Activision 2013 Annual Report Download - page 78

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Method and Assumptions on Valuation of Stock Options
Our employee stock options have features that differentiate them from exchange- traded options. These features
include lack of transferability, early exercise, vesting restrictions, pre- and post-vesting termination provisions, blackout dates,
and time-varying inputs. A binomial-lattice model was selected because it is better able to explicitly address these features than
closed-form models such as the Black-Scholes model, and is able to reflect expected future changes in model inputs, including
changes in volatility, during the option’s contractual term.
We have estimated expected future changes in model inputs during the option’s contractual term. The inputs required
by our binomial-lattice model include expected volatility, risk-free interest rate, risk-adjusted stock return, dividend yield,
contractual term, and vesting schedule, as well as measures of employees’ forfeiture, exercise, and post-vesting termination
behavior. Statistical methods were used to estimate employee rank-specific termination rates. These termination rates, in turn,
were used to model the number of options that are expected to vest and post-vesting termination behavior. Employee
rank-specific estimates of Expected Time-To- Exercise (“ETTE”) were used to reflect employee exercise behavior. ETTE was
estimated by using statistical procedures to first estimate the conditional probability of exercise occurring during each time
period, conditional on the option surviving to that time period and then using those probabilities to estimate ETTE. The model
was calibrated by adjusting parameters controlling exercise and post-vesting termination behavior so that the measures output by
the model matched values of these measures that were estimated from historical data.
The following tables present the weighted-average assumptions and the weighted-average fair value at grant date
using the binomial-lattice model:
Employee and director options
For the Year
Ended
December 31, 2013
For the Year
Ended
December 31, 2012
For the Year
Ended
December 31, 2011
Expected life (in years) ....................................................... 6.44 7.05 6.58
Risk free interest rate .......................................................... 1.86% 1.12% 1.91%
Volatility ............................................................................. 39.00% 40.76% 43.50%
Dividend yield ..................................................................... 1.08% 1.65% 1.34%
Weighted-average fair value at grant date .......................... $ 4.97 $ 3.47 $ 4.17
To estimate volatility for the binomial-lattice model, we use methods that consider 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, 2013, the expected
stock price volatility ranged from 25.73% to 39.00%.
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 expected movement in the interest rate
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”). The expected dividend yield assumption for options granted during the year ended December 31, 2013 is based on
the Company’s historical and expected future amount of dividend payouts.
The expected life of employee stock options represents the weighted-average period the stock options are expected to
remain outstanding and is an output from 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 multiples, of which the multiple is based on
historical employee exercise behaviors.
As stock-based compensation expense recognized in the consolidated statement of operations for the years ended
December 31, 2013, 2012, and 2011 is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures.
Forfeitures are 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 stock-based
payment awards at the grant date depends upon the accuracy of the model and our ability to accurately forecast model inputs as