing Director, Marsh, Inc.

Ms. Horn served as president of Private Client Services and managing director of Marsh, Inc. 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; chairman and chief executive officer of Bank One, Cleveland, N.A.; president of the Federal Reserve Bank of Cleveland; treasurer of Bell Telephone Company 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 Norfolk Southern Corporation. Ms. Horn has been senior managing director of Brock Capital Group since 2004.

John C. Lechleiter, Ph.D.		Age 55		Director since 2005

Chairman of the Board, President, and Chief Executive Officer

Dr. Lechleiter became chairman of the board of Eli Lilly and Company on January 1, 2009. Dr. Lechleiter was named president and chief executive officer of the company in April 2008. He served as president and chief operating officer from 2005 to 2008. 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 of pharmaceutical products and corporate development in 2001. He was named executive vice president of pharmaceutical operations, in 2004. He is a member of the American Chemical Society. Dr. Lechleiter serves as a member of the executive committee of the board of directors of Pharmaceutical Research and Manufacturers of America (PhRMA) and as a member of the Business Roundtable and the Business Council. He also serves as a member of the Visiting Committee of Harvard Business School and a member of the board of trustees of Xavier University (Cincinnati, Ohio). In addition, he serves as a distinguished advisor to The Children’s Museum of Indianapolis and a member of the United Way of Central Indiana board of directors.

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/governance.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 21–22.

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 an 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 $120,000 per year in direct compensation from Lilly other than for service as a nonexecutive 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 the compensation committee of that company’s board.
	•		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 two 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 two 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 2009, 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 11 nonemployee 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 11 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 of transactions, relationships, or arrangements considered by the board (in addition to those listed above) in reaching its determination that the directors are independent. All of these relationships and transactions were entered into at arm’s length in the normal course of business and, to the extent they are commercial relationships, have standard commercial terms. None of these relationships or transactions exceeded the thresholds described above or otherwise compromise the independence of the named director.

Name		Independent		Transactions/Relationships/Arrangements
Sir Winfried Bischoff		Yes
Mr. Cook		Yes
Mr. Eskew		Yes
Dr. Feldstein		Yes
Mr. Fyrwald		Yes
Dr. Gilman		Yes
Ms. Horn		Yes
Ms. Marram		Yes
Mr. Oberhelman		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 fails to receive a majority of the votes cast shall 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 director’s 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 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 fails to receive a majority of the votes cast at the same election, then the independent directors who did receive a majority of the votes cast 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. Directors are required to hold Lilly stock valued at a minimum of five times their annual cash retainer; new directors are allowed five years to reach this ownership level.

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 circumstances, and particularly during relatively short periods of leadership transition, these roles may be assigned to two different persons. The presiding director recommends to the board an appropriate process by which a new chairman and chief executive officer will be selected.

     A key responsibility of the CEO and the board is ensuring that an effective process is in place to provide continuity of leadership over the long term at all levels in the company. Each year, succession planning reviews are held at every significant organizational level of the company, culminating in a full review of senior leadership talent by the independent directors. During this review, the CEO and the independent directors discuss future candidates for senior leadership positions, succession timing for those positions, and development plans for the highest-potential candidates. This process ensures continuity of leadership over the long term, and it forms the

basis on which the company makes ongoing leadership assignments. It is a key success factor in managing the long planning and investment lead times of our business.

     In addition, the CEO maintains in place at all times and reviews with the independent directors a confidential plan for the timely and efficient transfer of his or her responsibilities in the event of an emergency or his or her sudden incapacitation or departure.

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 the 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 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://www.lilly.com/about/compliance/conduct/ 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;
	•		approves meeting agendas and schedules and generally approves information sent to the board;
	•		has the authority to call meetings of the independent directors; and
	•		has the authority to retain independent counsel or other advisors to the board.

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 written policy and written procedures for review, approval, and monitoring of transactions involving the company and “related persons” (directors and executive officers, 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 (v) 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 transaction annually to determine whether it continues to be in the company’s best interests.

     The only related-person transaction is a time-share arrangement (now ended) between the company and Mr. Taurel as described
on page 52. The compensation committee approved and monitored 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/governance.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 23.

Directors and Corporate Governance Committee
The duties of the directors and corporate governance committee are described on pages 21–22.

Compensation Committee
The duties of the compensation committee are described on pages 25–26, and the compensation committee report is shown on pages 38–39.

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
	•		reviews scientific aspects of business development projects.

Membership and Meetings of the Board and Its Committees

In 2008, each director attended more than 85 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 meeting of shareholders, and all but one attended in 2008. Current committee membership and the number of meetings of the board and each committee in 2008 are shown in the table below.

Directors and

Public

Corporate

Policy and

Science and

Name

Board

Audit

Compensation

Governance

Finance

Compliance

Technology

Sir Winfried Bischoff

Member

Member

Chair

Mr. Cook

Member

Chair

Member

Mr. Eskew

Member

Member

Member

Dr. Feldstein

Member

Member

Member

Chair

Mr. Fisher 1

Mr. Fyrwald

Member

Member

Member

Dr. Gilman

Member

Member

Chair

Ms. Horn

Presiding Director

Chair

Member

Dr. Lechleiter

Chair

Ms. Marram

Member

Member

Chair

Mr. Oberhelman 2

Member

Member

Member

Dr. Prendergast

Member

Member

Member

Ms. Seifert

Member

Member

Member

Mr. Taurel 3

Number of 2008 Meetings

9

9

9

6

5

5

5

Directors’ Compensation

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

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 share 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 one or both 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 below (4,513 shares in 2008) is credited to this account on a pre-set annual date. 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 2009 is 5.2 percent. The aggregate amount of interest that accrued in 2008 for the participating directors was $148,138, at a rate of 5.5 percent.

