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 plans. The restricted stock and stock options are equity-classified awards and the PSUs are liability-classified awards. In connection with the spin-off of our oilfield services business on June 30, 2014, and pursuant to the terms of our share-based compensation plans and the employee matters agreement between Chesapeake and Seventy Seven Energy Inc. (SSE), unexercised stock options and unvested restricted stock were modified as of the date of the spin-off. The modifications were designed to ensure that the value of each award of unexercised stock options and unvested restricted stock did not change as a result of the spin-off. The number of stock options and number of shares of restricted stock reported below have been adjusted to reflect modifications on the spin-off date.

Share-Based Compensation Plans

2014 Long Term Incentive Plan. Our 2014 Long Term Incentive Plan (2014 LTIP), which is administered by the Compensation Committee of our Board of Directors, became effective on June 13, 2014 after it was approved by shareholders at our 2014 Annual Meeting. The 2014 LTIP replaced our Amended and Restated Long Term Incentive Plan which was adopted in 2005. The 2014 LTIP provides for up to 71,600,000 shares of common stock that may be issued as long-term incentive compensation to our employees and non-employee directors; provided, however, that the 2014 LTIP uses a fungible share pool under which (i) each share issued pursuant to a stock option or stock appreciation right (SAR) reduces the number of shares available under the 2014 LTIP by 1.0 share; (ii) each share issued pursuant to awards other than options and SARs reduces the number of shares available by 2.12 shares; (iii) if any awards of restricted stock under the 2014 LTIP, or its predecessor plan, are forfeited, expire, are settled for cash, or are tendered by the participant or withhold by us to satisfy any tax withholding obligation, then the shares subject to the award may be used again for awards; and (iv) PSUs and other performance awards which are payable solely in cash are not counted against the aggregate number of shares issuable. In addition, the 2014 LTIP prohibits the reuse of shares withheld or delivered to satisfy the exercise price of, or to satisfy tax withholding requirements for, an option or SAR. The 2014 LTIP also prohibits “net share counting” upon the exercise of options or SARs.

The 2014 LTIP authorizes the issuance of the following types of awards: (i) nonqualified and incentive stock options; (ii) SARs; (iii) restricted stock; (iv) performance awards, including PSUs; and (v) other stock-based awards. For both stock options and SARs, the exercise price may not be less than the fair market value of our common stock on the date of grant and the maximum exercise period may not exceed ten years from the date of grant. Awards granted under the plan vest at specified dates and/or upon the satisfaction of certain performance or other criteria, as determined by the Compensation Committee. As of December 31, 2016, 61,856,065 shares of common stock remained issuable under the 2014 LTIP.

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. A summary of the changes in unvested restricted stock during 2016, 2015 and 2014 is presented below.



	Shares of Unvested Restricted Stock		Weighted Average Grant Date Fair Value
	(in thousands)
Unvested restricted stock as of January 1, 2016	10,455		$	17.31
Granted	4,604		$	4.58
Vested	(4,692	)	$	17.23
Forfeited	(1,275	)	$	13.91
Unvested restricted stock as of December 31, 2016	9,092		$	11.39

Unvested restricted stock as of January 1, 2015	10,091		$	21.20
Granted	7,095		$	13.90
Vested	(4,157	)	$	21.70
Forfeited	(2,574	)	$	16.98
Unvested restricted stock as of December 31, 2015	10,455		$	17.31

Unvested restricted stock as of January 1, 2014	13,400		$	23.38
Granted	5,049		$	25.92
Vested	(4,803	)	$	27.17
Forfeited	(3,555	)	$	28.09
Unvested restricted stock as of December 31, 2014	10,091		$	21.20

The aggregate intrinsic value of restricted stock that vested during 2016 was approximately $21 million based on the stock price at the time of vesting.

As of December 31, 2016, there was approximately $50 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 1.5 years.

Stock Options. In 2016, 2015 and 2014, we granted members of senior management stock options that vest ratably over a three-year period. 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. 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 2016.



