Share-Based Compensation

Stockholder Approved Share-Based Incentive Compensation Plan

As of December 31, 2016, we maintained one share-based incentive compensation plan, the Kilroy Realty 2006 Incentive Award Plan, as amended (the “2006 Plan”). At our annual meeting of stockholders on May 21, 2015, stockholders approved an amendment and restatement of the 2006 Plan, which included an increase in the maximum number of shares that may be issued or awarded under the 2006 Plan to 8,320,000 shares. As of December 31, 2016, 1.3 million shares were available for grant under the 2006 Plan. The calculation of shares available for grant is presented after taking into account a reserve for a sufficient number of shares to cover the vesting and payment of 2006 Plan awards that were outstanding on that date, including performance-based vesting awards at (i) levels actually achieved for the performance conditions (as defined below) and (ii) at target levels for the market conditions (as defined below) applicable to these awards.

The Executive Compensation Committee ( the “Compensation Committee”) of the Company's Board of Directors may grant the following share-based awards to eligible individuals, 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, restricted stock units (“RSUs”), profit interest units, performance bonus awards, performance-based awards and other incentive awards. 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.

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 such nonvested shares, or defer payment of RSU awards. 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 RSUs at the time dividends are paid equal to the value of the dividend earned on the shares underlying the participant’s RSUs. The dividend equivalents earned vest based on terms specified under the related RSU award agreement. Shares issued upon settlement of vested RSUs, including RSUs paid on dividend equivalents, are distributed in a single lump sum distribution upon the earlier of (1) the date specified by the participant when the election is made or (2) occurrence of certain other events specified under the RSU program.

Share-Based Compensation Programs

The Compensation Committee has historically awarded nonvested shares and RSUs under the share-based compensation programs described below. 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. Prior to 2014, the Compensation Committee awarded annual long-term equity awards based primarily on the prior year’s performance, however, starting in January 2014, such annual awards have been granted as an incentive for the year in which the awards were granted and subsequent years.

Executive Officer and Key Employee Share-Based Compensation Programs

The Compensation Committee has annually approved compensation programs that include the potential issuance of share-based awards to our executive officers and other key employees as part of their annual and long-term incentive compensation. 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.

Non-Employee Board Member 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 for the annual non-employee board awards and four years for the awards relating to newly elected non-employee board members.

2016 and 2015 Share-Based Compensation Grants

On January 28, 2016 (the “2016 RSU Grant Date”), the Compensation Committee of the Company’s Board of Directors awarded 294,821 RSUs to certain officers of the Company under the 2006 Plan, which included 168,077 RSUs (at the target level of performance), or 57%, that are subject to time-based, market and performance-based vesting requirements (each a “2016 Performance-Based RSU” and collectively, the “2016 Performance-Based RSU Grant”) and 126,744 RSUs, or 43%, that are subject to time-based vesting requirements (each a “2016 Time-Based RSU” and collectively, the “2016 Time-Based RSU Grant”).

On January 27, 2015 (the “2015 RSU Grant Date”), the Compensation Committee of the Company’s Board of Directors awarded 212,468 RSUs to certain officers of the Company under the 2006 Plan, which included 127,657 RSUs that are subject to time-based, market and performance-based vesting requirements (each a “2015 Performance-Based RSU” and collectively, the “2015 Performance-Based RSU Grant”) and 84,811 RSUs that are subject to time-based vesting requirements (each a “2015 Time-Based RSU” and collectively, the “2015 Time-Based RSU Grant”).

2016 and 2015 Performance-Based RSU Grants

The 2016 Performance-Based RSUs and 2015 Performance-Based RSUs (collectively, the “Performance-Based RSUs”) are scheduled to cliff vest at the end of a three-year service period subject to the compensation committee's determination that the Company has achieved the pre-defined FFO per share goals (the “performance conditions”) and upon the average annual relative total stockholder return versus a comparator group of Companies that consist of Companies in the SNL US REIT Office Index (the “market conditions”) for the three-year periods detailed in the table below. The number of Performance-Based RSUs ultimately earned, and therefore the compensation costs for these awards, can fluctuate from the original number of RSUs granted based upon the levels of achievement for both the FFO per share and relative total stockholder return metrics. During each of the 2016 and 2015 performance periods, the estimate of the number of RSUs earned was evaluated quarterly based on our forecasted level of achievement of the FFO per share hurdle. As of December 31, 2016, the FFO per share hurdle performance conditions were achieved at approximately 144% of target for the 2016 Performance-Based RSUs. As of December 31, 2015, the FFO per share hurdle performance conditions were achieved at 150% of target for the 2015 Performance-Based RSUs. As a result, the number of RSUs earned as of that date based on the FFO per share performance, excluding the impact of forfeitures, was as follows:



	2016 Performance-Based RSU Grant	2015 Performance-Based RSU Grant
Service vesting period	January 28, 2016 - January 5, 2019	January 27, 2015 - January 5, 2018
Target RSUs granted	168,077	127,657
Estimated RSUs earned based on FFO per share performance condition	241,438	185,510
Date of fair valuation	January 28, 2016	January 27, 2015

Each Performance-Based RSU represents the right to receive one share of our common stock in the future, subject to, and as modified by, the Company's level of achievement of the market condition. The fair value of the 2016 Performance-Based RSU Grant was $9.6 million at January 28, 2016 and the fair value of the 2015 Performance-Based RSU Grant was $10.1 million at January 27, 2015. The fair value for each grant was calculated using a Monte Carlo simulation pricing model based on the assumptions in the table below. The determination of the fair value of the Performance-Based RSU Grants take into consideration the likelihood of achievement of both the performance condition and the market condition discussed above. For the year ended December 31, 2016, we recorded compensation expense for the 2016 Performance-Based RSU Grant based upon the $57.08 fair value per share at January 28, 2016 multiplied by the 241,438 RSUs estimated to be earned at December 31, 2016. For the years ended December 31, 2016 and 2015, we recorded compensation expense for the 2015 Performance-Based RSU Grant based upon the $78.55 fair value per share at January 27, 2015 multiplied by the 185,510 RSUs, which is net of forfeitures, estimated to be earned at December 31, 2015. Compensation expense for the Performance-Based RSUs is recorded on a straight-line basis over the respective three-year periods. The following table summarizes the assumptions utilized in the Monte Carlo simulation pricing models:



	2016 Award Fair Value Assumptions	2015 Award Fair Value Assumptions
Valuation date	January 28, 2016	January 27, 2015
Fair value per share on valuation date	$57.08	$78.55
Expected share price volatility	26.00%	20.00%
Risk-free interest rate	1.13%	0.92%
Remaining expected life	2.9 years	2.9 years

The computation of expected volatility was based on a blend of the historical volatility of our shares of common stock over approximately five years, as this is expected to be most consistent with future volatility and equates to a time period twice as long as the approximate two and a half year remaining performance period of the RSUs and implied volatility data based on the observed pricing of six month publicly-traded options on shares of our common stock. The risk-free interest rate was based on the yield curve on zero-coupon U.S. Treasury STRIP securities in effect at January 28, 2016 and January 27, 2015.

2016 and 2015 Time-Based RSU Grants

The 2016 and 2015 Time-Based RSUs (collectively, the “Time-Based RSUs”) are scheduled to vest in equal installments over the periods listed below. Compensation expense for the Time-Based RSUs will be recognized on a straight-line basis from the grant date through the continued service vesting periods. Each Time-Based RSUs represents the right to receive one share of our common stock in the future, subject to continued employment through the applicable vesting date. The total fair value of the Time-Based RSUs is based on the Company's closing share price on the NYSE on the respective fair valuation dates as detailed in the table below:



	2016 Time-Based RSU Grant		2015 Time-Based RSU Grant
Service vesting period	January 28, 2016 - January 5, 2019		January 27, 2015 - January 5, 2018
Fair value on valuation date (in millions)	$	7.1	$	6.4
Fair value per share	$	56.23	$	75.34
Date of fair valuation	January 28, 2016		January 27, 2015

Summary of Market-Measure Based RSUs

A summary of our market-measure based RSU activity from January 1, 2016 through December 31, 2016 is presented below:



	Nonvested RSUs				Vested RSUs		Total RSUs
	Amount		Weighted-Average Fair Value Per Share ⁽¹⁾		Vested RSUs		Total RSUs
Outstanding at January 1, 2016	425,452		$	67.68	—		425,452
Granted	258,393		57.36		—		258,393
Vested	(36,914	)	43.53		36,914		—
Settled ⁽²⁾					(36,914	)	(36,914	)
Issuance of dividend equivalents ⁽³⁾	12,120		65.50		—		12,120
Outstanding as of December 31, 2016 ⁽⁴⁾	659,051		$	64.95	—		659,051

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(1)	Represents the grant-date fair value for all awards, excluding the 2014 Performance-Based RSU Grant, which was re-measured upon stockholder approval of the amended 2006 Plan on May 22, 2014, as an insufficient number of shares were available to settle these RSUs upon initial grant on January 29, 2014.