     Both accounts may be paid in a lump sum or in annual installments for up to 10 years, beginning the second January following the director’s departure from the board. Amounts in the deferred share account are paid in shares of Lilly stock.

In 2008, we provided the following compensation to directors who are not employees:

										All Other
		Fees Earned				Stock Awards				Compensation				Total
Name		or Paid in Cash ($)1				($)2				($)3				($)4
Current
Sir Winfried Bischoff		$	106,000			$	145,000			$	16,844			$	267,844
Mr. Cook		$	121,000			$	145,000			$	29,320			$	295,320
Mr. Eskew		$	80,667			$	145,000			$	8,399			$	234,065
Dr. Feldstein		$	108,000			$	145,000			$	48,699			$	301,699
Mr. Fyrwald		$	102,000			$	145,000			$	13,295			$	260,295
Dr. Gilman		$	100,000			$	145,000			$	50,191			$	295,191
Ms. Horn		$	133,000			$	145,000			$	33,915			$	311,915
Ms. Marram		$	106,000			$	145,000			$	48,173			$	299,173
Mr. Oberhelman		$	7,667			$	0			$	16,590			$	24,257
Dr. Prendergast		$	93,000			$	145,000			$	20,478			$	258,478
Ms. Seifert		$	94,000			$	145,000			$	34,676			$	273,676
Retired
Mr. Fisher		$	29,667			$	0			$	1,549			$	31,216

Name		2008 Cash Deferred				Shares
Current
Mr. Fyrwald		$	102,000				2,354
Retired
Mr. Fisher		$	14,833				284

Directors’ Outstanding Stock Options

														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
Mr. Eskew			—				—				—				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. 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
Mr. Oberhelman			—				—				—				0
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

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/governance.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
	•		health care environment and policy.

     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 and screening 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 or the search firm, 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). Mr. Oberhelman, who is standing for election, was referred to the committee by an independent executive search firm.

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 2010 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 9, 2009. 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/governance.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 auditor. 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 auditor, including a review of the significant management judgments underlying the financial statements and disclosures.

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

     We have discussed with the independent auditor matters required to be discussed by Statement on Auditing Standards No. 61 (Communication with Audit Committees), as amended and as adopted by the Public Company Accounting Oversight Board (PCAOB) in Rule 3200T, 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 auditor required by applicable requirements of the PCAOB regarding communications with the audit committee concerning independence, and have discussed with the independent auditor the auditor’s independence from the company and its management. In concluding that the auditor is independent, we determined, among other things, that the nonaudit services provided by Ernst & Young LLP (as described below) were compatible with its independence. Consistent with the requirements of the Sarbanes-Oxley Act of 2002, we have adopted policies to avoid compromising the independence of the independent auditor, 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 and the chief accounting officer) 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, 2008, for filing with the Securities and Exchange Commission. We have also appointed the company’s independent auditor, subject to shareholder ratification, for 2009.

Audit Committee
J. Michael Cook, Chair
Michael L. Eskew
Martin S. Feldstein, Ph.D.
Douglas R. Oberhelman
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 services.
	•		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 2008 and 2007. All such services were preapproved by the committee in accordance with the preapproval policy.

		2008				2007
		(millions)				(millions)
Audit Fees		$	___			$	7.0
•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
Audit-Related Fees		$	___			$	0.4
•Assurance and related services reasonably related to the performance of the audit or reviews of the financial statements
-2007: primarily related to employee benefit plan and other ancillary audits, and due diligence services on a possible acquisition
-2008: primarily related to
Tax Fees		$	___			$	1.4
•2007: primarily related to compliance services outside the U.S.
•2008: primarily related to
All Other Fees		$	___			$	0.1
•2007: primarily related to compliance services outside the U.S.
•2008: primarily related to
Total		$	___			$	8.9

Compensation Committee Matters

Scope of Authority
The compensation committee oversees the company’s global compensation philosophy and establishes the compensation of executive officers. The committee also acts as the oversight committee with respect to the company’s deferred compensation plans, management stock plans, and bonus plans covering executives. In overseeing those plans, the committee may delegate authority to company officers for day-to-day plan administration and interpretation, including selecting participants, determining award levels within plan parameters, and approving award documents. However, the committee may not delegate any authority for matters affecting 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 and Analyses” on pages 27–28. Additional processes and procedures include:

	•		Meetings. The committee meets several times each year (nine times in 2008). Committee agendas are established in consultation with the committee chair and the committee’s independent compensation consultant. The committee meets in executive session after each 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. Mr. Cook reports directly to the committee, and neither he nor his firm is permitted to perform any services for management. The consultant’s duties include the following:

	—		Review committee agendas and supporting materials in advance of each meeting and raise questions with the company’s global compensation group and the committee chair as appropriate
	—		Review the company’s total compensation philosophy, peer group, and target competitive positioning for reasonableness and appropriateness
	—		Review the company’s total executive compensation program and advise the committee of plans or practices that might be changed to better reflect evolving best practices
	—		Provide independent analyses and recommendations to the committee on the CEO’s pay
	—		Review draft Compensation Discussion and Analysis report and related tables for proxy statement
	—		Proactively advise committee on best practices ideas for board governance of executive compensation
	—		Undertake special projects at the request of the committee chair.

