Shareholders of Electronic Arts ( ERTS) have seen tough times of late, but they voted Thursday to make things better -- for employees. At the company's annual shareholder meeting, EA investors approved a
company plan that will allow employees to exchange their underwater options for restricted shares of the company's stock. In a related measure, investors also approved a management plan to bump up the number of restricted shares it can hand out to insiders. The two measures drew support from 80.3% and 75.3% of the shareholder votes cast at the meeting, respectively. The option exchange plan follows the poor performance of EA's stock in recent years. Over the past 15 months, shares of EA have fallen 31%. Over that same time period, the Nasdaq Composite has been essentially flat, while shares of chief video-game software rival Activision ( ATVI) are off only 7%. Under the exchange program, employees of EA will be able to trade in options that carry exercise prices that are 25% or more above the company's market price for shares of restricted stock. The company plans to award one share of restricted stock for every three to four options that employees hand over. Stock options grant employees the right to purchase their company's stock at a pre-set price. Their intrinsic value is the difference between the market price of the stock and the pre-set price. In the case of EA, the company awarded millions of options when its stock was trading higher than it is now; because of the stock's slump, those options are underwater and have no intrinsic value. But that doesn't necessarily make them worthless. Because employee options typically don't expire for five, seven or even 10 years -- as is the case with those awarded by EA -- they still could potentially be cashed in at a later date.
Still, EA argued that the underwater options had harmed their ability to retain key employees. And the company argued that the exchange program would benefit shareholders by reducing the company's overhang. That is, by given out fewer restricted shares in place of the options, the company would be reducing the potential dilution caused by all those outstanding options. The company also barred executives from taking part in the exchange, a key factor that proxy advisers such as Institutional Shareholder Services consider when weighing options exchange plans. Indeed, ISS recommended that shareholder vote in favor of EA's plan. Still, options exchange programs have been controversial in the past. Shareholder advocates have argued that they eliminate the one downside employees can see by taking options as payment, the risk that they will expire unused. And while the company's plan will reduce potential dilution, it may have little effect on actual dilution. While many of the options may have expired unused because they were underwater, the restricted shares will likely be cashed in, because they have some value unless EA suddenly -- and quite unexpectedly -- goes bankrupt. Even then, EA warned that while the plan would reduce its options overhang, the fall in the overhang would be somewhat counterbalanced by a plan to hand out millions of new options to "key employees," including, potentially, the company's executives. EA tried to address shareholder concerns by
revising its exchange proposal earlier this month. The company effectively reduced the number of options that employees could potentially exchange by raising the percentage by which their exercise price had to exceed the current market price. EA also added a provision that would call off the exchange program if EA's stock starts to average $55 a share or more. EA's stock closed Thursday at $46.84, down 96 cents, or 2% for the day.
Assuming EA's share price is about $41.21, employees would be eligible to exchange about 12.8 million shares of the company's stock. Those options would translate into about 3.8 million shares of restricted stock. Also during EA's shareholder meeting, investors re-elected all nine of the company's directors, approved the company's plan to re-appoint KPMG as its auditor and approved a plan to increase the number of shares that employees can purchase under the company's stock purchase plan. EA did not release the vote totals for its directors, but the other two proposals passed with 97.4% and 82.3% of shareholder votes, respectively.