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Electronic Arts


has been a crummy investment in recent years, but don't worry, help could be on the way -- if you're an insider.

The video game software company plans to allow employees and executives to exchange their stock options that are currently underwater because of the stock's decline for full shares of stock. Better yet for a select group of "key employees," which include EA's top executives, the company plans to hand out additional shares of stock and options as "retention awards."

EA's "underwater options may not be sufficiently effective as performance and retention incentives," the company said in its proxy statement filed on Friday, in which it outlined its plan. "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."

In order to exchange the options, the company will need get shareholders to approve the plan at its upcoming annual meeting, which will be held on July 27. Although the company doesn't need shareholder approval for the retention awards, it is separately asking investors to approve a sizeable increase in its employee stock grant plan that will allow for future grants of restricted shares.

But it's an open question about how accommodating -- and sympathetic -- shareholders will be.

That's in part because, with EA's stock down 18% over the last two years, longtime shareholders have themselves been suffering. The entire sector has been off of late due to a difficult transition to new video-game technology. But EA's shares are off to a greater extent than rivals such as





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as a result of repeated earnings disappointments and slumping sales.

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EA closed Friday down 43 cents, or 1%, to $43.04.

But setting aside the company's execution issues, governance advocates tend to frown on option-exchange programs. The thinking is that by exchanging or repricing options, companies eliminate the only risk employees see from accepting options.

Worse yet, by exchanging options for shares of stock, EA would be trading the mere possibility of diluting shareholders for the near certainty of diluting them. In other words, options ostensibly can expire unexercised, but shares of restricted stock -- which is what the company would be giving to employees -- likely won't.

Restricted shares are full shares of stock that are typically subject to a vesting period, i.e., employees who receive them can't sell them until they are fully vested, which often takes one to five years. However, in EA's case, the company plans to limit the vesting period for the restricted shares depending on the degree to which the options they will be exchanged for were already vested.

And then there's the larger issues surrounding options in general. Thanks to new accounting rules, options now count against companies' earnings. That change, as well as the recent scandals involving the backdating of options, has highlighted for many investors how corporate managers have abused options, both legally and illegally, in the past.

While EA has not been caught up in the backdating scandal to date, it has been a prolific dispenser of options. At the end of the company's fiscal year in March, it had some 40.9 million options outstanding, which was equivalent to about 13% of the company's total share count as of the end of this month.

And that's not including all the stock options that insiders have already exercised. From fiscal 1996 through 2006, EA employees and executives cashed in some 90.6 million options, equivalent to about 28% of what the company's total shares outstanding would be if not for some recent buybacks.

EA argues that the exchange plan would benefit shareholders by reducing some of the prospective options dilution. The company plans to give one share of restricted stock for every three to four shares of options that employees exchange, depending on the exercise price of the options.

And the company won't allow employees to exchange every underwater option for a restricted share. Employees will only be able to exchange options whose strike prices are at least 15% higher than the average closing stock price for the five days preceding the beginning of the exchange program.

Currently, nearly 16 million outstanding options at EA would qualify for the exchange program. Assuming all of those options were exchanged, the company would grant about 4.8 million restricted shares in their place, according to the proxy statement. So, on the surface, the company would reduce its overhang of employee stock grants by about 11.2 million shares, or about 3.6% of the company's outstanding stock.

But the reality is that the reduction won't be near that amount. The program won't be compulsory, so some employees may choose not to participate.

More importantly, though, there are all the additional options and shares the company aims to hand out. First, the company plans to dispense a total of 2.2 million options and 600,000 restricted shares as part of the retention program. And EA could continue to hand out options that could ostensibly be exchanged for restricted shares between now and the time the exchange program begins.

Then, the company is asking shareholders to hand out a raft of new restricted shares in the future. As part of the second proxy proposal, the company wants shareholders to boost the limits on the number of restricted shares it can hand out from 4 million to 11 million.

Last year, shareholders approved an increase in the number of restricted shares the company can hand out by 1 million. Shareholders also increased the number of options the company could hand out to employees under the plan by 10 million.

With another year of stock price declines behind them, it remains to be seen whether investors will be as generous to insiders this time around.