hare-Based and Other Compensation

Stockholder Approved Share-Based Incentive Compensation Plan

As of December 31, 2018, we maintained one share-based incentive compensation plan, the Kilroy Realty 2006 Incentive Award Plan, as amended (the “2006 Plan”). The Company has a currently effective registration statement registering 9.2 million shares of our common stock for possible issuance under our 2006 Incentive Award Plan. As of December 31, 2018, approximately 0.6 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) for which the performance period has been completed and (ii) at maximum levels for the other performance and market conditions (as defined below) for awards still in a performance period.

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.

2018, 2017 and 2016 Share-Based Compensation Grants

In connection with entering into an amended employment agreement (the “Amended Employment Agreement”), on December 27, 2018, the Compensation Committee of the Company’s Board of Directors awarded John Kilroy, the Chairman of the Board of Directors, Chief Executive Officer and President of the Company and the Operating Partnership 483,871 RSUs, providing an additional retention incentive during the term of the agreement and enticing Mr. Kilroy to delay his retirement. Of these RSUs awarded, 266,130 RSUs (at the target level of performance) are subject to market-based vesting requirements and 217,741 RSUs are subject to time-based vesting requirements. In addition to Mr. Kilroy’s award, the Compensation Committee of the Company’s Board of Directors awarded 161,290 RSUs to certain members of management. Of these RSUs awarded, 80,647 RSUs (at the target level of performance) are subject to market-based vesting requirements (together totaling 346,777 target RSUs with Mr. Kilroy’s award, the “December 2018 Market-Based RSUs”) and 80,643 RSUs are subject to time-based vesting requirements (together totaling 298,384 RSUs with Mr. Kilroy’s award, the “December 2018 Time-Based RSUs”).

In January and February 2018, the Executive Compensation Committee of the Company’s Board of Directors awarded 282,038 RSUs to certain officers of the Company under the 2006 Plan, which included 158,205 RSUs (at the target level of performance) that are subject to market and/or performance-based vesting requirements (the “2018 Performance-Based RSUs”) and 123,833 RSUs that are subject to time-based vesting requirements (the “2018 Time-Based RSUs”). Additionally, during 2018, 14,999 RSUs were granted to the board of directors and certain members of management subject to time vesting requirements.

In February 2017, the Executive Compensation Committee of the Company’s Board of Directors awarded 229,976 RSUs to certain officers of the Company under the 2006 Plan, which included 130,956 RSUs (at the target level of performance) that are subject to time-based, market-measure based and performance-based vesting requirements (the “2017 Performance-Based RSUs”) and 99,020 RSUs that are subject to time-based vesting requirements (the “2017 Time-Based RSUs”). Additionally, during 2017, 43,081 RSUs were granted to the board of directors and certain members of management subject to time vesting requirements.

On January 28, 2016, the Executive 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) that are subject to time-based, market-measure based and performance-based vesting requirements (the “2016 Performance-Based RSUs”) and 126,744 RSUs that are subject to time-based vesting requirements (“2016 Time-Based RSUs”). Additionally, during 2016, 47,003 RSUs were granted to the board of directors and certain members of management subject to time vesting requirements.

December 2018 Market-Based RSU Grant

Between 0% and 200% of the total 346,777 target number of December 2018 Market-Based RSUs will be eligible to vest based on the Company’s relative total shareholder return (“TSR”) versus a comparative group of companies that consist of companies in the SNL US REIT Office Index over the performance period. An initial number of RSUs (the “Initial Number of RSUs”) will be determined at the end of 2021 based on a three-year performance period (2019 through 2021). Once the Initial Number of RSUs is determined, 75% of the Initial Number of RSUs will be scheduled to vest on January 5, 2022. The remaining 25% of the Initial Number of RSUs will be scheduled to vest on January 5, 2023, subject to adjustment based on the Company’s relative TSR for the entire four-year performance period (2019 through 2022). The December 2018 Market-Based RSUs are also subject to service vesting requirements through the scheduled vest dates.

Each December 2018 Market-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 applicable market conditions. The December 27, 2018 grant date fair value of the December 2018 Market-Based RSUs was $23.8 million. The fair value was calculated using a Monte Carlo simulation pricing model based on the assumptions in the table below. For the year ended December 31, 2018, we recorded compensation expense based upon the $68.66 grant date fair value per share. Compensation expense for the December 2018 Market-Based RSUs is recognized using a graded vesting approach, where 75% of the fair value will be recognized on a straight-line basis over the three-year initial performance period through the end of 2021, and the remaining 25% of the fair value will be recognized on a straight-line basis over the four-year final performance period through the end of 2022. The following table summarizes the assumptions utilized in the Monte Carlo simulation pricing models:



		December 2018 Market-Based RSU Award Fair Value Assumptions
Valuation date		December 27, 2018
Fair value per share on valuation date		$68.66
Expected share price volatility		23.0%
Risk-free interest rate		2.4%

The computation of expected volatility was based on a blend of the historical volatility of our shares of common stock over a period of twice the performance period 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 December 27, 2018.