(2)

Represents vested RSUs that were settled in shares of the Company’s common stock. Total shares settled include 19,264 shares that were tendered in accordance with the terms of the 2006 Plan to satisfy minimum statutory tax withholding requirements related to the RSUs settled. We accept the return of RSUs at the current quoted closing share price of the Company’s common stock to satisfy tax obligations.


(3)	Represents the issuance of dividend equivalents earned on the underlying RSUs. The dividend equivalents vest based on terms specified under the related RSU award agreement.

(4)

Outstanding RSUs as of December 31, 2016 represent the achievement of the maximum performance conditions and assumed target levels for the market conditions. The number of restricted stock units ultimately earned is subject to change based upon actual performance over the three-year vesting period. Dividend equivalents earned will vest along with the underlying award and are also subject to changes based on the number of RSUs ultimately earned for each underlying award.

A summary of our market-measure based RSU activity for years ended December 31, 2016, 2015 and 2014 is presented below:



	RSUs Granted			RSUs Vested
Years ended December 31,	Non-Vested RSUs Granted	Weighted-Average Fair Value Per Share ⁽¹⁾		Vested RSUs		Total Vest-Date Fair Value (in thousands)
2016	258,393	$	57.36	(36,914	)	$	2,788
2015	191,483	79.25		—		—
2014	183,365	64.86		(16,338	)	1,092

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(1)	Represents the grant-date fair value for all awards, excluding the 2014 Performance-Based RSU Grant, which was re-measured upon stockholder approval of the amended 2006 Plan on May 22, 2014, as an insufficient number of shares were available to settle these RSUs upon initial grant on January 29, 2014.

Summary of Time-Based RSUs

A summary of our time-based RSU activity from January 1, 2016 through December 31, 2016 is presented below:



	Nonvested RSUs				Vested RSUs		Total RSUs
	Amount		Weighted Average Fair Value Per Share ⁽¹⁾		Vested RSUs		Total RSUs
Outstanding at January 1, 2016	318,449		$	58.91	951,360		1,269,809
Granted	173,747		58.29		—		173,747
Vested	(130,784	)	57.91		130,784		—
Settled ⁽²⁾					(72,148	)	(72,148	)
Issuance of dividend equivalents⁽³⁾	5,027		65.78		23,243		28,270
Canceled ⁽⁴⁾					(4,489	)	(4,489	)
Outstanding as of December 31, 2016	366,439		$	59.07	1,028,750		1,395,189

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(1)	Represents the grant-date fair value for all awards, excluding the 2014 Performance-Based RSU Grant, which was re-measured upon stockholder approval of the amended 2006 Plan on May 22, 2014, as an insufficient number of shares were available to settle these RSUs upon initial grant on January 29, 2014.

(2)

Represents vested RSUs that were settled in shares of the Company’s common stock. Total shares settled include 23,087 shares that were tendered in accordance with the terms of the 2006 Plan to satisfy minimum statutory tax withholding requirements related to the RSUs settled. We accept the return of RSUs at the current quoted closing share price of the Company’s common stock to satisfy tax obligations.


(3)	Represents the issuance of dividend equivalents earned on the underlying RSUs. The dividend equivalents vest based on terms specified under the related RSU award agreement.


(4)	For shares vested but not yet settled, we accept the return of RSUs at the current quoted closing share price of the Company’s common stock to satisfy minimum statutory tax-withholding requirements related to either the settlement or vesting of RSUs in accordance with the terms of the 2006 Plan.

A summary of our time-based RSU activity for the years ended December 31, 2016, 2015 and 2014 is presented below:



	RSUs Granted			RSUs Vested
Year ended December 31,	Non-Vested RSUs Issued	Weighted-Average Grant Date Fair Value Per Share		Vested RSUs		Total Vest-Date Fair Value ⁽¹⁾ (in thousands)
2016	173,747	$	58.29	(130,784	)	$	8,438
2015	98,802	74.49		(107,541	)	7,528
2014	155,016	59.89		(116,447	)	6,675

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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. Excludes the issuance of dividend equivalents earned on the underlying RSUs. The dividend equivalents vest based on terms specified under the related RSU award agreement.

