Share-Based Compensation

Stockholder Approved Equity Compensation Plans

We establish share-based incentive compensation plans for the purpose of attracting and retaining officers, key employees, and non-employee board members. As of December 31, 2012, we had one share-based incentive compensation plan, the Kilroy Realty 2006 Incentive Award Plan as amended (the “2006 Plan”), which was adopted by our board of directors and approved by our stockholders.

As of December 31, 2012, 639,487 shares were available for grant under the 2006 Plan. The number of shares that remains available for grant is calculated using the weighted share counting provisions set forth in the 2006 Plan, which are based on the type of awards that are granted. The maximum number of shares available for grant subject to full value awards (which generally include equity awards other than options and stock appreciation rights) was 219,002 shares as of December 31, 2012.

The Executive Compensation Committee, which is comprised of four independent directors, may grant the following share-based awards as provided under the 2006 Plan: incentive stock options, nonqualified stock options, restricted stock (nonvested shares), stock appreciation rights, performance shares, performance stock units, dividend equivalents, stock payments, deferred stock, RSUs, profit interest units, performance bonus awards, performance-based awards, and other incentive awards to eligible individuals. For each award granted under our share-based incentive compensation programs, the Operating Partnership simultaneously issues to the Company a number of common units equal to the number of shares of common stock ultimately paid by the Company in respect of such awards.

All of our outstanding share-based awards issued prior to 2007 were issued under the 1997 Stock Option and Incentive Plan (the “1997 Plan”), which was terminated by our board of directors in September 2006. Any awards that were outstanding upon the termination of the 1997 Plan continued in effect in accordance with the terms of such plan and the applicable award agreement following termination of the 1997 Plan.

Stock Award Deferral Program

We have a Stock Award Deferral Program (the “RSU Program”) under the 2006 Plan. Under the RSU Program, participants may defer receipt of awards of nonvested shares that may be granted by electing to receive an equivalent number of RSUs in lieu of nonvested shares. Each RSU represents the right to receive one share of our common stock in the future and is subject to the same vesting conditions that would have applied if the award had been issued in nonvested shares. RSUs carry with them the right to receive dividend equivalents such that participants receive additional, fully-vested RSUs at the time dividends are paid equal to the value of the dividend paid on the shares underlying participant RSUs. Shares issued in settlement of vested RSUs including RSUs paid on dividend equivalents will be distributed in a single lump sum distribution upon the earlier of (1) the date specified by the participant when the election is made, which may be no earlier than two years after the start of the calendar year to which the election applies, or (2) upon other certain events specified under the RSU program.

Share-Based Compensation Programs

The Executive Compensation Committee has historically awarded nonvested shares and RSUs under the following share-based compensation programs. These share-based awards were valued based on the quoted closing share price of the Company’s common stock on the NYSE on the applicable grant date. Dividends are paid on all outstanding shares and RSUs whether vested or nonvested and are not forfeitable if the underlying shares or RSUs ultimately do not vest.

Executive Officer Share-Based Compensation Programs

The Executive Compensation Committee has annually approved compensation programs that include the potential issuance of share-based awards to our Chief Executive Officer, Chief Operating Officer, Chief Investment Officer and Chief Financial Officer (“the Executive Officers”) as part of their annual and long-term incentive compensation. Incentive compensation for our executive officers for 2011 and 2012 was structured to allow the Executive Compensation Committee to evaluate a variety of key factors and metrics at the end of the year and make a determination of share-based incentive compensation for executive officers based on the Company's and management's overall performance. In years prior to 2011, the number of nonvested shares or nonvested RSUs issued has been contingent upon specific corporate performance and market conditions. The share-based awards are generally issued in the first quarter after the end of our prior fiscal year. The share-based awards generally have a service vesting period, which has historically ranged from one to five years, depending on the type of award.

Key Employee Share-Based Compensation Program

The Executive Compensation Committee has historically awarded nonvested shares or nonvested RSUs to other key employees on an annual basis as part of their long-term incentive compensation. The share-based awards are generally issued in the first quarter, and the individual share awards generally vest in equal annual installments over the applicable service vesting period, which has historically ranged from two to five years.

Non-employee Board Members Share-Based Compensation Program

The Board of Directors awards nonvested shares or nonvested RSUs to non-employee board members on an annual basis as part of such board members’ annual compensation and to newly elected non-employee board members in accordance with our board of directors compensation program. The share-based awards are generally issued in the second quarter, and the individual share awards vest in equal annual installments over the applicable service vesting period, which will be one year.

