RATIONAL SOFTWARE CORP, DEF 14A, 1999-07-21

RATIONAL SOFTWARE CORP
DEF 14A, 1999-07-21
PREPACKAGED SOFTWARE

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<PAGE>

SCHEDULE 14A INFORMATION

Proxy Statement Pursuant to Section 14(a) of the
Securities Exchange Act of 1934
(Amendment No. )

Filed by the Registrant [X]

Filed by a Party other than the Registrant [_]

Check the appropriate box:

[_] Confidential, for Use of the
[_] Preliminary Proxy Statement Commission Only (as Permitted by
Rule 14a-6(e)(2))

[X] Definitive Proxy Statement

[_] Definitive Additional Materials

[_] Soliciting Material Pursuant to (S)240.14a-11(c) or (S)240.14a-12

RATIONAL SOFTWARE CORPORATION
(Name of Registrant as Specified In Its Charter)

N/A
(Name of Person(s) Filing Proxy Statement, if other than the Registrant)

Payment of Filing Fee (Check the appropriate box):

[X] No fee required.

[_] Fee computed on table below per Exchange Act Rules 14a-6(i)(4) and 0-11.

(1) Title of each class of securities to which transaction applies:

(2) Aggregate number of securities to which transaction applies:

(3) Per unit price or other underlying value of transaction computed
pursuant to Exchange Act Rule 0-11 (Set forth the amount on which the
filing fee is calculated and state how it was determined):

(4) Proposed maximum aggregate value of transaction:

(5) Total fee paid:

[_] Fee paid previously with preliminary materials.

[_] Check box if any part of the fee is offset as provided by Exchange Act
Rule 0-11(a)(2) and identify the filing for which the offsetting fee was
paid previously. Identify the previous filing by registration statement
number, or the Form or Schedule and the date of its filing.

(1) Amount Previously Paid:

(2) Form, Schedule or Registration Statement No.:

(3) Filing Party:

(4) Date Filed:

Notes:
<PAGE>

RATIONAL SOFTWARE CORPORATION

----------------

NOTICE OF ANNUAL MEETING OF STOCKHOLDERS
TO BE HELD AUGUST 26, 1999

TO THE STOCKHOLDERS:

The Annual Meeting of Stockholders of Rational Software Corporation (the
"Company") will be held at the principal offices of the Company at 18880
Homestead Road, Cupertino, CA 95014, on August 26, 1999 at 11:00 a.m. local
time, for the following purposes:

1. To elect two Class I members of the Board of Directors (Proposal 1);

2. To approve an amendment to the 1997 Stock Option Plan reserving an
additional 6,000,000 shares of the Company's authorized but unissued
Common Stock for issuance thereunder (Proposal 2);

3. To approve an amendment to the 1997 Stock Option Plan providing that up
to 12,000,000 shares of Common Stock repurchased by the Company in the
open market pursuant to the Company's stock repurchase program be
reserved for issuance under the 1997 Stock Option Plan (Proposal 3);

4. To ratify the appointment of Ernst & Young LLP as the Company's
independent auditors to examine the financial statements of the Company
for the fiscal year ending March 31, 2000 (Proposal 4); and

5. To transact such other business as may properly come before the meeting
or any adjournment thereof.

Only holders of record of the Company's Common Stock at the close of
business on June 30, 1999, the record date fixed by the Company's Board of
Directors, are entitled to notice of and to vote at the Annual Meeting.

By Order of the Board of Directors,

Timothy A. Brennan
Secretary

Cupertino, California
July 23, 1999

IT IS IMPORTANT THAT PROXIES BE RETURNED PROMPTLY. THEREFORE, WHETHER OR NOT
YOU PLAN TO ATTEND THE ANNUAL MEETING, PLEASE COMPLETE, DATE, SIGN AND
RETURN THE ENCLOSED PROXY IN THE ENCLOSED POSTAGE PAID ENVELOPE. YOU MAY, IF
YOU WISH, REVOKE YOUR PROXY AT ANY TIME PRIOR TO THE TIME IT IS VOTED.
STOCKHOLDERS WHO HOLD THEIR SHARES IN "STREET NAME" MAY VOTE VIA THE
INTERNET OR TELEPHONE BY FOLLOWING INSTRUCTIONS ON THE VOTING FORM RECEIVED
FROM THEIR BROKER OR BANK.

<PAGE>

RATIONAL SOFTWARE CORPORATION

----------------

PROXY STATEMENT

----------------

FOR THE ANNUAL MEETING OF STOCKHOLDERS
TO BE HELD AUGUST 26, 1999

INFORMATION CONCERNING
SOLICITATION, VOTING AND REVOCABILITY OF PROXIES

This Proxy Statement is furnished to stockholders in connection with the
solicitation by the Board of Directors of Rational Software Corporation
("Rational" or the "Company") of proxies in the accompanying form for use at
the Annual Meeting of Stockholders of the Company to be held at the principal
offices of the Company at 18880 Homestead Road, Cupertino, CA 95014, at 11:00
a.m. on Thursday, August 26, 1999, and at any adjournment thereof. If a proxy
in the accompanying form is duly executed and returned, the shares represented
thereby will be voted at the Annual Meeting and, where a choice is specified,
will be voted in accordance with the specification made. Any stockholder who
gives a proxy may revoke it at any time before it is exercised by giving a
later proxy, by attending the meeting and voting in person, or by giving
written notice of revocation to the Company's Secretary. These proxy materials
are first being provided to stockholders on or about July 23, 1999.