2018, 2017 and 2016 Annual Performance-Based RSU Grants

The 2018 Performance-Based RSUs are scheduled to vest at the end of a three-year period (consisting of calendar years 2018-2020). A target number of 2018 Performance-Based RSUs were awarded, and the final number of 2018 Performance-Based RSUs that vest (which may be more or less than the target number) will be based upon (1) the achievement of pre-set FFO per share goals for the year ending December 31, 2018 that applies to 100% of the Performance-Based RSUs awarded (the “2018 FFO Performance Condition”) and (2) a performance measure that applies to 50% of the award based upon a measure of the Company’s average debt to EBITDA ratio for the three-year performance period (the “2018 Debt to EBITDA Ratio Performance Condition” and together with the 2018 FFO Performance Condition, the “2018 Performance Conditions”) and a market measure that applies to the other 50% of the award based upon the relative ranking of the Company’s TSR for the three-year performance period compared to the TSR of an established comparison group of companies over the same period (the “2018 Market Condition”). The 2018 Performance-Based RSUs are also subject to a three-year service vesting provision and are scheduled to cliff vest on the date the final vesting percentage is determined following the end of the three-year performance period under the awards. The 2018 FFO Performance Condition was achieved 175% of target for one participant and 150% of target for all other participants. The number of 2018 Performance-Based RSUs ultimately earned could fluctuate from the current estimated number of 2018 Performance-Based RSUs granted based upon the levels of achievement for the 2018 Debt to EBITDA Ratio Performance Condition, the 2018 Market Condition and the extent to which the service vesting condition is satisfied.

The 2017 Performance-Based RSUs are scheduled to cliff vest at the end of a three-year period (consisting of calendar years 2017-2019) based upon (1) the achievement of pre-defined FFO per share goals for the year ended December 31, 2017 that applies to 100% of the 2017 Performance-Based RSUs awarded (the “2017 FFO Performance Condition”) and (2) also based upon either the average FAD per share growth that applies to 30% of the award or the Company’s average debt to EBITDA ratio that applies to a separate 30% of the award (together, the “Other 2017 Performance Conditions” and together with the 2017 FFO Performance Condition, the “2017 Performance Conditions”) or the relative TSR versus a comparative group of companies that consist of companies in the SNL US REIT Office Index that applies to the remaining 40% of the award (the “2017 Market Condition”) for the three-year period ending December 31, 2019. The 2017 FFO Performance Condition was achieved at a weighted average of approximately 131% of target for the 2017 Performance-Based RSUs. The number of 2017 Performance-Based RSUs ultimately earned could fluctuate from the current estimated number of 2017 Performance-Based RSUs granted based upon the levels of achievement for the Other 2017 Performance Conditions, the 2017 Market Condition and the extent to which the service vesting condition is satisfied.

The 2016 Performance-Based RSUs are also scheduled to cliff vest at the end of a three-year service period based upon the achievement of pre-defined FFO per share goals for the year ended December 31, 2016 (the “2016 Performance Condition”) and also upon the average annual relative total stockholder return versus a comparative group of companies that consist of companies in the SNL US REIT Office Index (the “2016 Market Condition”) for the three-year period ending December 31, 2018. Based upon the combined results of the final 2016 Performance Condition and 2016 Market Condition, the 2016 Performance-Based RSUs achieved 144% of their target level of performance.

As of December 31, 2018, the estimated number of RSUs earned for the 2018 and 2017 Performance-Based RSUs and the actual number of RSUs earned for the 2016 Performance-Based RSUs was as follows:



	2018 Performance-Based RSUs	2017 Performance-Based RSUs	2016 Performance-Based RSUs
Service vesting period	February 14, 2018 - January, 2021	February 24, 2017 - January, 2020	January 28, 2016 - January, 2019
Target RSUs granted	158,205	130,956	168,077
Estimated RSUs earned ⁽¹⁾	254,235	170,994	241,438
Date of valuation	February 14, 2018	February 24, 2017	January 28, 2016

_______________

(1)

Estimated RSUs earned for the 2018 Performance-Based RSUs are based on the actual achievement of the 2018 FFO Performance Condition and assumes target level achievement of the 2018 Debt to EBITDA Ratio Performance Condition and the 2018 Market Condition. Estimated RSUs earned for the 2017 Performance-Based RSUs are based on the actual achievement of the 2017 FFO Performance Condition and assume target level achievement of the 2017 Market Condition and Other 2017 Performance Conditions. The 2016 Performance-Based RSUs earned are based on actual performance of the 2016 Performance Condition and the 2016 Market Condition.