Summary of Nonvested Restricted Stock

A summary of our nonvested restricted stock activity from January 1, 2016 through December 31, 2016 is presented below:



	Nonvested Restricted Stock		Weighted-Average Grant Date Fair Value Per Share
Outstanding at January 1, 2016	60,797		$	47.32
Vested ⁽¹⁾	(24,262	)	46.39
Outstanding as of December 31, 2016	36,535		$	47.93

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(1)	The total shares vested includes 12,661 shares that were tendered in accordance with the terms of the 2006 Plan to satisfy minimum statutory tax withholding requirements related to the restricted shares that have vested. We accept the return of shares at the current quoted closing share price of the Company’s common stock to satisfy tax withholding obligations.

A summary of our nonvested and vested restricted stock activity for years ended December 31, 2016, 2015 and 2014 is presented below:



	Shares Granted			Shares Vested
Years ended December 31,	Nonvested Shares Issued	Weighted-Average Grant Date Fair Value Per Share		Vested Shares		Total Fair Value at Vest Date⁽¹⁾ (in thousands)
2016	—	$	—	(24,262	)	$	1,527
2015	—	—		(24,264	)	1,725
2014	213	51.35		(25,899	)	1,323

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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 date of vesting.

Summary of Stock Options

On February 22, 2012, the 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 (the “February 2012” Grant) 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. During the year ended December 31, 2016, 267,000 stock options vested with a total fair value of $2.5 million. During the year ended December 31, 2015, 298,000 stock options vested with a total fair value of $2.7 million. During the year ended December 31, 2014, 304,000 stock options vested with a total fair value of $2.8 million.

A summary of our stock option activity related to the February 2012 grant from January 1, 2016 through December 31, 2016 is presented below:



	Number of Options		Exercise Price		Intrinsic Value (in millions) ⁽¹⁾
Outstanding at December 31, 2015	610,000		$	42.61	$	12.6
Exercised	(286,500	)	42.61		8.4
Forfeited	(9,000	)	42.61		0.1
Outstanding at December 31, 2016 ⁽²⁾	314,500		$	42.61	$	9.6

Options exercisable at December 31, 2016 ⁽³⁾	50,500		$	42.61	$	1.5

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(1)	The intrinsic value of a stock option is the amount by which the fair value of the underlying stock exceeds the exercise price of an option. The fair value of the underlying stock was determined by using the closing share price on the NYSE on the date of exercise, forfeiture or respective period end.


(2)	As of December 31, 2016, the average remaining life of stock options outstanding was 5.1 years


(3)	As of December 31, 2016, the average remaining life of stock options exercisable was approximately 5.1 years.

In accordance with the provisions of the 2006 Plan, we allow shares of our common stock to be withheld to satisfy the payment of exercise price and/or minimum statutory tax withholding obligations due upon the exercise of stock options. The value of the shares withheld is calculated based on the closing market price of our common stock on the NYSE on the exercise date. During the year ended December 31, 2016, 25,680 shares were withheld on stock option exercises with an aggregate value of $1.8 million. During the year ended December 31, 2015, 62,072 shares were withheld on stock option exercises with an aggregate value of $3.9 million. During the year ended December 31, 2014, 23,664 shares were withheld on stock option exercises with an aggregate value of $1.5 million.

Share-Based Compensation Cost Recorded During the Period

The total compensation cost for all share-based compensation programs was $26.6 million, $18.9 million and $14.5 million for the years ended December 31, 2016, 2015 and 2014, respectively. Of the total share-based compensation costs, $5.6 million, $3.3 million and $2.3 million was capitalized as part of real estate assets and deferred leasing costs for the years ended December 31, 2016, 2015 and 2014, respectively. As of December 31, 2016, there was approximately $29.6 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 1.8 years. The remaining compensation cost related to these nonvested incentive awards had been recognized in periods prior to December 31, 2016. The $29.6 million of unrecognized compensation costs does not reflect the future compensation cost related to share-based awards that were granted subsequent to December 31, 2016.