			The consultant interacts directly with members of Lilly management only on matters under the committee’s oversight and with the knowledge and permission of the committee chairperson.
	•		Role of Executive Officers and Management. With the oversight of the CEO 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 below). 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 attend committee meetings but are not present for the executive sessions or for any discussion of their own compensation. (Only nonemployee directors and the committee’s consultant attend executive sessions.)

     The CEO does not participate in the formulation or discussion of his pay recommendations and has no prior knowledge of the recommendations that the consultant makes to the 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 2008 (see page 16 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
2008 Summary

Executive compensation for 2008 aligned well with the objectives of our compensation philosophy and with our performance, driven by these factors:

Mr. Taurel retired as CEO effective March 31, 2008, but remained as chairman of the board and a director through December 31, 2008. His salary and cash bonus were reduced by half for the period of April through December 2008. Dr. Lechleiter was elected CEO effective April 1, 2008, and received increases to his salary and target cash bonus at that time to reflect his increased responsibilities.

Executive Compensation Philosophy

Our success depends on our ability to discover, develop, and market a stream of innovative medicines that address important medical needs. In addition, we must continually improve productivity in all that we do. To achieve these goals, we need to attract, engage, and retain highly talented individuals who are committed to the company’s core values of excellence, integrity, and respect for people. Our compensation and benefit programs are based on these objectives:

•

Compensation should reflect individual and company performance. We link all employees’ pay to individual and company performance.

	•		Compensation should foster a long-term focus. A long-term focus is critical to success in our industry. As employees progress to higher levels of the organization, a greater portion of compensation is tied to our longer-term performance.
	•		Compensation should be based on the level of job responsibility. We seek internal pay relativity, meaning that pay differences among jobs should be commensurate with differences in the levels of responsibility and impact of the jobs.
	•		Compensation should reflect the marketplace for talent. We aim to remain competitive with the pay of other premier employers with which we compete for talent.
	•		Compensation and benefit programs should attract employees who are interested in a career at Lilly. Our employee benefit programs provide a competitive advantage by helping us attract and retain highly talented employees who are looking for the opportunity to build careers.
	•		Compensation should be efficient. To deliver superior long-term shareholder returns, we must deliver value to employees in a cost-effective manner.
	•		Compensation and benefit programs should be egalitarian. While compensation 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.

The Committee’s Processes and Analyses

The compensation committee uses several tools to help it structure compensation programs that meet company objectives. Among those are:

•

Assessment of individual performance. Individual performance has a strong impact on compensation. The independent directors, under the direction of the presiding director, meet with the CEO in executive session at the beginning of the year to agree upon the CEO’s performance objectives for the year. At the end of the year, the independent directors again meet in executive session to review the performance 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 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 executive’s performance evaluation is based on the executive’s achievement of objectives established between the executive and his or her supervisor, the executive’s contribution to the company’s performance, and other leadership attributes and accomplishments.

•

Peer group analysis. The committee compares the company’s programs with a peer group of global pharmaceutical companies: Abbott Laboratories; Amgen Inc.; Bristol-Myers Squibb Company; GlaxoSmithKline plc; Johnson & Johnson; Merck & Co.; Pfizer, Inc.; Schering-Plough Corporation; and Wyeth. Pharmaceutical companies’ needs for scientific and sales and marketing talent are unique to the industry and as such, Lilly must compete with these companies for talent. The committee uses the peer group data in two ways:

	—		Overall competitiveness. The committee uses aggregated data as a reference point to ensure that the executive compensation program as a whole is competitive, meaning within the broad middle range of comparative pay of the peer group companies when the company achieves the targeted performance levels. The committee does not target a specific position within the range.
	—		Individual competitiveness. The committee compares the overall pay of individual executives, if the jobs are sufficiently similar, to make the comparison meaningful. The individual’s pay is driven primarily by individual and company performance and internal relativity rather than the peer group data; the peer group data is used as a “market check” to ensure that individual pay remains within the broad middle range of peer group pay. The committee does not target a specific position within the range.

			The peer group is reviewed for appropriateness at least every three years. The group was reviewed in June 2008, and the new group will be used to assess company performance for purposes of 2009 compensation decisions.
	•		CEO compensation. To provide further assurance of independence, the compensation recommendation for the CEO is developed by an independent consultant (Frederic W. Cook and his firm, Frederic W. Cook & Co.) without the input or knowledge of the CEO and with limited support from company staff. The Cook firm prepares analyses showing median CEO compensation among the peer group in terms of base salary, target annual incentive award, most recent equity grant value, and resulting total direct compensation. Mr. Cook develops a range of recommendations for any change in the CEO’s base salary, annual incentive target, equity grant value, and mix. Mr. Cook’s recommendations for target CEO pay take into account the peer competitive pay analysis and, importantly, the position of the CEO in relation to other senior company executives and proposed pay actions for all key employees of the company. The range allows for the committee to exercise its discretion based on the CEO’s individual performance. The CEO has no prior knowledge of the recommendations and takes no part in the recommendations, committee discussions, or decisions.