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 applicable performance and market conditions. The fair values of the 2018 Performance-Based RSUs, 2017 Performance-Based RSUs and 2016 Performance-Based RSUs were $10.8 million at February 14, 2018, $10.3 million at February 24, 2017 and $9.6 million at January 28, 2016, respectively. The fair values for the awards with market conditions were calculated using a Monte Carlo simulation pricing model based on the assumptions in the table below. The determination of the fair value of the 2018, 2017 and 2016 Performance-Based RSUs takes into consideration the likelihood of achievement of the 2018, 2017 and 2016 Performance Conditions and the 2018, 2017 and 2016 Market Conditions, respectively, as discussed above. The following table summarizes the assumptions utilized in the Monte Carlo simulation pricing models:



	2018 Award Fair Value Assumptions	2017 Award Fair Value Assumptions	2016 Award Fair Value Assumptions
Valuation date	February 14, 2018	February 24, 2017	January 28, 2016
Fair value per share on valuation date	$70.08	$80.89	$57.08
Expected share price volatility	20.00%	21.00%	26.00%
Risk-free interest rate	2.37%	1.39%	1.13%

The computation of expected volatility was based on a blend of the historical volatility of our shares of common stock over a period of twice the remaining performance period as of the grant date 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 February 14, 2018, February 24, 2017 and January 28, 2016.

Compensation expense for the Performance-Based RSUs is recognized on a straight-line basis over the requisite service period for each participant, which is generally the three-year service period. However, for one participant there was a shorter service period for their 2017 and 2018 Performance-Based RSUs. As of December 31, 2018, the number of 2018 Performance-Based RSUs estimated to be earned based on the Company’s estimate of the performance conditions measured against the applicable goals was 254,235, and the compensation cost recorded to date for this program was based on that estimate. For the portion of the 2018 Performance-Based RSUs subject to the 2018 Market Condition, for the year ended December 31, 2018, we recorded compensation expense based upon the $70.08 fair value per share at February 14, 2018. Compensation expense will be variable for the portion of the 2018 Performance-Based RSUs subject to the 2018 Debt to EBITDA Ratio Performance Condition, based upon the outcome of that condition. As of December 31, 2018, the number of 2017 Performance-Based RSUs estimated to be earned based on the Company’s estimate of the performance conditions measured against the applicable goals was 170,994, and the compensation cost recorded to date for this program was based on that estimate. For the portion of the 2017 Performance-Based RSUs subject to the 2017 Market Condition, for the years ended December 31, 2018 and 2017, we recorded compensation expense based upon the $80.89 fair value per share at February 24, 2017. Compensation expense will be variable for the portion of the 2017 Performance-Based RSUs subject to the Other 2017 Performance Conditions, based upon the outcome of those conditions. For the years ended December 31, 2018, 2017 and 2016, we recorded compensation expense for the 2016 Performance-Based RSUs based upon $57.08 fair value per share at January 28, 2016 multiplied by the 241,438 RSUs, which is net of forfeitures, estimated to be earned at December 31, 2016.

December 2018 and Annual 2018, 2017 and 2016 Time-Based RSU Grants

The annual 2018, 2017 and 2016 Time-Based RSUs are scheduled to vest in equal installments over the periods listed below. The December 2018 Time-Based RSUs are scheduled to vest 50% on January 5, 2022 and 50% on January 5, 2023. Compensation expense for the December 2018 and annual 2018, 2017 and 2016 Time-Based RSUs is recognized on a straight-line basis over the requisite service period, which is generally the explicit service period. However, for one participant there was a shorter service period for their 2017 and 2018 Time-Based RSUs. Each Time-Based RSU 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:



	December 2018 Time-Based RSU Grant		2018 Time-Based RSU Grant⁽¹⁾		2017 Time-Based RSU Grant⁽²⁾		2016 Time-Based RSU Grant
Service vesting period	December 27, 2018 - January 5, 2023		January & February 2018 - January 5, 2021		February 2017 - January 5, 2020		January 28, 2016 - January 5, 2019
Fair value on valuation date (in millions)	$	18.5	$	8.4	$	7.5	$	7.1
Fair value per share	$	62.00	$	70.37	$	73.30	$	56.23
Date of fair valuation	December 27, 2018		January & February 2018		February 2017		January 28, 2016

_______________


(1)	The 2018 Time-Based RSUs consist of 56,015 RSUs granted on January 29, 2018 at a fair value per share of $70.37 and 67,818 RSUs granted on February 14, 2018 at a fair value per share of $66.46.


(2)	The 2017 Time-Based RSUs consist of 41,119 RSUs granted on February 3, 2017 at a fair value per share of $73.30 and 57,901 RSUs granted on February 24, 2017 at a fair value per share of $77.16.