Expected option life – years	6.0
Volatility	46.07	%
Risk-free interest rate	1.70	%
Dividend yield	—	%

The following table provides information related to stock option activity for 2016, 2015 and 2014.



	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 as of January 1, 2016	5,377		$	19.37	5.80	$	—
Granted	4,932		$	3.71
Exercised	—		$	—		$	—
Expired	(771	)	$	19.46
Forfeited	(945	)	$	5.66
Outstanding as of December 31, 2016	8,593		$	11.88	7.22	$	14

Exercisable as of December 31, 2016	2,844		$	19.60	5.53	$	—

Outstanding as of January 1, 2015	4,599		$	19.55	7.03	$	5
Granted	1,208		$	18.37
Exercised	(14	)	$	18.13		$	—
Expired	(416	)	$	18.46
Forfeited	—		$	—
Outstanding as of December 31, 2015	5,377		$	19.37	5.80	$	—

Exercisable as of December 31, 2015	2,045		$	19.61	5.07	$	—

Outstanding as of January 1, 2014	5,268		$	19.28	6.66	$	41
Granted	994		$	24.43
Exercised	(1,322	)	$	18.71		$	11
Expired	(28	)	$	18.97
Forfeited	(313	)	$	21.05
Outstanding as of December 31, 2014	4,599		$	19.55	7.03	$	5

Exercisable as of December 31, 2014	1,304		$	18.71	5.70	$	1

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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 December 31, 2016, there was $7 million of total unrecognized compensation expense related to stock options. The expense is expected to be recognized over a weighted average period of approximately 1.70 years.

Restricted Stock and Stock Option Compensation. We recognized the following compensation costs related to restricted stock and stock options for the years ended December 31, 2016, 2015 and 2014.



	Years Ended December 31,
	2016		2015		2014
	($ in millions)
General and administrative expenses	$	38	$	43	$	46
Oil and natural gas properties	16		23		29
Oil, natural gas and NGL production expenses	13		18		18
Marketing, gathering and compression expenses	1		5		6
Oilfield services expenses	—		—		5
Total	$	68	$	89	$	104

Liability-Classified Awards

Performance Share Units. We have 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 levels.

For PSUs granted in 2016, the TSR component can range from 0% to 100% and the operational component can range from 0% to 100%, resulting in a maximum payout of 200%. 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%. For PSUs granted in 2014, the TSR component can range from 0% to 200%, with no operational components. Compensation expense associated with PSU grants is recognized over the service period based on the graded-vesting method. The value of the PSU awards at the end of each reporting period is dependent upon the Company’s estimates of the underlying performance measures. The Company utilized a Monte Carlo simulation for the TSR performance measure and the following assumptions to determine the grant date fair value of the PSUs. The payout percentage for all PSU grants is capped at 100% if the Company's absolute TSR is less than zero.



Volatility	91.19	%
Risk-free interest rate	1.20	%
Dividend yield for value of awards	—	%

The following table presents a summary of our 2016, 2015 and 2014 PSU awards.



		Grant Date Fair Value		December 31, 2016
	Units	Grant Date Fair Value		Fair Value		Vested Liability
		($ in millions)
2016 Awards:
Payable 2019	2,348,893	$	10	$	20	$	12
2015 Awards:
Payable 2018	629,694	$	13	$	4	$	3
2014 Awards:
Payable 2017	561,215	$	16	$	—	$	—

PSU Compensation. We recognized the following compensation costs (credits) related to PSUs for the years ended December 31, 2016, 2015 and 2016.



	Years Ended December 31,
	2016		2015			2014
	($ in millions)
General and administrative expenses	$	14	$	(19	)	$	(4	)
Restructuring and other termination costs	1		(19		)	(19		)
Marketing, gathering and compression	—		(1		)	—
Oil and natural gas properties	—		(2		)	3
Total	$	15	$	(41	)	$	(20	)

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 13) addresses the treatment of holders of Chesapeake stock options, restricted stock and PSUs that were impacted by the spin-off. Unvested equity-based compensation awards held by Chesapeake Oilfield Operating, L.L.C. (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.