Executive Compensation for 2008

Overview—Establishment of Overall Pay

In making its pay decisions for 2008, the committee reviewed 2007 company performance data and peer group data as discussed above, and also considered expected competitive trends in executive pay. That review showed:

	•		Company performance. In 2007, Lilly performed in the upper tier of the peer group in adjusted earnings per share growth, sales growth, return on assets, and return on equity and in the lower tier in five-year total shareholder return.
	•		Pay relative to peer group. Lilly’s total pay to executive officers for 2007 was in the broad middle range.

The committee determined the following:

•

Program elements. The 2008 program consisted of base salary, a cash incentive bonus award, and two forms of performance-based equity grants: performance awards and shareholder value awards (SVAs). Executives also received the company employee

			benefit package. This program balances the mix of cash and equity compensation, the mix of current and longer-term compensation, the mix of financial and market goals, and the security of foundational benefits in a way that furthers the compensation objectives discussed above.
	•		Pay ranges and mix of pay elements. The company generally maintained the same pay ranges and mix of pay elements as in 2007. The committee believes this overall program continues to provide a cost effective delivery of total compensation that:

	—		encourages retention and employee engagement by delivering competitive cash and equity components
	—		maintains a strong link to company performance and shareholder returns through a balanced equity incentive program without encouraging excessive risk-taking
	—		maintains appropriate internal pay relativity
	—		provides opportunity for total pay within the broad middle range of expected peer group pay given company performance comparable to that of our peers.

Base Salary

In setting base salaries for 2008, the committee considered the following:

•

Individual performance. As described above under “The Committee’s Processes and Analyses,” base salary increases were driven largely by individual performance assessments.

—

The independent directors assessed Mr. Taurel’s 2007 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 2007, the company:

	§		exceeded its sales and earnings targets;
	§		made significant progress on the transformation agenda, including progressing the tailored therapy strategy;
	§		exceeded its Six Sigma and related productivity goals;
	§		strengthened its public image; and
	§		met or exceeded its targets for research pipeline progress and acquisition of new compounds.

—

Mr. Taurel’s decision to retire as CEO as of April 1, 2008, and as chairman as of December 31, 2008, resulted in the committee’s decision to maintain his annual salary at the 2007 level through March 31, 2008, and then reduce it by one-half for the remainder of 2008.

The committee reviewed similar performance considerations for each of the other named executives.

—

With regard to Dr. Lechleiter, the committee considered his new position as chief executive officer and increased Dr. Lechleiter’s annual salary by 21 percent effective April 1, 2008, to $1,400,000. The committee considered Dr. Lechleiter’s strong leadership in 2007 in driving the company’s operational results and transformational agenda.

	—		With regard to Dr. Paul, the committee noted that Lilly Research Laboratories met or exceeded nearly all 2007 pipeline progress goals and implemented several strategic actions to increase flexibility and productivity. The committee increased Dr. Paul’s annual salary by four percent.
	—		Mr. Carmine’s annual salary was increased by 79 percent upon his promotion, effective April 1, 2008, to recognize his significantly expanded responsibilities.
	—		Mr. Rice’s annual salary was increased 13 percent in recognition of his assumption of increased operational responsibilities, his strong leadership of the financial component, and outstanding contributions to the management of the company.
	—		In establishing Mr. Armitage’s annual salary (a five percent increase), the committee noted his leadership in driving a culture of compliance and transparency, shaping intellectual property laws to foster innovation, and implementing effective litigation strategies.

	•		Internal relativity, meaning the relative pay differences between different job levels.
	•		Peer group data specific to certain positions in which the jobs were viewed as comparable in content and importance to the company. We used the peer group data not to target a specific position in range, but instead as a market check for reasonableness and competitiveness. The salaries as determined by the other factors were within the broad middle range of expected competitive pay and, therefore, no further adjustments were necessary for competitiveness.

Cash Incentive Bonuses

The company’s annual cash bonus programs 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 most nonmanagement employees in the U.S., are determined under the Eli Lilly and Company Bonus Plan. Under the plan, the company sets target bonus amounts (a percentage of base salary) for all participants at the beginning of each year. Bonus payouts range from zero to 200 percent of target depending on the company’s financial results relative to predetermined performance measures. At the end of the performance period, the committee has discretion to adjust an award payout downward for executive officers, but not upward, from the amount yielded by the formula.

     The committee considered the following when establishing the 2008 awards:

•

Bonus targets. Bonus targets (expressed as a percentage of base salary) were based on job responsibilities, internal relativity, and peer group data. Consistent with our compensation objectives, as executives assume greater responsibilities, more of their pay is linked to company performance. For most executive officers, the committee maintained the same bonus targets as 2007; for some, targets were increased due to peer group trends or internal relativity. The committee determined that these targets appropriately reflected internal relativity and would maintain cash compensation within the broad middle range of expected competitive pay given median peer group performance. The 2008 targets for the named executives were as follows:

	—		Mr. Taurel – 140 percent (increased from 125 percent to approximate the peer group median)
	—		Dr. Lechleiter – 100 percent (through March 31, 2008; 140 percent upon becoming CEO April 1, 2008)
	—		Dr. Paul – 85 percent
	—		Mr. Carmine – 85 percent
	—		Mr. Rice – 80 percent (increased from 75 percent due to internal relativity)
	—		Mr. Armitage – 80 percent (increased from 75 percent due to internal relativity).

