Share-Based Compensation

Chesapeake’s share-based compensation program consists of restricted stock, stock options and performance share units (PSUs) granted to employees and common stock and restricted stock granted to non-employee directors under our long term incentive plans. 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 units to employees and non-employee directors. Prior to 2014, we also granted restricted stock awards as equity compensation. We refer to both types of awards as restricted stock. Restricted stock vests over a minimum of three years and the holder receives dividends, if paid, on unvested shares. A summary of the changes in unvested restricted stock during the Current Period is presented below.



	Shares of Unvested Restricted Stock		Weighted Average Grant Date Fair Value
	(in thousands)
Unvested restricted stock as of January 1, 2015	10,091		$	21.20
Granted	7,016		$	13.97
Vested	(4,025	)	$	21.78
Forfeited	(899	)	$	17.21
Unvested restricted stock as of September 30, 2015	12,183		$	17.14

The aggregate intrinsic value of restricted stock that vested during the Current Period was approximately $59 million based on the stock price at the time of vesting.

As of September 30, 2015, there was approximately $149 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 2.04 years.

The vesting of certain restricted stock grants may result in state and federal income tax benefits, or reductions in these 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, the Prior Quarter, the Current Period and the Prior Period, we recognized reductions in tax benefits related to restricted stock of $5 million, $4 million, $11 million and $1 million, respectively. Each adjustment was recorded to additional paid-in capital and deferred income taxes.

Stock Options. In the Current Period and the Prior Period, we granted members of senior management stock options that vest ratably over a three-year period. In January 2013, we also granted retention awards of stock options to certain officers that 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 expire seven to 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 dividend policy, over the expected life of the option. The Company used the following weighted average assumptions to estimate the grant date fair value of the stock options granted in the Current Period:



Expected option life – years	4.5
Volatility	39.91	%
Risk-free interest rate	1.33	%
Dividend yield	1.91	%

The following table provides information related to stock option activity for the Current Period:



	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, 2015	4,599		$	19.55	7.03	$	5
Granted	1,208		$	18.37
Exercised	(14	)	$	18.13		$	—
Expired	(213	)	$	18.54
Forfeited	—		$	—
Outstanding at September 30, 2015	5,580		$	19.33	5.83	$	—

Exercisable at September 30, 2015	2,248		$	19.50	4.86	$	—

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(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 September 30, 2015, there was $10 million of total unrecognized compensation expense related to stock options. The expense is expected to be recognized over a weighted average period of approximately 1.80 years.

The vesting of certain stock option grants may result in state and federal income tax benefits, or reductions in these 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, the Prior Quarter, the Current Period and the Prior Period, we recognized a reduction in tax benefits related to stock options of nominal amounts. Each adjustment was recorded to additional paid-in capital and deferred income taxes.

Restricted Stock and Stock Option Compensation. We recognized the following compensation costs related to restricted stock and stock options for the Current Quarter, the Prior Quarter, the Current Period and the Prior Period:



	Three Months Ended September 30,				Nine Months Ended September 30,
	2015		2014		2015		2014
	($ in millions)
General and administrative expenses	$	9	$	12	$	33	$	36
Oil and natural gas properties	3		6		18		22
Oil, natural gas and NGL production expenses	4		5		14		13
Marketing, gathering and compression expenses	—		2		3		5
Oilfield services expenses	—		—		—		5
Total	$	16	$	25	$	68	$	81

Liability-Classified Awards

Performance Share Units. In 2013, 2014 and 2015, we granted PSUs to senior management that vest ratably over a three-year term and are settled in cash on the third anniversary of the awards. The ultimate amount earned is based on achievement of performance metrics established by the Compensation Committee of the Board of Directors, which include total shareholder return (TSR) and, for certain of the awards, operational performance goals such as finding and development costs and production and proved reserve growth.

For PSUs granted in 2013, the TSR component can range from 0% to 125% of base salary, 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 PSUs granted in 2015, the TSR component can range from 0% to 100%, and each of the two operational components can range from 0% to 50% resulting in a maximum total payout of 200%. The payout percentage for these PSUs is capped at 100% if the Company’s absolute TSR is less than zero. Compensation expense associated with PSU grants is recognized over the service period based on the graded-vesting method. The number of units settled is dependent upon the Company’s estimates of the underlying performance measures. The Company utilized the Monte Carlo simulation for the TSR performance measure and the following assumptions to determine the grant date fair value of the PSUs:



Volatility	46.36	%
Risk-free interest rate	0.71	%
Dividend yield for value of awards	—	%

The following table presents a summary of our 2013, 2014 and 2015 PSU awards:



	Units	Fair Value as of Grant Date		Fair Value^(a)		Liability for Vested Amount^(a)
		($ in millions)
2013 Awards:
Payable 2016	1,701,941	$	35	$	9	$	9

2014 Awards:
Payable 2017	609,637	$	16	$	1	$	1

2015 Awards:
Payable 2018	696,683	$	13	$	4	$	2

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(a)	As of September 30, 2015.

PSU Compensation. We recognized the following compensation costs (credits) related to PSUs for the Current Quarter, the Prior Quarter, the Current Period and the Prior Period:



	Three Months Ended September 30,						Nine Months Ended September 30,
	2015			2014			2015			2014
	($ in millions)
General and administrative expenses	$	(2	)	$	(12	)	$	(16	)	$	(2	)
Restructuring and other termination costs	(1		)	(17		)	(16		)	(11		)
Marketing, gathering and compression	—			(1		)	(1		)	—
Oil and natural gas properties	—			—			(1		)	3
Total	$	(3	)	$	(30	)	$	(34	)	$	(10	)

Effect of the Spin-off on Share-Based Compensation

The employee matters agreement entered into in connection with the June 2014 spin-off of our oilfield services business (see Note 15) addresses the treatment of holders of Chesapeake stock options, restricted stock and PSUs. Unvested equity-based compensation awards held by COO employees were canceled and replaced with new awards of SSE, and unvested equity-based compensation awards held by Chesapeake employees were adjusted to account for the spin-off, each as of the spin-off date. The employee matters agreement provides that employees of SSE ceased to participate in benefit plans sponsored or maintained by Chesapeake as of the spin-off date. In addition, the employee matters agreement provides that as of the spin-off date, each party is responsible for the compensation of its current employees and for all liabilities relating to its former employees, as determined by their respective employer on the date of termination.