Remuneration report

The market price at the date of award for awards made on 22 March 2007 under the Share Matching Plan was £4.565. The awards will vest, subject to the attainment of the performance condition, on the third anniversary of grant.

The performance condition for the grants of matched shares made in 2007 under the Share Matching Plan on a one-to-one match was based on real EPS growth over the three-year performance period, with one-third of the matched shares vesting where the Company achieved on average real EPS growth per annum of 3% but less than 4%, two-thirds vesting with a growth rate of 4% but less than 5%, and full vesting at growth of 5% or over. The revised performance conditions for the Share Matching Plan for grants to be made in 2008 and 2009 are set out on Information on share plans page.

The matching award of shares under the Restricted Share Plan, under which awards have not been granted since 2006, was historically not subject to any performance criteria as it was designed to retain key staff and encourage executives to re-invest in company shares the cash bonuses that they had earned under the annual bonus plan which was itself subject to performance conditions. The Restricted Share Plan was replaced by the Share Matching Plan, which is subject to performance conditions as described above and on Information on share plans page.

Awards granted to Walt Havenstein (a US national) under the Performance Share Plan are characterised as long-term incentives rather than options as, subject to attainment of the performance condition, they are delivered automatically on the third, fourth and fifth anniversary of the award without the need to exercise an option. They are subject to the same performance conditions as options granted under the Performance Share Plan to the UK-based directors as set out below. The market price at the date of the award granted on 30 March 2007 was £4.57.

The net aggregate value of assets received by directors in 2007 from long-term incentive plans, as calculated at the date of vesting, was £1,066,284 (2006 nil).

* or upon appointment
1 retired as a director on 31 December 2007. With the Remuneration Committee’s agreement, the Matching award of shares under the Restricted Share Plan for Chris Geoghegan will be released in full at the end of the three-year period.
2 appointed as a director on 2 January 2007
3 appointed as a director on 1 January 2007
4 retired as a director on 9 May 2007

Note: Awards granted to Walt Havenstein⁴, a US national, under the Performance Share Plan are characterised as long-term incentives, rather than as options, and are shown under Table B.

1 retired as a director on 31 December 2007. With the agreement of the Remuneration Committee the performance condition on the 2005, 2006 and 2007 PSP awards for Chris Geoghegan will be tested at the end of the normal three-year performance period, and any part of the award vesting will be pro-rated for service completed and be exercisable for six months.
2 appointed as a director on 1 January 2007
3 retired as a director on 9 May 2007. With the agreement of the Remuneration Committee the performance condition on the 2005 and 2006 PSP awards for Steve Mogford was tested at his date of retirement. The 2005 award vested in full (subject to pro-rating for service completed) and the 2006 award lapsed. All vested PSP awards became exercisable within six months of retirement.
4 appointed as a director on 2 January 2007
5 subject to a performance condition which has been met
6 subject to a performance condition that is yet to be tested
* The date from which exercisable refers to the first date from which any tranche of the option remaining at the year end is exercisable (subject to the attainment of the performance condition where the award has not yet vested).

Awards granted under the Performance Share Plan between 2003 and 2007 are subject to the same performance conditions as those for awards to be granted under the PSP^TSR in 2008 as set out on Information on share plans page, ie 100% of the conditional awards vest if the Company’s Total Shareholder Return (TSR) is in the top 20% of TSRs achieved by a sectoral comparator group of 18 companies, with 25% vesting if TSR is in the top 50%, and nil vesting if the Company’s performance is outside the top 50%. The awards are also subject to the same secondary measure for underlying financial performance set out on Information on share plans page. Awards that vest at the end of year three are exercisable in three tranches at the end of years three, four and five.

The mid-market price for the Company’s ordinary shares at 31 December 2007 was 498p (2006 425.75p). The range during the year was 401.5p to 515p.

The exercise of options under the SAYE Share Option Scheme, an all-employee scheme, was not subject to the satisfaction of any performance conditions.