•

Company performance measures. The committee established 2008 company performance measures with a 25 percent weighting on sales growth and a 75 percent weighting on growth in adjusted EPS (reported earnings per share adjusted as described below under “Adjustments for Certain Items”). This mix of performance

measures focuses employees appropriately on improving both top-line sales and bottom-line earnings, with special emphasis on earnings in order to tie rewards directly to productivity improvements. The measures are also effective motivators because they are easy for employees to track and understand.

(0.25 x sales multiple) + (0.75 x adjusted EPS multiple) = bonus multiple

Bonus multiple X bonus target X base salary earnings = payout

     2008 sales and adjusted EPS multiples are illustrated by these charts:

     2008 pro forma sales growth of 8.7 percent resulted in a sales multiple of 1.475.

     2008 pro forma adjusted EPS growth of 13.6 percent resulted in an adjusted EPS multiple of 1.556.

     Together, the sales multiple and the adjusted EPS multiple yielded a total bonus multiple of 1.54.

(0.25 x 1.475) + (0.75 x 1.556) = 1.54 bonus multiple

     See page 35 for a reconciliation of 2008 reported and pro forma sales and reported and pro forma adjusted EPS.

Equity Incentives—Total Equity Program

In 2008, we employed two forms of equity incentives granted under the 2002 Lilly Stock Plan: performance awards and shareholder value awards. These incentives ensure that our leaders are properly focused on long-term shareholder value.

						Shareholder
Name		Performance Awards				Value Awards
Mr. Taurel		$	4,000,000			$	4,000,000
Dr. Lechleiter		$	3,250,000			$	3,250,000
Dr. Paul		$	1,500,000			$	1,500,000
Mr. Carmine		$	1,500,000			$	1,500,000
Mr. Rice		$	1,200,000			$	1,200,000
Mr. Armitage		$	855,000			$	855,000

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 are structured as a schedule of shares of Lilly stock based on the company’s achievement of specific adjusted earnings per share (adjusted EPS) levels over specified time periods of one or more years. In 2009, the company will grant both a one-year and a two-year award, as a transition to a two-year performance period for all performance awards granted beginning in 2010. Possible payouts range from zero to 200 percent of the target amount, depending on adjusted EPS growth over the period. 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 the 2008 grants, the committee considered the following:

Adjusted 2008 EPS Growth		Less than 3.00%				3.00-4.99%				5.00-6.99%				7.00-8.99%				9.00-10.99%				11.00-12.99%				13.00-15.99%				16.00% +
Percent of Target			0				50	%			75	%			100	%			125	%			150	%			175	%			200	%

     Pro forma adjusted EPS growth of 13.6 percent ($4.02 per share) resulted in a 2008 performance award payout at 175 percent of target. See page 35 for a reconciliation of 2008 reported and pro forma adjusted EPS.

Equity Incentives—Shareholder Value Awards

Beginning in 2007, the company implemented a new equity program, the shareholder value award (SVA), which replaced our stock option program. The SVA pays out shares of Lilly stock based on the performance of the company’s stock over a three-year period. No dividends are paid on the awards during the performance period. Payouts range from zero to 140 percent of the target amount, depending on stock price performance over the period. The SVA program delivers equity compensation that is strongly linked to long-term shareholder returns. It is more cost-effective than the stock option program it replaced because the SVA program delivers, at a lower cost to the company, an equity incentive that is equally or more effective in aligning employee interests with long-term shareholder returns. For the 2008 grants, the committee considered the following:

     The starting price for the 2008 SVAs was $52.71 per share, representing the average of the closing prices of Lilly stock for all trading days in November and December 2007. The ending price to determine payouts will be the average of the closing prices of Lilly stock for all trading days in November and December 2010.

     Payouts of the 2008 grant will be determined by this grid when they are paid out in early 2011:

Ending Stock Price		Less than $46.79				$46.79-$52.39				$52.40-$57.99				$58.00-$61.99				$62.00-$65.99				$66.00-$69.99				$69.99 +
Percent of Target			0				40	%			60	%			80	%			100	%			120	%			140	%

Adjustments for Certain Items

Consistent with past practice, the committee adjusted the results on which 2008 bonuses and performance awards were determined to eliminate the distorting effect of certain unusual income or expense items on year-over-year growth percentages. The adjustments are intended to:

•

align award payments with the underlying growth of the core business

	•		avoid volatile, artificial inflation or deflation of awards due to the unusual items in either the award year or the previous (comparator) year
	•		eliminate certain counterproductive short-term incentives—for example, incentives to refrain from acquiring new technologies or to defer disposing of underutilized assets or settling legacy legal proceedings in order to protect current bonus payments.

To assure the integrity of the adjustments, the committee establishes adjustment guidelines at the beginning of the year. These guidelines are consistent with the company guidelines for reporting adjusted earnings to the investment community, which are reviewed by the audit committee of the board. The adjustments apply equally to income and expense items and must exceed a materiality threshold. The committee reviews all adjustments and retains “downward discretion”—i.e., discretion to reduce compensation below the amounts that are yielded by the adjustment guidelines.

