18.

Stock-Based Compensation

The Company may grant stock options, stock appreciation rights (“SARs”), restricted shares, and deferred common stock units or restricted stock units (collectively, “RSUs”) to its directors, officers, other employees and affiliates. As of December 31, 2012, the Company’s active stock-based compensation plan consists of the amended and restated 2007 Equity and Incentive Plan, under which the Company is authorized to grant up to 16 million shares of its common stock, and approximately 5 million shares were available for future grants. The Company may settle employee stock option exercises with either treasury shares, newly issued shares or shares purchased on the open market. The Company typically issues shares related to vested RSUs from treasury shares.

The Company applies the direct method and tax law ordering approach to calculate the tax effects of stock-based compensation. In jurisdictions with net operating loss carryforwards, tax deductions for exercises of stock-based awards have generated a $36 million tax benefit at December 31, 2012, with a corresponding increase to additional paid-in capital. Approximately $14 million of incremental tax benefits will be recorded in additional paid-in capital when realized in these jurisdictions.

Stock Options

In 2010, the Company granted 160,000 stock options under the Company’s amended 2007 Equity and Incentive Plan. The stock options (i) vest ratably over a five-year term, (ii) expire ten years from the date of grant and (iii) have an exercise price that was set at the closing price of the Company’s common stock on the date of the grant.

Following the spin-offs of Realogy and Wyndham in 2006, all previously outstanding and unvested stock options vested and converted into stock options of Avis Budget, Realogy and Wyndham.

The Company used the Black-Scholes option pricing model to calculate the fair value of the time-vesting stock options granted in 2010, with assumptions including, but not limited to, the options’ expected life and the expected volatility of the underlying stock. Based on facts and circumstances at the time of the grant, the Company used the implied volatility of its publicly traded, near-the-money stock options with a remaining maturity of at least one year in 2010. The Company considered several factors in estimating the life of the options granted, including the historical option exercise behavior of employees and the option vesting periods. The risk-free interest rate is derived from the U.S. Treasury yield curve in effect at the time of grant and, since the Company does not currently pay or plan to pay a dividend on its common stock, the expected dividend yield was zero. Based on these assumptions, the fair value of the Company’s time-vesting stock options issued in 2010 was estimated to be $6.16.

The weighted average fair value of stock options granted during the periods and the assumptions used to estimate those values using the Black-Scholes option pricing model in 2010 were as follows:


		2010
Expected volatility of stock price		54%
Risk-free interest rate		2.82%
Expected life of options		6 years
Dividend yield		0.0%

The annual activity of the Company’s common stock option plans consisted of (in thousands of shares):


	2012				2011				2010
	Number of Options		Weighted Average Exercise Price		Number of Options		Weighted Average Exercise Price		Number of Options		Weighted Average Exercise Price
Balance at beginning of year		3,432	$	7.90		5,026	$	7.22		7,196	$	11.30
Granted at fair market value		-		-		-		-		160		11.53
Exercised ^(a)		(756)		0.86		(1,231)		0.98		(982)		8.45
Canceled/forfeited/expired		(775)		27.04		(363)		21.97		(1,348)		28.63

Balance at end of year ^(c)		1,901		2.89		3,432		7.90		5,026		7.22

^(a)

Stock options exercised during 2012 and 2011 had intrinsic values of $11 million and $18 million, respectively.

^(b)

As of December 31, 2012, the Company’s outstanding stock options had an aggregate intrinsic value of $32 million; there were 1.9 million “in-the-money” stock options; and the aggregate unrecognized compensation expense related to unvested stock options was $1 million, to be recognized over 2.1 years. Approximately 1.8 million stock options are exercisable as of December 31, 2012 and approximately 32,000 stock options are eligible to vest in 2013.

