Electronic Arts 2006 Annual Report Download - page 26

than $41.21, the closing price of our Common Stock on that date, as reported on the NASDAQ National
Market. These underwater options had a weighted average exercise price of $55.89 and a weighted average
expected term of 6 years. On June 19, 2006, approximately 92% of our employees held at least some
options that were underwater, and for approximately 63% of our employees all of their options were
underwater. The exercise prices of options that were underwater on June 19, 2006, ranged from $41.49 to
$65.93 per share. These underwater options may not be suÇciently eÅective as performance and retention
incentives. We believe that to enhance long-term stockholder value we need to maintain competitive
employee compensation and incentive programs that will assist us to motivate and retain our employees.
By oÅering restricted stock rights, which are designed to deliver value without regard to an exercise price,
we believe the Exchange Program will oÅer a meaningful retention incentive for eligible employees to
remain with the Company.
Reduce Outstanding Overhang. Since many of the Eligible Options have been out of the money for an
extended period of time, employees have had little or no incentive to exercise them. As a result, the value
of our overhang (i.e., the total number of shares subject to outstanding equity awards as a percentage of
our total shares of Common Stock outstanding) has decreased as a potential retention incentive for our
employees. The Exchange Program will also serve to reduce our overhang, particularly that portion
consisting of stock options having the highest exercise prices with the least employee retention value.
Under the program, participating employees will receive signiÑcantly fewer restricted stock rights than the
number of shares subject to the options they surrender. Because participating employees will exchange a
greater number of options for a lesser number of restricted stock rights, there will be an immediate
reduction in our overhang. For example, assuming that the average closing market price of our Common
Stock for the Ñve business days preceding the commencement of the Exchange Program is $41.21, options
for a total of 15,989,086 shares having exercise prices greater than $47.39 (115% of $41.21) would be
eligible for participation. If all of these Eligible Options are surrendered for cancellation, we would issue
restricted stock rights for 4,829,496 shares, based on the exchange ratios described in the table set forth
under ""Exchange Ratios'' below, resulting in a net reduction in overhang from the Exchange Program of
11,159,590 shares or approximately 3.6% of the number of shares of our Common Stock issued and
outstanding as of June 19, 2006. In this example, assuming all Eligible Options were surrendered for
cancellation in the Exchange Program and not taking into account additional stock option grant and
exercise activity prior to completion of the Exchange Program, immediately following the conclusion of the
Exchange Program, we would have (i) options outstanding to purchase 23,664,173 shares, with a weighted
average exercise price of $26.88 and a weighted average remaining contractual term of 5.21 years, and
(ii) 5,453,430 restricted stock rights outstanding (as compared to 623,934 restricted stock rights
outstanding on June 19, 2006).
The actual reduction in our overhang that could result from the Exchange Program could diÅer materially
from the example in the preceding paragraph and is dependent on a number of factors, including the
exercise price at which outstanding options become eligible to participate in the Exchange Program and
the actual level of employee participation in the program. The reduction in overhang would also be
partially oÅset by the grant of additional awards under our Equity Plan, including the retention awards
described in ""Additional Retention Awards'' below. As of June 19, 2006, there were 17,258,478 shares
available for future issuance under the Equity Plan. In addition, consistent with the terms of the Equity
Plan, we intend to (i) use shares subject to the options cancelled for the issuance of the restricted stock
rights granted under the Exchange Program, and (ii) return up to a total of 7 million shares subject to the
options cancelled in the Exchange Program to the Equity Plan to be available for issuance pursuant to
future awards. While returning these shares to the Equity Plan will not have any immediate impact on our
outstanding overhang, their use for future equity awards would increase our outstanding overhang.
Align Equity Incentives with Current Compensation Philosophy. In designing the terms of the Exchange
Program and recommending its approval by the Board of Directors, the Compensation Committee took
into account its philosophy of shifting from the exclusive use of stock options to using a mix of stock
options and other equity-based incentives, such as restricted stock units, to provide long-term equity
incentives to our employees (see ""Compensation Committee Report on Executive Compensation Ì
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