     For the 2008 awards calculation, the committee made these adjustments to EPS:

	•		Both 2007 and 2008: Eliminated the impact of (i) one-time accounting charges for the acquisition of in-process research and development and (ii) significant asset impairments and restructuring charges
	•		2007: Eliminated the impact of special charges related to product liability litigation
	•		2008: Eliminated the impact of (i) a one-time benefit to income resulting from settlement of a tax audit and (ii) special charges related to the resolution of government investigations of prior sales and marketing practices of the company.

In addition, to eliminate the distorting effect of the acquisition of ICOS Corporation (completed in late January 2007) on year-over-year growth rates, the committee adjusted sales and EPS for 2007 on a pro forma basis as if the acquisition had been completed at the beginning of 2007. The committee also eliminated the impact on 2008 sales and EPS of the acquisition of ImClone Systems Incorporated (completed in late November 2008).

     The adjustments were intended to align award payments more closely to underlying business growth trends and eliminate volatile swings (up or down) caused by the unusual items. This is demonstrated by the 2006, 2007, and 2008 adjustments:

     Reconciliations of the adjustments to our reported sales and earnings per share are below. The bold numbers were used for calculating growth percentages for the compensation programs.

											% Growth										% Growth
		2008				2007					2008 vs. 2007					2006					2007 vs. 2006
Sales as reported ($ millions)		$	20,378.0			$	18,633.5					9.4	%			$	15,691.0					18.8	%
pro forma ICOS adjustment			—			$	72.7									$	755.2
pro forma ImClone adjustment		$	35.6				—										—
Sales—pro forma adjusted		$	20,342.4			$	18,706.2					8.7	%			$	16,446.2					13.7	%
EPS as reported		$	(1.89	)		$	2.71				NM					$	2.45					10.6	%
Eliminate net impact associated with ImClone acquisition		$	4.46				—										—
Eliminate charges related to Zyprexa investigations		$	1.20				—										—
Eliminate IPR&D charges for acquisitions and in-licensing transactions		$	0.10			$	0.63										—
Eliminate asset impairments, restructuring and other special charges (including product liability charges)		$	0.34			$	0.21									$	0.73
Eliminate benefit from resolution of IRS audit		$	(0.19	)			—										—
EPS—adjusted		$	4.02			$	3.55									$	3.18
pro forma ICOS adjustment			—			$	(0.01	)								$	(0.15	)
EPS—pro forma adjusted		$	4.02			$	3.54					13.6	%			$	3.03					16.8	%

The bonus paid to all management was based on 13.6 percent growth between the adjusted EPS of $3.54 for 2007 and $4.02 for 2008.

Equity Incentive Grant Mechanics and Timing

The committee approves target grant values for equity incentives prior to the grant date. On the grant date, those values are converted to shares based on:

	•		the closing price of Lilly stock on the grant date
	•		the same valuation methodology the company uses to determine the accounting expense of the grants under Statement of Financial Accounting Standards (SFAS) 123R.

     The committee’s procedure for timing of equity grants assures that grant timing is not being manipulated for employee gain. The annual equity grant date for all eligible employees is in mid-February. This date is established by the committee well in advance—typically at the committee’s October meeting. The mid-February grant date timing is driven by these considerations:

	•		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.
	•		It follows the annual earnings release by approximately two weeks, 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.

     Grants to new hires and other off-cycle grants are effective on the first trading day of the following month.

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
	•		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 include medical and dental coverage, disability insurance, and life insurance.

     In addition, the Lilly 401(k) Plan and the Lilly Retirement Plan provide a reasonable level of retirement income reflecting employees’ careers with the company. U.S. employees are eligible to 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 nonqualified

retirement plan and a nonqualified savings plan. These plans provide only the difference between the calculated benefits and the IRS limits, and the formula is the same for all U.S. employees.

     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 to executive officers, except that the company aircraft is made available for the personal use of Dr. Lechleiter, where the committee believes the security and efficiency benefits to the company clearly outweigh the expense. The company aircraft was similarly made available to Mr. Taurel prior to his retirement and is also made available to other executive officers for the more limited purpose of travel to outside board meetings. 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.

     Mr. Taurel’s primary use of the corporate aircraft for personal flights in 2008 was to attend outside board meetings for the two public companies at which he serves as an independent director. The committee believes that Mr. Taurel’s service on these boards, and his ability to conduct Lilly business while traveling to board meetings, provided clear benefits to the company. Mr. Taurel entered into a time-share arrangement (now ended) for the corporate aircraft under which he paid the company a lease fee for personal use, other than for attending outside board meetings. This amount offset part of the company’s incremental cost of providing the aircraft. Dr. Lechleiter had minimal use of the corporate aircraft for personal flights during 2008. Mr. Rice’s personal use of the aircraft was limited to travel to outside board meetings.

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 2008 table on page 48.

Severance Benefits

Except in the case of a change in control of the company, the company is not obligated to pay severance 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. Because this program is guided by different objectives than the regular compensation program, decisions made under this program do not affect the regular compensation program.