Summary of Performance and Market-Measure Based RSUs

A summary of our performance and market-measure based RSU activity from January 1, 2018 through December 31, 2018 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, 2018	665,110		$	68.83	55,672		720,782
Granted	601,012		68.51		1,067		602,079
Vested	(261,875	)	74.25		261,875		—
Settled ⁽²⁾					(285,818	)	(285,818	)
Issuance of dividend equivalents ⁽³⁾	14,090		71.75		2,976		17,066
Forfeited	—				(11	)	(11	)
Outstanding as of December 31, 2018 ⁽⁴⁾	1,018,337		$	67.29	35,761		1,054,098

_______________


(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 139,933 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, 2018 represent the actual achievement of the FFO performance conditions and assumes target levels for the market and other performance 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 performance and market-measure based RSU activity for years ended December 31, 2018, 2017 and 2016 is presented below:



	RSUs Granted			RSUs Vested
Years ended December 31,	Non-Vested RSUs Granted ⁽¹⁾	Weighted-Average Fair Value Per Share ⁽²⁾		Vested RSUs		Total Vest-Date Fair Value (in thousands)
2018	601,012	$	68.51	(265,918	)	$	18,906
2017	170,994	78.97		(194,991	)	14,270
2016	258,393	57.36		(36,914	)	2,788

_______________

(1)

Non-vested RSUs granted during the years ended December 31, 2018 and 2017 are based on the actual achievement of the FFO performance conditions and assumes target level achievement for the market and other performance conditions. Non-vested RSUs granted during the year ended December 31, 2016 are based on the final performance of both the 2016 Performance and Market Conditions, and are non-vested as of December 31, 2018 as they were subject to the Compensation Committee’s confirmation of final performance.


(2)	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, 2018 through December 31, 2018 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, 2018	331,546		$	66.83	1,080,928		1,412,474
Granted	437,216		64.21		—		437,216
Vested	(187,209	)	63.85		187,209		—
Settled ⁽²⁾					(202,536	)	(202,536	)
Issuance of dividend equivalents⁽³⁾	6,316		71.75		26,922		33,238
Forfeited	(1,090	)	70.62		—		(1,090	)
Canceled ⁽⁴⁾					(3,435	)	(3,435	)
Outstanding as of December 31, 2018	586,779		$	65.87	1,089,088		1,675,867

_______________


(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 85,598 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, 2018, 2017 and 2016 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)
2018	437,216	$	64.21	(214,131	)	$	14,768
2017	142,101	74.91		(228,095	)	16,735
2016	173,747	58.29		(130,784	)	8,438

_______________


(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, 2018 through December 31, 2018 is presented below:



	Nonvested Restricted Stock		Weighted-Average Grant Date Fair Value Per Share
Outstanding at January 1, 2018	22,884		$	55.23
Transferred from time-based RSUs	—		—
Vested ⁽¹⁾	(22,884	)	55.23
Outstanding as of December 31, 2018	—		$	—

_______________


(1)	The total shares vested includes 9,637 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, 2018, 2017 and 2016 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)
2018	—	$	—	(22,884	)	$	1,652
2017	—	—		(24,261	)	1,781
2016	—	—		(24,262	)	1,527

_______________


(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.

Share-Based Compensation Cost Recorded During the Period

The total compensation cost for all share-based compensation programs was $35.9 million, $26.3 million and $26.6 million for the years ended December 31, 2018, 2017 and 2016, respectively. Of the total share-based compensation costs, $8.0 million, $7.3 million and $5.6 million was capitalized as part of real estate assets and deferred leasing costs for the years ended December 31, 2018, 2017 and 2016, respectively. As of December 31, 2018, there was approximately $60.5 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 3.0 years. The remaining compensation cost related to these nonvested incentive awards had been recognized in periods prior to December 31, 2018. The $60.5 million of unrecognized compensation costs does not reflect the future compensation cost related to share-based awards that were granted subsequent to December 31, 2018.

Other Compensation

On December 27, 2018, the Executive Compensation Committee of the Company’s Board approved, and the Company and the Operating Partnership entered into the Amended Employment Agreement with John Kilroy, which amends and supersedes the existing employment agreement dated January 1, 2012. Except as noted below, the Amended Employment Agreement continues Mr. Kilroy’s employment on terms substantially similar to those of the existing employment agreement, with a new term scheduled to continue through December 31, 2023. The Amended Employment Agreement includes a cash retirement benefit of $13.2 million, or $16.2 million for a retirement at or after attaining age 73, with at least twelve months’ advance notice or at or after the end of the term of the agreement. For the year ended December 31, 2018, the Company recognized $12.1 million of compensation expense in general and administrative expenses on the consolidated statement of operations, representing the present value of the potential cash retirement benefit amount that was earned based on prior service.