The table below summarizes information regarding the Company’s outstanding stock options as of December 31, 2012 (in thousands of shares):


	Outstanding Options
Range of Exercise Prices	Number of Options		Weighted Average Remaining Contractual Life		Weighted Average Exercise Price
Less than $5.00		1,623		6.06	$	0.79
$5.01 to $10.00		-		-		-
$10.01 to $15.00		160		7.07		11.53
$15.01 to $20.00		104		0.28		18.82
$20.01 and above		14		1.32		30.63

		1,901		5.80		2.89

Restricted Stock and Stock Unit Awards

RSUs granted by the Company entitle the employee to receive one share of Avis Budget common stock upon vesting, which occurs ratably over a 2.5-, three- or four-year period for the RSUs outstanding as of December 31, 2012. The Company also employs performance-, market- and time-vesting criteria for RSU grants made to certain of the Company’s employees, where the number of performance-based RSUs that will ultimately vest may range from 0% to 100% of the award.

During 2012, the Company granted 488,000 market-vesting restricted stock units, 835,000 time-based restricted stock units and 486,000 performance-based restricted stock units under the Company’s 2007 Equity and Incentive Plan. Vesting of all or a portion of the market-vesting and performance-based restricted stock units will occur on the third anniversary of the grant date or as otherwise provided by the grant, subject to continued employment through such anniversary, and (i) in the case of the market-based restricted stock units, attainment of certain Company stock price targets and (ii) in the case of the performance-based restricted stock units, attainment of certain Company performance goals. All of the time-based restricted stock units granted during 2012 vest ratably on the first three anniversaries of the grant date or as otherwise provided by the grant, subject to continued employment.

In 2011, the Company granted 357,000 market-vesting restricted stock units and 652,000 time-based restricted stock units under the Company’s amended 2007 Equity and Incentive Plan. The number of market-vesting restricted stock units which will ultimately vest is based on the Company’s common stock achieving certain average stock price targets for a specified number of trading days. Of the market-vesting restricted stock units granted during 2011, 264,000 units vest after three years and 93,000 units vest 50% on each of the third and fourth anniversaries of the date of grant. Of the time-based restricted stock units granted during 2011, 621,000 vest ratably on the first three anniversaries of the grant date and 31,000 vest on the first anniversary of the date of the grant.

The Company determined the fair value of its market-vesting restricted stock units granted in 2012 and 2011 using a Monte Carlo simulation model. The weighted-average fair value of each of the Company’s market-vesting restricted stock units, issued in 2012, which contain 2.5- and three-year vesting periods were estimated to be approximately $11.93 and $10.59, respectively. The fair value of each of the Company’s market-vesting restricted stock units issued in 2011, which contain three- and four-year vesting periods, was estimated to be approximately $11.38 and $12.53, respectively. The assumptions used to estimate the fair values of the market-vesting restricted stock awards using the Monte Carlo simulation model in 2012 and 2011 were as follows:


	2012	2011
Expected volatility of stock price	50%	48%
Risk-free interest rate	0.30% - 0.42%	0.47% - 1.21%
Valuation period	2¹/₂ & 3 years	3 & 4 years
Dividend yield	0.0%	0.0%

The annual activity related to the Company’s RSUs consisted of (in thousands of shares):


	2012				2011				2010
	Number of RSUs		Weighted Average Exercise Price		Number of RSUs		Weighted Average Exercise Price		Number of RSUs		Weighted Average Exercise Price
Balance at beginning of year		2,998	$	12.74		3,059	$	13.64		1,855	$	19.32
Granted at fair market value ^(a)		1,809		14.44		1,009		14.45		1,960		11.55
Vested ^(b)		(1,252)		12.61		(729)		14.41		(585)		21.89
Canceled		(58)		13.92		(341)		22.32		(171)		23.10

Balance at end of year ^(c)		3,497		13.64		2,998		12.74		3,059		13.64

^(a)

Reflects the maximum number of RSUs assuming achievement of all performance-, market- and time-vesting criteria. During 2012, 2011 and 2010, the Company granted 835,000, 652,000 and 989,000 time-based RSUs, respectively. The number of RSUs granted does not include those for non-employee directors, which are discussed separately below.

^(b)

During 2012, approximately 615,000 market- and performance-based RSUs vested; no performance-based RSUs vested during 2011 and 2010.

