Remuneration report

Performance Share Plan (PSP)
Key features for PSP awards in 2008:

• half the PSP award will be based on a Total Shareholder Return performance condition (PSP^TSR) and the other half on an Earnings per Share (PSP^EPS)* performance condition; and
• length of period for performance condition: three years with any shares vesting paid out in three equal tranches on vesting* at the end of years three, four and five.

For the US executives, the awards are automatically delivered at the end of years three, four and five, subject to the performance condition achieved.

• Shares under award attract dividends prior to vesting.

Performance Condition – PSP^EPS

• Proportion of the award capable of exercise: determined by the rate of annual actual EPS growth over the three-year performance period, with nil vesting at annual actual EPS growth of 5% or less and 100% vesting at 11% growth as set out below:

• Rationale for performance measure: major investors consider EPS to be a key indicator of long-term financial performance and value creation.

Performance Condition – PSP^TSR

• Proportion of the award capable of exercise determined by:

(i) the Company’s TSR (share price growth plus dividends) ranking relative to a comparator group of 18 other international defence and aerospace companies (see table below):

• nil vesting if the Company’s TSR is outside the top 50% of TSRs achieved by the sectoral comparator group and 100% vesting if it is in the top quintile (ie top 20%) as set out below:

and

(ii) whether there has been a sustained improvement in the Company’s underlying financial performance and whether it is appropriate to release some or all of the awards. In taking such a view, the Committee may consider (but not exclusively) the following financial metrics: net cash/debt; EBITA; order book; turnover; risk and underlying project performance.

• Rationale for performance measures: importance to major investors as an indication of both earnings and capital growth relative to other major companies in the same sector and to ensure that awards only vest if there has been a clear improvement in the Company’s performance over the relevant period.

Performance of outstanding PSP awards

The graph above summarises the position for all outstanding awards under the PSP as at 31 December 2007. The coloured box shows the range of TSR required for 25% vesting to full vesting, and the square shows BAE Systems’ TSR.

Share Matching Plan (SMP)
Key features for grants of awards in 2008 and 2009:

• stand-alone share investment plan with the investment linked to the bonus awarded under the Annual Bonus Plan;
• participants are granted a conditional award of Matching Shares against the gross value of the bonus invested; and
• Matching Shares attract dividends during the three-year deferral period, released on vesting of any Matching Shares.
• 2008 awards:
• the executive directors will be invited to acquire shares (Investment Shares) by deferring part or all of their 2007 net annual bonus into the SMP; and
• match and performance condition: nil match for actual EPS growth of 5% pa or less, increasing uniformly to a 1:1 match for 8% pa growth.
• 2009 awards:
• the UK-based executive directors are required to invest one-quarter of their 2008 net bonus into the SMP and the US-based executive director one-third;
• maximum level of investment will be 50% of the net annual bonus; and
• match and performance condition: the match will be extended from a 1:1 match at 8% pa actual EPS growth, increasing uniformly to a 2:1 match at 11% pa growth*.
• rationale for performance measure: major investors consider EPS to be a key indicator of long-term financial performance and value creation.