Summary of 2012 CEO RSU Awards

On March 30, 2012, the Executive Compensation Committee of the Company's Board of Directors granted 206,477 restricted stock units ("RSUs") to the Company's Chief Executive Officer. Fifty-percent of the RSUs granted will vest in seven equal annual installments beginning on December 31, 2012 through December 31, 2018, subject to continued employment through the applicable vesting date. The grant date fair value of these time-based RSUs was $4.8 million, which was based on the $46.61 closing share price of the Company's common stock on the New York Stock Exchange on the grant date. Compensation expense will be recognized on a straight-line basis over the service vesting period for these time-based RSUs. The remaining 50% of the RSUs granted will vest in seven equal annual installments for each calendar year during 2012 through 2018 based on the achievement of certain absolute or relative total shareholder return goals measured annually or, if neither of the shareholder return hurdles are achieved for an applicable year during the performance period, those RSUs will remain eligible to vest in a subsequent year (ending in 2018) based on the achievement of a cumulative total shareholder return goal, as well as (in each case) continued employment through the applicable vesting date. The grant date fair value of these market measure-based RSUs was $4.3 million and was calculated using a Monte Carlo simulation pricing model based on the assumptions in the table below. The grant date fair value is allocated among each of the seven annual vesting tranches for these market measure-based RSUs and compensation expense will be recognized over the service vesting period using the accelerated expense attribution method.



	March 2012 Market Measure-based RSU Grant
Grant date fair value per share	$41.20
Expected share price volatility	31.00%
Risk-free interest rate	1.60%
Dividend yield	3.80%
Expected life	7 years

The computation of expected volatility is based on a blend of the historical volatility of our shares of common stock over 14 years as that is expected to be most consistent with future volatility and equates to a time period twice as long as the seven-year term of the RSUs and implied volatility data based on the observed pricing of six-month publicly-traded options on our shares of common stock. The risk-free interest rate is based on the yield curve on zero-coupon U.S. Treasury STRIP securities in effect at the grant date. The expected dividend yield is estimated by examining the average of the historical dividend yield levels over the seven-year term of the RSUs and our current annualized dividend yield as of the grant date. The expected life of the RSUs is equal to the seven-year vesting period.

As of December 31, 2012, the first tranche of 14,748 market-measure based RSUs was earned and distributed to the Chief Executive Officer, with 6,883 shares tendered for taxes.

Summary of Time-Based RSUs

A summary of our time-based RSU activity from January 1, 2012 through December 31, 2012 is presented below:



	Nonvested RSUs
Nonvested and Vested Restricted Stock Units	Amount		Weighted-Average Grant Date Fair Value		Vested RSUs		Total RSUs
Outstanding at January 1, 2012	147,961		$	32.18	694,714		842,675
Granted ⁽¹⁾	204,829		44.34		—		204,829
Vested	(73,688	)	38.91		73,688		—
Settled⁽²⁾					(19,955	)	(19,955	)
Issuance of dividend equivalents ⁽³⁾					28,368		28,368
Canceled ^{(2) (4)}					(7,054	)	(7,054	)
Outstanding as of December 31, 2012	279,102		$	41.30	769,761		1,048,863

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(1)	Includes 103,239 RSUs issued to the Company's Chief Executive Officer, as described above.


(2)	In August 2012 and December 2012, certain vested RSUs were settled in shares of the Company's common stock.


(3)	RSUs issued as dividend equivalents are vested upon issuance.


(4)	We accept the return of RSUs, at the current quoted market price of the Company's common stock, to satisfy minimum statutory tax-withholding requirements related to either RSUs that have vested or RSU dividend equivalents in accordance with the terms of the 2006 Plan.

A summary of our time-based RSU activity for the years ended December 31, 2012, 2011, and 2010 is presented below:



	RSUs Granted			RSUs Vested
Year Ended	Non-Vested RSUs Issued	Weighted- Average Grant-Date Fair Value		Vested RSUs		Total Vest-Date Fair Value ⁽¹⁾ (in thousands)
2012	204,829	$	44.34	(73,688	)	$	3,118
2011	107,673	37.94		(85,466	)	3,273
2010	159,606	30.24		(303,146	)	10,936

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(1) Total fair value of RSUs vested was calculated based on the quoted closing share price of the Company's common stock on the NYSE on the day of vesting.