     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 generally 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. A partial exception is made for performance awards, a portion of which would be paid out upon a change in control, based on time worked up 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. Likewise, if Lilly is not the surviving entity, a portion of the shareholder value awards is paid out, based on time worked up to the change in control and the merger price for Lilly stock.
	•		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 48–51 for a more detailed discussion, including a discussion of what constitutes a change in control.
	•		Two-year protections. Employees who suffer a covered termination receive up to two years of pay and benefit protection. The purpose of these provisions is to assure employees a reasonable period of protection of their income and core employee benefits upon which they depend for financial security.

	•		Accelerated vesting of equity awards. Any unvested equity awards at the time of termination of employment would become vested.
	•		Excise tax. In some circumstances, the payments or other benefits received by the employee in connection with a change in control may exceed certain limits established under Section 280G of the Internal Revenue Code. The employee would then be subject to an excise tax on top of normal federal income tax. Because of the way the excise tax is calculated, it can impose a large burden on some employees while similarly compensated employees will not be subject to the tax. The costs of this excise tax—but not the regular income tax—would be borne by the company. To avoid triggering the excise tax, payments that would otherwise be due under the program that are up to three percent over the IRS limit will be cut back to the IRS limit. Effective in 2010, this cutback threshold will be raised to five percent above the IRS limit.

Share Ownership and Retention Guidelines; Hedging Prohibition

Share ownership and retention guidelines help to foster a focus on long-term growth. The committee has adopted a guideline requiring the CEO to own Lilly stock valued at least five times his or her annual base salary, and other executive officers to own at least three times their annual base salary. A phase-in of up to five years is provided for newly hired or promoted executive officers. Individual shareholding requirements were set at the beginning of 2008, and will be reset for each individual periodically or when their job changes significantly. Lilly executives have a long history of maintaining extensive holdings in Lilly stock, and all executive officers already meet or exceed the guideline, or in the case of new executive officers, are on track to meet or exceed the guideline within the phase-in period. As of his retirement, Mr. Taurel held shares valued at 50 times his salary and Dr. Lechleiter currently holds shares valued, as of year-end 2008, at 7 times his salary.

     Executive officers are required to retain all shares received from the company equity programs, net of acquisition costs and taxes, for at least one year. In addition, any executive officer who does not meet the stock ownership guideline must retain all net shares until the requisite ownership level is achieved.

     Employees are not permitted to hedge their economic exposures to the Lilly stock that they own through short sales or derivative transactions.

Tax 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 certain executive officers. However, performance-based compensation 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 objectives.

     We have taken steps to qualify cash bonus compensation, performance awards, and SVAs 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 2008, the non-deductible compensation under this law for Dr. Lechleiter was essentially equal to the portion of his base salary that exceeded $1,000,000 as shown in the Summary Compensation Table. Mr. Taurel’s non-deductible compensation was approximately the amount listed under all other compensation in the Summary Compensation Table.

Executive Compensation Recovery Policy

Any incentive awards, including SVAs, are subject to forfeiture prior to payment for termination of employment or disciplinary reasons. In addition, 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. The committee and management have implemented a three-pronged approach to minimizing the risk of compensation programs encouraging misconduct or undue risk-taking. First, incentive programs are designed using a diversity of meaningful financial metrics (growth in total shareholder return, measured over three years, net sales, and EPS, measured over one and two years), thus providing a balanced approach between short- and long-term performance. The committee reviews incentive programs each year against the objectives of the programs and makes changes as necessary. Second, management has implemented effective controls that minimize unintended and willful reporting errors. Third, if despite these actions an executive officer’s fraudulent conduct leads to “ill-gotten gains” due to misstated financial results, the committee will “claw back” the portion of a bonus or performance award attributed to the misstatement. The committee does not believe it is practical to apply a specific claw-back policy to the shareholder value award since it is very difficult to isolate the amount, if any, by which the stock price benefited from misstated earnings over the three-year performance period. In this case, the committee has the authority to exercise negative discretion to reduce or withhold payouts.

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 26–38 of this proxy statement. 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.

Compensation Committee
Karen N. Horn, Ph.D., Chair
Michael L. Eskew
J. Erik Fyrwald
Ellen R. Marram

