eTrade 2010 Annual Report Download - page 81

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Valuation and Expensing of Share-Based Payments
Description
We value employee share-based payments, which include stock options, restricted stock awards and
restricted stock units, at the grant date and expense the associated compensation cost over the vesting period less
estimated forfeitures. The fair value of restricted stock awards and restricted stock units is calculated using the
market price upon issuance. The fair value of each stock option is estimated on the date of grant using an option
pricing model using assumptions that match the characteristics of the granted options. We then assume a
forfeiture rate that is used to calculate each period’s compensation expense attributed to these options.
Judgments
We estimate the value of employee stock options using the Black-Scholes-Merton option pricing model.
Assumptions necessary for the calculation of fair value include expected term and expected volatility. These
assumptions are management’s best estimate of the characteristics of the options. Additionally, forfeiture rates
are estimated based on historical vesting experience.
Effects if Actual Results Differ
If our estimates of employees’ forfeiture rates are not correct at the end of the term of the option, we will
record either additional expense or a reduction of expense in the period it completely vests. This adjustment may
be material to the period in which it is recorded. In addition, option fair value is based on estimates of volatility
determined by us. Many methods are available to determine volatility, so the determination is subjective.
Applying a different method to determine volatility could impact earnings. A 10% change in volatility would
increase or decrease stock option fair value by approximately 8%. A change in fair value would affect all
amortization periods.
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