The BAE Systems Executive Share Option Plan was used to grant options to the executive directors between 2001 and 2007. No further grants will be made under this Plan other than in exceptional circumstances. Options granted under this Plan are normally exercisable between the third and tenth anniversary of their grant and options granted between 2005 and 2007 may only be exercised during this period as follows: (i) 33.33% of each option grant is exercisable if the Company achieves on average real EPS growth per annum of 3% but less than 4% over the three-year performance period; (ii) 66.67% of each option grant is exercisable if the Company achieves on average real EPS growth of 4% but less than 5% over the three-year performance period; and (iii) 100% of each option grant is exercisable if the Company achieves on average real EPS growth per annum of 5% or more over the three-year performance period. The performance conditions for the grants of options made between 2001 and 2004 were the same as for grants made between 2005 and 2007 with the exception of the retesting provision: for grants made between 2001 and 2003, where the original three-year performance is not met, performance is re-tested at the end of years four and five against the full period from grant; for grants made in 2004, where the original performance target is not met, performance is re-tested at the end of year five against the full period from grant. In all these cases the option will lapse in year five if the targets have not been achieved. In determining the performance measures the Remuneration Committee took the view that the Company’s major investors believe EPS to be a key indicator of long-term financial performance and value creation.

On completion of the BAe/MES merger in 1999, options were granted to executive directors (and other senior executives) under the predecessor Executive Share Option Scheme. Options granted to Ian King in 1999 could only be exercised if the pre-exceptional EPS for any three-year period exceeded the sum of inflation for that period and a real growth requirement of 9% was achieved and these options vested in full in February 2006. Options granted to the other executive directors in 1999 (which partially vested in 2004) were conditional on the satisfaction of a special performance condition based on the achievement of cost savings of the merger integration process over the three-year performance period commencing on 1 January 2000.

The mid-market price for the Company’s ordinary shares at 31 December 2007 was 498p (2006 425.75p). The range during the year was 401.5p to 515p.

A breakdown of options held by executive directors under the Executive Share Option Plan is given overleaf.

Awards granted to Walt Havenstein under the Executive Share Option Plan between 2003 and 2005 were granted under the Stock Appreciation Rights (SARs) Schedule to that plan and are equity-settled. They are subject to the same performance conditions as options granted under this plan as set out above.

During 2007 SAR awards over 264,261 shares were subject to exercise and the number of shares vesting and allotted under these stock appreciation rights totalled 158,842 as set
out above.

In addition, Walt Havenstein has a cash-settled SAR over 53,010 ordinary shares granted on 27 November 2000 at a SAR price of £3.73, exercisable from 27 November 2003. The right is
exercisable until 27 November 2010 and was subject to the performance condition relating to options granted in 2000 (ie exercisable only if growth in pre-exceptional EPS for any threeyear
period over the ten-year life exceeded the sum of inflation for that period and a growth requirement of 9%) which has been met.

1 retired as a director on 31 December 2007
2 appointed as a director on 1 January 2007
3 appointed as a director on 2 January 2007
4 retired as a director on 9 May 2007

1 retired as a director on 31 December 2007. With the Remuneration Committee’s agreement, and exercise being subject to attainment of the performance condition, options granted prior to 2001 for Chris Geoghegan had their period of exercise determined as 24 months from the date of leaving and options granted from 2001 onwards had their period of exercise determined as the end of the option’s ten-year life.
2 appointed as a director on 2 January 2007
3 appointed as a director on 1 January 2007
4 retired as a director on 9 May 2007. With the Remuneration Committee’s agreement, and exercise being subject to attainment of the performance condition, options granted prior to 2001 for Steve Mogford had their period of exercise determined as 24 months from the date of leaving and options granted from 2001 onwards had their period of exercise determined as the end of the option’s ten-year life.
5 subject to a performance condition which has been met
6 subject to a performance condition that is yet to be tested

The maximum duration for the grant of an option under the Executive Share Option Plan is ten years.

The mid-market price for the Company’s ordinary shares at 31 December 2007 was 498p (2006 425.75p). The range during the year was 401.5p to 515p.

1 subject to performance condition
2 retired as a director on 31 December 2007
3 appointed as a director on 2 January 2007
4 appointed as a director on 1 January 2007
5 retired as a director on 9 May 2007

* equity-settled Stock Appreciation Right

The aggregate amount of gains made by directors from the exercise of share options in 2007, as calculated at the date of exercise, was £14,882,281 (2006 £1,395,166).

Mike Turner was granted a contingent award over 231,618 shares on 16 October 2007. The shares will vest in two equal tranches, for nil consideration, in the year following his retirement on 31 August 2008, subject to the satisfaction of certain performance targets by 31 August 2008. These targets relate to continuing the successful implementation of the Company’s business strategy, satisfaction of leadership objectives set by the Remuneration Committee, achieving an orderly handover of key external relationships and facilitating an orderly succession to the Chief Executive role. The market price at the date of award was £5.10.