Share-Based Payments

Activision Blizzard Equity Incentive Plans

On June 5, 2014, our shareholders approved the Activision Blizzard, Inc. 2014 Incentive Plan (the "2014 Plan") and the 2014 Plan became effective. The 2014 Plan authorizes the Compensation Committee of our Board of Directors to provide share-based compensation in the form of stock options, share appreciation rights, restricted stock, restricted stock units, performance shares, and other performance- or value-based awards structured by the Compensation Committee within parameters set forth in the 2014 Plan.

While the Compensation Committee has broad discretion to create equity incentives, our share-based compensation program for the most part currently utilizes a combination of options and restricted stock units. The majority of our options have time-based vesting schedules, generally vesting annually over a period of three to five years, and expire ten years from the grant date. Restricted stock units either have time-based vesting schedules, generally vesting in their entirety on an anniversary of the date of grant, or vest annually over a period of three to five years, or vest only if certain performance measures are met. In addition, under the terms of the 2014 Plan, the exercise price for the options must be equal to or greater than the closing price per share of our common stock on the date the award is granted, as reported on NASDAQ.

Upon the effective date of the 2014 Plan, we ceased making awards under our prior equity incentive plans (collectively, the "Prior Plans"), although such plans will remain in effect and continue to govern outstanding awards. Additionally, in connection with the King Acquisition, a majority of the outstanding options and awards with respect to King shares that were unvested as of the King Closing Date were converted into equivalent options and awards with respect to shares of the Company’s common stock (see Note 21 for further discussion). As part of the conversion, we assumed King's equity incentive plan (the "King Plan") and amended the King Plan to convert it to a plan with respect to shares of the Company's common stock for the King shares assumed. No future shares can be granted from King Plan.

As of the date it was approved by our shareholders, there were 46 million shares available for issuance under the 2014 Plan. The number of shares of our common stock reserved for issuance under the 2014 Plan has been, and may be further, increased from time to time by: (i) the number of shares relating to awards outstanding under any Prior Plan that: (a) expire, or are forfeited, terminated or canceled, without the issuance of shares; (b) are settled in cash in lieu of shares; or (c) are exchanged, prior to the issuance of shares of our common stock, for awards not involving our common stock; (ii) if the exercise price of any option outstanding under any Prior Plans is, or the tax withholding requirements with respect to any award outstanding under any Prior Plans are, satisfied by withholding shares otherwise then deliverable in respect of the award or the actual or constructive transfer to the Company of shares already owned, the number of shares equal to the withheld or transferred shares; and (iii) if a share appreciation right is exercised and settled in shares, a number of shares equal to the difference between the total number of shares with respect to which the award is exercised and the number of shares actually issued or transferred. As of December 31, 2016, we had approximately 34 million shares of our common stock reserved for future issuance under the 2014 Plan. Shares issued in connection with awards made under the 2014 Plan are generally issued as new stock issuances.

Fair Value Valuation Assumptions

Valuation of Stock Options

We use a binomial-lattice model to value our stock options. We estimate expected future changes in model inputs during an option's contractual term. The inputs required by our binomial-lattice model include expected volatility, risk-free interest rate, dividend yield, contractual term, and vesting schedule, as well as measures of employees' cancellations, 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 probability of exercise occurring during each time period, conditional on the option surviving to that time period, and then using those probabilities to determine the 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, the weighted-average fair value at grant date using the binomial-lattice model, and the range of expected stock price volatilities:



	Employee and Director Options
	For the Years Ended December 31,
	2016			2015			2014
Expected life (in years)	6.86			6.26			5.97
Risk free interest rate	1.56		%	1.90		%	1.82		%
Volatility	35.31		%	36.13		%	37.09		%
Dividend yield	0.67		%	0.72		%	0.98		%
Weighted-average fair value at grant date	$	12.83		$	9.87		$	5.87
Stock price volatility range:
Low	29.20		%	26.96		%	29.72		%
High	36.00		%	37.00		%	38.00		%

Expected life

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 multiple, of which the multiple is based on historical employee exercise behaviors.

Risk-free interest rate

As is the case for volatility, the risk-free interest rate is assumed to change during the option's contractual term. Consistent with the calculation required by a binomial-lattice model, the risk-free interest 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").

Volatility

To estimate volatility for the binomial-lattice model, we use methods that consider the implied volatility based upon the volatilities for exchange-traded options on our stock to estimate short-term volatility, the historical volatility of our common shares 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.

Dividend yield

The expected dividend yield assumption for options granted during the year ended December 31, 2016 is based on our historical and expected future amount of dividend payouts.

As share-based compensation expense recognized in the consolidated statement of operations for the years ended December 31, 2016, 2015, and 2014 is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. Forfeitures are estimated at the time of grant based on historical experience and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates.

Valuation of Restricted Stock Units ("RSUs")

The fair value of the Company’s RSU awards granted is based upon the closing price of the Company’s stock price on the date of grant reduced by the present value of dividends expected to be paid on our common stock prior to vesting.

Accuracy of Fair Value Estimates

We developed the assumptions used in the models above, 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 10 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 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 and a willing seller. Unfortunately, it is difficult to determine if this is the case, as markets do not currently exist that permit the active trading of employee stock option and other share-based instruments.