Summary of Nonvested Shares

A summary of our nonvested shares activity from January 1, 2012 through December 31, 2012 is presented below:



Nonvested Shares	Shares		Weighted-Average Grant-Date Fair Value
Outstanding at January 1, 2012	83,966		$	39.83
Granted	62,137		41.84
Vested ⁽¹⁾	(50,862	)	41.29
Outstanding as of December 31, 2012	95,241		$	40.42

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(1)	The total shares vested include 18,766 of shares that were then tendered to satisfy minimum statutory tax withholding requirements related to the restricted shares that have vested in accordance with the terms of the 2006 Plan. We accept the return of shares at the current quoted market price of the Company's common stock to satisfy tax obligations.

A summary of our nonvested and vested shares activity for the years ended December 31, 2012, 2011, and 2010 is presented below:



	Shares Granted			Shares Vested
Year Ended	Non-Vested Shares Issued	Weighted- Average Grant-Date Fair Value		Vested Shares		Total Vest-Date Fair Value ⁽¹⁾ (in thousands)
2012	62,137	$	41.84	(50,862	)	$	2,110
2011	68,727	37.83		(34,793	)	1,334
2010	3,239	30.88		(41,680	)	1,398

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(1)	Total fair value of shares vested was calculated based on the quoted closing share price of the Company's common stock on the NYSE on the day of vesting.

Summary of Stock Options

On February 22, 2012, the Executive Compensation Committee of the Company granted non-qualified stock options to certain key members of our senior management team, including our executive officers, to purchase an aggregate 1,550,000 shares of the Company's common stock at an exercise price per share equal to $42.61, the closing price of the Company's common stock on the grant date. The options will vest ratably in annual installments over a five-year period, subject to continued employment through the applicable vesting date. The term of each option is ten years from the date of the grant. Dividends will not be paid on vested or unvested options. The options were granted pursuant to the 2006 Plan.

The fair value of each stock option granted is estimated on the date of grant using the Black-Scholes option pricing model based on the following assumptions for the February 2012 grant.



	February 2012 Option Grant
Fair value of options granted per share	$9.20
Expected stock price volatility	33.00%
Risk-free interest rate	1.35%
Dividend yield	3.80%
Expected life of option	6.5 years

The computation of expected volatility is based on a blend of the historical volatility of our shares of common stock over a time period longer than the expected life of the option and implied volatility data based on the observed pricing of six-month publicly traded options on our shares of common stock. The risk-free interest rate is based on the yield curve on zero-coupon U.S. Treasury STRIP securities in effect at the grant date. The expected dividend yield is estimated by examining the average of the historical dividend yield levels over the expected life of the option and the current dividend yield as of the grant date. The expected life of the options is calculated as the average of the vesting term and the contractual term.

A summary of our stock option activity from January 1, 2012 through December 31, 2012 is presented below:



	Number of Options		Exercise Price	Remaining Contractual Term (years)
Outstanding at January 1, 2012 ⁽¹⁾	5,000		$25.77
Granted	1,550,000		42.61
Exercised ⁽¹⁾	(5,000	)	25.77
Forfeited	(10,000	)	42.61
Outstanding at December 31, 2012 ⁽²⁾⁽³⁾	1,540,000		$42.61	9.2

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(1)	Stock options outstanding as of December 31, 2011 were granted in 2002 and exercised in 2012 prior to expiration. No stock options were granted during 2003 through 2011.


(2)	As of December 31, 2012, none of the outstanding stock options were exercisable.


(3)	The total intrinsic value of options outstanding at December 31, 2012 was $7.3 million.

Share-based Compensation Cost Recorded During the Period

The total compensation cost for all share-based compensation programs was $8.5 million, $5.6 million, and $7.4 million for the years ended December 31, 2012, 2011, and 2010, respectively. Included in the total $7.4 million of compensation cost for the year ended December 31, 2010 was the reversal of approximately $1.1 million of cumulative compensation expense previously recorded during the years 2007 through 2010 for the 2007 Development Performance Plan, because the performance targets for this program were not ultimately achieved. Of the total share-based compensation cost, $0.9 million, $1.1 million, and $1.4 million was capitalized as part of real estate assets for the years ended December 31, 2012, 2011, and 2010, respectively. As of December 31, 2012, there was approximately $25.9 million of total unrecognized compensation cost related to nonvested incentive awards granted under share-based compensation arrangements that is expected to be recognized over a weighted-average period of 2.6 years. The remaining compensation cost related to these nonvested incentive awards had been recognized in periods prior to December 31, 2012. The $25.9 million of unrecognized compensation cost does not reflect the potential future compensation related to share-based awards that were granted subsequent to December 31, 2012.