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 and performance bonuses 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 on unvested shares. A summary of the changes in unvested shares of restricted stock during the Current Period 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	4,754		$	26.11
Vested	(2,623	)	$	23.00
Forfeited	(2,706	)	$	29.27
Unvested shares as of June 30, 2014	12,825		$	23.23

The aggregate intrinsic value of restricted stock that vested during the Current Period was approximately $70 million based on the stock price at the time of vesting.

As of June 30, 2014, there was $191 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 2.4 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 and the Current Period, we recognized excess tax benefits related to restricted stock of a nominal amount and $3 million, respectively, and during the Prior Quarter and the Prior Period we recognized reductions in tax benefits related to restricted stock of $2 million and $12 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 to certain officers of stock options 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 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 weighted average assumptions to estimate the grant date fair value of the stock options granted in the Current Period:



Expected option life - years	5.9
Volatility	48.63	%
Risk-free interest rate	1.93	%
Dividend yield	1.33	%

The following table provides information related to stock option activity during 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, 2014	5,268		$	19.28	6.66	$	41
Granted	994		$	24.43
Exercised	(1,309	)	$	18.75		$	11
Expired	(19	)	$	18.97
Forfeited	(262	)	$	20.30
Outstanding at June 30, 2014	4,672		$	19.60	7.90	$	54

Exercisable at June 30, 2014	1,106		$	18.55	6.97	$	14

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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 June 30, 2014, there was $16 million of total unrecognized compensation expense related to stock options. The expense is expected to be recognized over a weighted average period of approximately 2.2 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, the Prior Quarter, the Current Period and the Prior Period, we recognized excess tax benefits related to stock options of a nominal amount, $0, a nominal amount and $0, respectively. 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 during the Current Quarter, the Prior Quarter, the Current Period and the Prior Period:



	Three Months Ended June 30,				Six Months Ended June 30,
	2014		2013		2014		2013
	($ in millions)
General and administrative expenses	$	11	$	15	$	24	$	35
Natural gas and oil properties	9		12		16		32
Natural gas, oil and NGL production expenses	5		6		8		12
Marketing, gathering and compression expenses	1		1		3		4
Oilfield services expenses	3		2		5		5
Total	$	29	$	36	$	56	$	88

Liability-Classified Awards

Performance Share Units. In 2012, 2013 and 2014, we granted PSUs to senior management 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 achievement of 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.

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 PSU grants are recognized quarterly and valued based on the 20-day average stock price multiplied by the current estimate of the performance units that will be allocated upon vesting. The number of units allocated is dependent upon the Company’s estimates of the underlying performance measures. For the 2014 awards, the Company utilized the Monte Carlo simulation for the TSR performance measure, and used the following assumptions to determine the grant date fair value of the PSUs granted in the Current Period:



Volatility	41.37	%
Risk-free interest rate	0.76	%
Dividend yield for value of awards	1.36	%

The following table presents a summary of our PSU awards as of June 30, 2014:



	Units	Fair Value as of Grant Date		Fair Value		Liability for Vested Amount
		($ in millions)
2012 Awards ^(a)
Payable 2015	884,507	$	23	$	31	$	31

2013 Awards
Payable 2016	1,701,941	$	35	$	66	$	59

2014 Awards
Payable 2017	658,059	$	17	$	20	$	9

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

PSU Compensation. We recognized the following compensation costs related to PSUs during the Current Quarter, the Prior Quarter, the Current Period and the Prior Period:



	Three Months Ended June 30,				Six Months Ended June 30,
	2014		2013		2014		2013
	($ in millions)
Natural gas and oil properties	$	2	$	1	$	3	$	4
General and administrative expenses	11		4		10		9
Marketing, gathering and compression expenses	1		—		1		2
Total	$	14	$	5	$	14	$	15

Effects of the Spin-off on Share Based-Compensation

The employee matters agreement (see Note 2) addresses the treatment of holders of Chesapeake stock options, restricted stock and performance share units. 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 will no longer participate in benefit plans sponsored or maintained by Chesapeake. In addition, the employee matters agreement provides that each party will be responsible for the compensation of its current employees and for all liabilities relating to its former employees.