Stock Option Activity

Stock option activity for the year ended December 31, 2016 is as follows (amounts in millions, except number of shares, which are in thousands, and per share amounts):



	Number of Shares		Weighted-average exercise price		Weighted-average remaining contractual term	Aggregate intrinsic value
Outstanding stock options at December 31, 2015	24,329		$	17.90
Granted	5,695		39.41
Assumed in King Acquisition	9,575		32.73
Exercised	(7,131	)	14.75
Forfeited	(972	)	25.52
Expired	(11	)	10.54
Outstanding stock options at December 31, 2016	31,485		$	26.79	6.31	$	388
Vested and expected to vest at December 31, 2016	27,849		$	24.91	6.11	$	372
Exercisable at December 31, 2016	12,991		$	15.79	3.91	$	264

For options assumed in the King Acquisition, 0.7 million of the options are based on performance conditions which do not have an accounting grant date as of December 31, 2016, as there is not a mutual understanding between the Company and the employee of the performance terms.

The aggregate intrinsic values in the table above represents the total pretax intrinsic value (i.e. the difference between our closing stock price on the last trading day of the period and the exercise price, times the number of shares for options where the closing stock price is greater than the exercise price) that would have been received by the option holders had all option holders exercised their options on that date. This amount changes based on the market value of our stock. The total intrinsic value of options actually exercised was $161 million, $125 million, and $117 million for the years ended December 31, 2016, 2015, and 2014, respectively. The total grant date fair value of options vested was $40 million, $19 million, and $19 million for the years ended December 31, 2016, 2015, and 2014, respectively.

At December 31, 2016, $88 million of total unrecognized compensation cost related to stock options is expected to be recognized over a weighted-average period of 1.73 years.

RSU Activity

We grant RSUs, which represent the right to receive shares of our common stock. Vesting for RSUs is contingent upon the holders' continued employment with us and may be subject to other conditions (which may include the satisfaction of a performance measure). Also, certain of our performance-based RSUs include a range of shares that may be released at vesting which are above or below the targeted number of RSUs based on actual performance relative to the grant date performance measure. If the vesting conditions are not met, unvested RSUs will be forfeited. Upon vesting of the RSUs, we may withhold shares otherwise deliverable to satisfy tax withholding requirements.

The following table summarizes our RSU activity for the year ended December 31, 2016, with performance-based RSUs presented at the maximum potential shares that could be earned and issued at vesting (amounts in thousands except per share amounts):



	Number of shares		Weighted- Average Grant Date Fair Value
Unvested RSUs at December 31, 2015	11,930		$	12.74
Granted	5,320		36.92
Assumed in King Acquisition	3,349		30.18
Vested	(7,109	)	18.34
Forfeited	(1,513	)	20.84
Unvested RSUs at December 31, 2016	11,977		$	17.44

Certain of our performance-based RSUs did not have an accounting grant date as of December 31, 2016, as there is not a mutual understanding between the Company and the employee of the performance terms. Generally, these performance terms relate to revenue and operating income performance for future years where the performance goals have not yet been set. As of December 31, 2016, there were 5.1 million performance-based RSUs outstanding for which the accounting grant date has not been set, of which 3.6 million were 2016 grants. Accordingly, no grant date fair value was established and the weighted average grant date fair value calculated above for 2016 grants excludes these RSUs.

At December 31, 2016, approximately $89 million of total unrecognized compensation cost was related to RSUs and is expected to be recognized over a weighted-average period of 1.65 years. Of the total unrecognized compensation cost, $56 million was related to performance-based RSUs, which is expected to be recognized over a weighted-average period of 1.85 years. The total grant date fair value of vested RSUs was $123 million, $93 million and $92 million for the years ended December 31, 2016, 2015 and 2014, respectively.

The income tax benefit from stock option exercises and RSUs was $134 million, $109 million, and $89 million for the years ended December 31, 2016, 2015, and 2014, respectively.

Share-Based Compensation Expense

The following table sets forth the total share-based compensation expense included in our consolidated statements of operations for the years ended December 31, 2016, 2015, and 2014 (amounts in millions):



	For the Years Ended December 31,
	2016			2015			2014
Cost of revenues—product sales: Software royalties, amortization, and intellectual property licenses	$	20		$	12		$	15
Cost of revenues—subscription, licensing, and other revenues: Game Operations and Distribution Costs	2			—			1
Cost of revenues—subscription, licensing, and other revenues: Software royalties, amortization, and intellectual property licenses	2			3			2
Product development	47			25			22
Sales and marketing	15			9			8
General and administrative	73			43			56
Share-based compensation expense before income taxes	159			92			104
Income tax benefit	(42		)	(27		)	(38		)
Total share-based compensation expense, net of income tax benefit	$	117		$	65		$	66

The following table summarizes share-based compensation included in our consolidated balance sheets as a component of "Software development" (amounts in millions):



	Software Development
Balance at December 31, 2013	$	22
Share-based compensation expense capitalized and deferred during period	27
Amortization of capitalized and deferred share-based compensation expense	(23		)
Balance at December 31, 2014	$	26
Share-based compensation expense capitalized and deferred during period	36
Amortization of capitalized and deferred share-based compensation expense	(34		)
Balance at December 31, 2015	$	28
Share-based compensation expense capitalized and deferred during period	25
Amortization of capitalized and deferred share-based compensation expense	(37		)
Balance at December 31, 2016	$	16