Blizzard 2008 Annual Report Download - page 97

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To estimate volatility for the binomial-lattice model, we use methods or capabilities that
are discussed in SFAS No. 123R and Staff Accounting Bulletin No. 107, “Share-Based Payment”
(“SAB No. 107”). These methods include the implied volatility method based upon the volatilities
for exchange-traded options on our stock to estimate short-term volatility, the historical method
(annualized standard deviation of the instantaneous returns on Activision Blizzard’s stock) during
the option’s contractual term to estimate long-term volatility and a statistical model to estimate the
transition or “mean reversion” from short-term volatility to long-term volatility. Based on these
methods, for options granted during the year ended December 31, 2008, the expected stock price
volatility ranged from 46.15% to 69.08%.
As is the case for volatility, the risk-free rate is assumed to change during the option’s
contractual term. Consistent with the calculation required by a binomial lattice model, the risk-free
rate reflects the interest from one time period to the next (“forward rate”) as opposed to the
interest rate from the grant date to the given time period (“spot rate”). Since we do not currently
pay dividends and are not expected to pay them in the future, we have assumed that the dividend
yield is zero.
The expected life of employee stock options represents the weighted-average period the
stock options that are expected to remain outstanding and is, as required by SFAS No. 123R, an
output by the binomial-lattice model. The expected life of employee stock options depends on all
of the underlying assumptions and calibration of our model. A binomial-lattice model can be
viewed as assuming that employees will exercise their options when the stock price equals or
exceeds an exercise boundary. The exercise boundary is not constant but continually declines as
one approaches the option’s expiration date. The exact placement of the exercise boundary
depends on all of the model inputs as well as the measures that are used to calibrate the model to
estimated measures of employees’ exercise and termination behavior.
As stock-based compensation expense recognized in the Consolidated Statement of
Operations for the year ended December 31, 2008 is based on awards ultimately expected to vest,
it has been reduced for estimated forfeitures. SFAS No. 123R requires forfeitures to be estimated
at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from
those estimates. Forfeitures were estimated based on historical experience.
Accuracy of Fair Value Estimates
We developed the assumptions used in the binomial-lattice model, including model
inputs and measures of employees’ exercise and post-vesting termination behavior. Our ability to
accurately estimate the fair value of share-based payment awards at the grant date depends upon
the accuracy of the model and our ability to accurately forecast model inputs as long as ten years
into the future. These inputs include, but are not limited to, expected stock price volatility, risk-
free rate, dividend yield, and employee termination rates. Although the fair value of employee
stock options is determined in accordance with SFAS No. 123R and SAB No. 107 using an
option-pricing model, the estimates that are produced by this model may not be indicative of the
fair value observed between a willing buyer/willing seller. It is difficult to determine if this is the
case, because markets do not currently exist that permit the active trading of employee stock
option and other share-based instruments.