Share-Based Compensation

Chesapeake’s share-based compensation program consists of restricted stock, stock options and performance share units (PSUs) granted to employees and restricted stock granted to non-employee directors under our Long Term Incentive Plan. The restricted stock and stock options are equity-classified awards and the PSUs are liability-classified awards.

Equity-Classified Awards

Restricted Stock. We grant restricted stock to employees and non-employee directors. Restricted stock vests over a minimum of three years and the holder receives dividends or dividend equivalents on unvested shares. A summary of the changes in unvested shares of restricted stock during the Current Quarter is presented below.



	Number of Unvested Restricted Shares		Weighted Average Grant Date Fair Value
	(in thousands)
Unvested shares as of January 1, 2014	13,400		$	23.38
Granted	3,943		$	25.13
Vested	(2,350	)	$	26.41
Forfeited	(638	)	$	25.69
Unvested shares as of March 31, 2014	14,355		$	23.26

The aggregate intrinsic value of restricted stock that vested during the Current Quarter was approximately $62 million based on the stock price at the time of vesting.

As of March 31, 2014, there was $255 million of total unrecognized compensation expense related to unvested restricted stock. The expense is expected to be recognized over a weighted average period of approximately 2.5 years.

The vesting of certain restricted stock grants may result in state and federal income tax benefits related to the difference between the market price of the common stock at the date of vesting and the date of grant. During the Current Quarter, we recognized excess tax benefits related to restricted stock of $3 million and during the Prior Quarter we recognized reductions in tax benefits related to restricted stock of $10 million, which were recorded as adjustments to additional paid-in capital and deferred income taxes.

Stock Options. In the Current Quarter and the Prior Quarter, we granted members of senior management stock options that will vest ratably over a three-year period. In the Prior Quarter, we also granted retention awards to certain officers of stock options that will vest one-third on each of the third, fourth and fifth anniversaries of the grant date. Each stock option award has an exercise price equal to the closing price of the Company’s common stock on the grant date. Outstanding options generally expire ten years from the date of grant.

We utilize the Black-Scholes option pricing model to measure the fair value of stock options. The expected life of an option is determined using the "simplified method", as there is no adequate historical exercise behavior available. Volatility assumptions are estimated based on an average of historical volatility of Chesapeake stock over the expected life of an option. The risk-free interest rate is based on the U.S. Treasury rate in effect at the time of the grant over the expected life of the option. The dividend yield is based on an annual dividend yield, taking into account the Company's current dividend policy over the expected life of the option. The Company used the following assumptions to estimate the grant date fair value of the stock options granted in the Current Quarter:



Expected option life - years	6.0
Volatility	48.33	%
Risk-free interest rate	1.97	%
Dividend yield	1.36	%

The following table provides information related to stock option activity during the Current Quarter:



	Number of Shares Underlying Options		Weighted Average Exercise Price Per Share		Weighted Average Contract Life in Years	Aggregate Intrinsic Value^(a)
	(in thousands)					($ in millions)
Outstanding at January 1, 2014	5,268		$	19.28	6.66	$	41
Granted	786		$	25.71
Exercised	(270	)	$	18.23		$	2
Expired	—		$	—
Outstanding at March 31, 2014	5,784		$	20.20	7.15	$	31

Exercisable at March 31, 2014	1,766		$	18.95	3.72	$	12

___________________________________________


(a)	The intrinsic value of a stock option is the amount by which the current market value or the market value upon exercise of the underlying stock exceeds the exercise price of the option.

As of March 31, 2014, there was $21 million of total unrecognized compensation expense related to stock options. The expense is expected to be recognized over a weighted average period of approximately 2.4 years.

The vesting of certain stock option grants may result in state and federal income tax benefits related to the difference between the market price of the common stock at the date of vesting and the date of grant. During the Current Quarter and the Prior Quarter, we recognized excess tax benefits related to stock options of a nominal amount and $0, respectively. All amounts were recorded as adjustments to additional paid-in capital and deferred income taxes.

Compensation Expenses. We recorded the following compensation expenses related to restricted stock and stock options during the Current Quarter and the Prior Quarter:



	Three Months Ended March 31,
	2014		2013
	($ in millions)
General and administrative expenses	$	12	$	20
Natural gas and oil properties	7		21
Natural gas, oil and NGL production expenses	4		6
Marketing, gathering and compression expenses	2		3
Oilfield services expenses	2		3
Total	$	27	$	53

Liability-Classified Awards

Performance Share Units. In 2012, 2013 and 2014, we granted PSUs to senior management under our Long Term Incentive Plan that settle in cash at the end of their respective performance periods and vest ratably over their respective terms. The 2012 awards were granted in one-, two- and three-year tranches and are settled in cash on the first, second and third anniversary dates of the awards, and the 2013 and 2014 awards are settled in cash on the third anniversary of the awards. The ultimate amount earned is based on the performance metrics established by the Compensation Committee of the Board of Directors, which include relative and absolute total shareholder return (TSR) and, for certain of the awards, the achievement of operational performance goals such as production and proved reserve growth. The TSR metric is considered a market condition and generally requires a Monte Carlo simulation to determine the fair value.

For PSUs granted in 2012, each of the TSR and operational payout components can range from 0% to 125% resulting in a maximum total payout of 250%. For PSUs granted in 2013, the TSR component can range from 0% to 125% and each of the two operational components can range from 0% to 62.5%; however, the maximum total payout is capped at 200%. For PSUs granted in 2014, the TSR component can range from 0% to 200%, with no operational components. For the 2013 and 2014 PSUs, the payout percentage is capped at 100% if the Company’s absolute TSR is less than zero. The following table presents a summary of our PSU awards as of March 31, 2014:



	Units	Fair Value as of Grant Date		Fair Value		Liability for Vested Amount
		($ in millions)
2012 Awards ^(a)
Payable 2015	834,248	$	23	$	21	$	21

2013 Awards
Payable 2016	1,600,438	$	35	$	52	$	45

2014 Awards
Payable 2017	620,669	$	17	$	16	$	4

___________________________________________


(a)	In the Current Quarter and the Prior Quarter, we paid $11 million and $2 million, respectively, related to 2012 PSU awards.

Compensation Expenses. We recorded the following compensation expenses related to PSUs during the Current Quarter and the Prior Quarter:



	Three Months Ended March 31,
	2014			2013
	($ in millions)
Natural gas and oil properties	$	1		$	4
General and administrative expenses	(1		)	5
Marketing, gathering and compression expenses	—			2
Total	$	—		$	11