Summary Compensation Table ¹

																		Non-Equity
											Stock				Option			Incentive Plan				Change in				All Other				Total
Name and Principal						Salary				Awards				Awards				Compensation				Pension Value				Compensation				Compensation
Position		Year				($)				($)2				($)2				($)3				($)4				($)5				($)
Sidney Taurel			2008			$	1,080,313			$	8,353,333			$	0			$	2,329,154			$	456,787			$	839,428			$	13,059,014
Chairman Emeritus			2007			$	1,717,417			$	6,443,000			$	600,000			$	4,035,929			$	0			$	215,044			$	13,011,390
			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.			2008			$	1,339,125			$	6,621,333			$	0			$	2,709,053			$	2,221,597			$	87,107			$	12,978,215
Chairman of the Board,			2007			$	1,149,083			$	4,641,000			$	390,000			$	2,160,277			$	921,394			$	70,761			$	9,332,515
President, and Chief Executive Officer			2006			$	1,112,000			$	3,510,000			$	3,967,976			$	1,490,080			$	1,156,247			$	68,790			$	11,305,093
Steven M. Paul, M.D.			2008			$	1,000,250			$	3,194,250			$	0			$	1,309,327			$	997,863			$	18,372			$	6,520,062
Executive Vice President,			2007			$	960,333			$	2,852,671			$	200,000			$	1,534,613			$	396,687			$	13,500			$	5,957,804
Science and Technology			2006			$	916,167			$	1,864,460			$	1,240,000			$	1,043,514			$	607,463			$	55,789			$	5,727,393
Bryce D. Carmine			2008			$	783,113			$	2,958,333			$	0			$	1,006,135			$	1,158,720			$	55,789			$	5,962,090
Executive Vice President, Global Marketing and Sales
Derica W. Rice			2008			$	834,117			$	2,485,000			$	318,133			$	1,027,632			$	455,226			$	86,034			$	5,206,142
Senior Vice President and			2007			$	747,583			$	1,995,000			$	473,675			$	1,054,093			$	194,469			$	78,787			$	4,543,607
Chief Financial Officer			2006			$	615,000			$	675,000			$	590,928			$	580,466			$	168,627			$	37,722			$	2,667,743
Robert A. Armitage			2008			$	778,767			$	1,852,500			$	375,000			$	959,441			$	439,374			$	53,138			$	4,458,219
Senior Vice President and			2007			$	741,667			$	1,995,000			$	716,400			$	1,045,750			$	232,697			$	45,551			$	4,777,065
General Counsel			2006			$	701,657			$	1,394,053			$	1,339,911			$	705,165			$	231,862			$	42,691			$	4,415,339

							Savings				Tax											Total “All Other
Name		Year				Plan Match				Reimbursements1				Perquisites2				Other				Compensation”
Mr. Taurel			2008			$	64,819			$	752,768	3		$	21,840			$	0			$	839,428
			2007			$	103,045			$	2,731			$	109,268			$	0			$	215,044
			2006			$	99,020			$	1,382			$	92,007			$	0			$	192,409
Dr. Lechleiter			2008			$	80,348			$	6,759			$	0			$	0			$	87,107
			2007			$	68,945			$	1,816			$	0			$	0			$	70,761
			2006			$	66,720			$	2,070			$	0			$	0			$	68,790
Dr. Paul			2008			$	13,800			$	4,572			$	0			$	0			$	18,372
			2007			$	13,500			$	0			$	0			$	0			$	13,500
			2006			$	54,970			$	819			$	0			$	0			$	55,789
Mr. Carmine			2008			$	46,987			$	6,510			$	0			$	0			$	53,497
Mr. Rice			2008			$	50,047			$	6,246			$	29,741			$	0			$	86,034
			2007			$	44,855			$	15,030	4		$	0			$	18,902	5		$	78,787
			2006			$	36,900			$	822			$	0			$	0			$	37,722
Mr. Armitage			2008			$	46,726			$	6,412			$	0			$	0			$	53,138
			2007			$	44,500			$	1,051			$	0			$	0			$	45,551
			2006			$	42,099			$	592			$	0			$	0			$	42,691

     We have no employment agreements with our named executive officers. See, however, the description of additional years of service that may be credited to certain named executive officers (page 47).

Grants of Plan-Based Awards During 2008

     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 26, 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, shareholder value awards, stock options, restricted stock grants, and stock units.

										Estimated Possible Payouts												Estimated Possible and Future												All Other
										Under Non-Equity												Payouts Under Equity												Option
										Incentive Plan Awards1												Incentive Plan Awards2												Awards: Number				Grant Date
						Compensation																												of Securities				Fair Value
						Committee				Threshold				Target				Maximum				Threshold				Target				Maximum				Underlying				of Equity
Name		Grant Date				Action Date				($)				($)				($)				(# shares)				(# shares)				(# shares)				Options3				Awards
Mr. Taurel			—				—			$	226,866			$	1,512,438			$	3,024,875
			2/7/2008	4			12/17/2007																39,047				78,094				156,189							$	4,000,000
			2/7/2008	5			12/17/2007																42,542				106,355				148,897							$	4,000,000
																																			0
Dr. Lechleiter			—				—			$	263,869			$	1,759,125			$	3,518,250
			2/7/2008	4			12/17/2007																31,726				63,452				126,904							$	3,250,000
			2/7/2008	5			12/17/2007																34,565				86,414				120,980							$	3,250,000
																																			0
Dr. Paul			—				—			$	127,532			$	850,213			$	1,700,425
			2/7/2008	4			12/17/2007																14,643				29,285				58,571							$	1,500,000
			2/7/2008	5			12/17/2007																15,953				39,884				55,838							$	1,500,000
																																			0
Mr. Carmine			—				—			$	98,000			$	653,334			$	1,306,669
			2/7/2008	4			12/17/2007																14,643				29,285				58,571							$	1,500,000
			2/7/2008	5			12/17/2007																15,953				39,884				55,838							$	1,500,000
																																			0
Mr. Rice			—				—			$	100,094			$	667,293			$	1,334,587
			2/7/2008	4			12/17/2007																11,714				23,428				46,857							$	1,200,000
			2/7/2008	5			12/17/2007																12,762				31,907				44,670							$	1,200,000
																																			0
Mr. Armitage			—				—			$	93,452			$	623,013			$	1,246,027
			2/7/2008	4			12/17/2007																8,346				16,693				33,385							$	855,000
			2/7/2008	5			12/17/2007																9,093				22,734				31,828							$	855,000
																																			0