^(c)

As of December 31, 2012, the Company’s outstanding RSUs had aggregate intrinsic value of $69 million. Aggregate unrecognized compensation expense related to RSUs amounted to $25 million as of December 31, 2012, recognized over the weighted average vesting period of 1.6 years. The Company had approximately 1,439,000, 1,281,000 and 1,393,000 time-based awards outstanding at December 31, 2012, 2011 and 2010, respectively. Performance- and market-based awards outstanding at December 31, 2012, 2011 and 2010 were approximately 2,058,000, 1,717,000 and 1,666,000, respectively. Approximately 687,000 time-based, 440,000 market-based and no performance-based RSUs are eligible to vest in 2013, if applicable service and performance criteria are satisfied.

Restricted Cash Units

During 2012, the Company granted 35,000 time-based restricted cash units and 121,000 market-based restricted cash units, under the Company’s amended 2007 Equity and Incentive Plan, which vest 2.5-years after the grant date, subject to continued employment through such anniversary. The number of market-based restricted cash units, which will ultimately vest is based on total shareholder return over the vesting period in comparison to a specified market index. These units will be settled in cash, with the final payment amount for each vested unit based on the Company’s average closing stock price over a specified number of trading days. The Company determined the fair market value of these market-vesting restricted cash units, based on the expected cash payout. The expected expense for these shares was calculated using a Monte-Carlo simulation model, which takes into consideration several factors including volatility, risk free interest rates, and the correlation of the Company’s stock price with the Russell 2000 Index. The fair value of these market-based restricted cash units, which contain a 2.5-year vesting period, was estimated to be approximately $11.93. Compensation expense during 2012 related to the award was immaterial. At December 31, 2012, the Company had 156,000 restricted cash units outstanding with a weighted average contractual life of 2.1 years.

Stock Appreciation Rights

In 2006, the Company issued stock-settled SARs to certain employees. Such SARs are settled in Company stock, have a seven-year term, and vest ratably over a four-year period or after three years with no graded vesting prior thereto. The Company’s policy is to grant SARs with exercise prices at then-current fair market value. At December 31, 2012, the Company had approximately 0.5 million SARs outstanding with a weighted average exercise price of $24.40 and a weighted average contractual life of 0.6 years.

Non-employee Directors Deferred Compensation Plan

The Company grants RSUs annually to members of its Board of Directors representing annual retainer, committee chair and membership stipends, which are payable in the form of Avis Budget common stock upon termination of service. During 2012, 2011 and 2010, the Company granted 53,000, 54,000 and 51,000 RSUs, respectively under the 2007 Equity and Incentive Plan to members of its Board of Directors. The RSU grants are included in the calculation of basic and diluted earnings per share as common stock equivalents.

Employee Stock Purchase Plan

The Company is authorized to sell shares of its Avis Budget common stock to eligible employees under its non-compensatory employee stock purchase plan (“ESPP”). In June 2009, stockholders approved the adoption of the Avis Budget Group Inc. Employee Stock Purchase Plan. Under the terms of the ESPP, the fair market value of the shares of common stock which may be purchased by any employee cannot exceed $25,000 during any calendar year or 10% of the employee’s annual base salary. The purchase price is calculated at 95% of the fair market value of Avis Budget common stock. The Company reserved 2.5 million shares of its common stock for potential purchases under the ESPP. In any given period, up to 125,000 shares purchased may be either newly issued shares or existing treasury shares, and in the aggregate, up to 1 million shares of common stock purchased under the ESPP may be either newly issued shares or existing treasury shares. Subject to the preceding limitation, shares purchased under the ESPP may be either newly issued shares, existing treasury shares, or new purchases in the open market. During 2012, the Company sold approximately 12,000 shares under this plan.

Compensation Expense

Compensation expense for all outstanding employee stock awards is based on the estimated fair value of the award at the grant date and is recognized as an expense in the Consolidated Statements of Operations over the requisite service period. The Company’s policy is to record compensation expense related to the issuance of stock options, time- and market-based RSUs and SARs to its employees on a straight-line basis over the vesting period of the award and based on the estimated number of stock awards the Company believes it will ultimately provide. The Company records amortization expense related to performance-based RSUs on a straight-line basis over the remaining vesting periods of the respective award and based on the estimated vesting the Company believes will ultimately occur.

The Company recorded stock-based compensation expense of $16 million ($10 million, net of tax) during 2012, $17 million ($11 million, net of tax) during 2011 and $15 million ($9 million, net of tax) in 2010, related to employee stock awards that were granted by the Company.