The Annual Meeting has been called for the following purposes: (1) to elect
two Class I members of the Board of Directors; (2) to approve an amendment to
the 1997 Stock Option Plan reserving an additional 6,000,000 shares of the
Company's authorized but unissued Common Stock for issuance thereunder; (3) to
approve an amendment to the 1997 Stock Option Plan providing that up to
12,000,000 shares of the Company's Common Stock repurchased by the Company in
the open market pursuant to the Company's stock repurchase program be reserved
for issuance under the 1997 Stock Option Plan; (4) to ratify the appointment
of Ernst & Young LLP as the Company's independent auditors to examine the
financial statements of the Company for fiscal year ending March 31, 2000; and
(5) to transact such other business as may properly come before the meeting or
any adjournment thereof. Only holders of record of the Company's Common Stock
at the close of business on June 30, 1999, the record date fixed by the
Company's Board of Directors (the "Record Date"), are entitled to notice of
and to vote at the Annual Meeting.

If the enclosed form of proxy is properly executed and returned to the
Company in time to be voted at the Annual Meeting, the shares represented
thereby will be voted in accordance with the instructions marked therein.
Executed but unmarked proxies will be voted FOR the election of the Company's
two nominees to the Board of Directors and FOR each of the other proposals.

The Company's capital stock currently consists of a single class of Common
Stock, par value $0.01 per share, of which 87,029,872 shares were outstanding
at the close of business on the Record Date. This number does not include
8,128,234 shares repurchased by the Company prior to the Record Date under the
Company's stock repurchase program, which, pursuant to Delaware law, are not
entitled to vote nor be counted for quorum purposes. Stockholders of record at
the close of business on the Record Date have the right to receive notice of
and to vote at the Annual Meeting. For each share held, a stockholder is
entitled to one vote on each matter to be considered and acted upon at the
Annual Meeting. There are no cumulative voting rights in the election of
directors.

The presence, in person or by proxy, of at least a majority of the total
number of outstanding shares of Common Stock entitled to vote at the Annual
Meeting is necessary to constitute a quorum at the Annual Meeting.
Stockholders' votes will be tabulated by persons appointed by the Board of
Directors to act as inspectors of election for the Annual Meeting. While there
is no definitive statutory or case law authority in Delaware as to
<PAGE>

the proper treatment of abstentions in the counting of votes, the Company
believes that abstentions should be counted for purposes of determining both
(i) the presence or absence of a quorum for the transaction of business and
(ii) the total number of shares present and entitled to vote with respect to
the particular proposal on which the stockholder has abstained. In the absence
of controlling precedent to the contrary, the Company intends to treat
abstentions in this manner. In a 1988 Delaware case, Berlin v. Emerald
Partners, the Delaware Supreme Court held that, while broker non-votes may be
counted for purposes of determining the presence or absence of a quorum for
the transaction of business, broker non-votes should not be counted for
purposes of determining the number of shares present and entitled to vote with
respect to the particular proposal on which the broker has expressly not
voted.

A copy of the Company's Annual Report on Form 10-K, without exhibits
thereto, for the fiscal year ended March 31, 1999, as filed with the
Securities and Exchange Commission (the "SEC") accompanies copies of this
Proxy Statement mailed to stockholders. Stockholders may obtain, for the cost
of copying, a copy of any exhibits thereto by writing: Rational Software
Corporation, 18880 Homestead Road, Cupertino, CA 95014, Attention: Investor
Relations.

2
<PAGE>

BENEFICIAL OWNERSHIP OF COMMON STOCK

Under the proxy rules of the SEC, a person who directly or indirectly has or
shares voting power or investment power with respect to a security is
considered a beneficial owner of the security. Voting power is the power to
vote or direct the voting of shares, and investment power is the power to
dispose of or direct the disposition of shares. Shares as to which voting
power or investment power may be acquired within 60 days are also considered
as beneficially owned under the proxy rules.

The following table sets forth certain information as of the Record Date,
regarding beneficial ownership of the Company's Common Stock by (i) each
person who is known to the Company to own beneficially more than 5% of the
Company's Common Stock, (ii) each director and each nominee for election as a
director of the Company, (iii) each executive officer named in the Summary
Compensation Table set forth in this Proxy Statement, and (iv) all current
directors and current executive officers of the Company as a group. The
information on beneficial ownership in the table and the footnotes thereto is
based upon the Company's records and, in the case of holders of more than 5%
of the Company's stock, the most recent Schedule 13D or 13G filed by each such
person or entity and information supplied to the Company by such person or
entity. Unless otherwise indicated, each person has sole voting power and sole
investment power with respect to the shares shown.

<TABLE>
<CAPTION>
Number of Shares
Directors, Officers and 5% Stockholders Beneficially Owned Percent Owned(1)
--------------------------------------- ------------------ ----------------
<S> <C> <C>
Kopp Investment Advisors Inc.(2)
7701 France Ave. South, Suite 500, Edina
MN 55435.................................. 6,792,743 7.81
Wellington Management Company, LLP(3)
75 State Street, Boston MA 02109.......... 6,293,905 7.23
VGH Partners, LLC (4)
260 Franklin St., Boston MA 02110......... 5,063,000 5.82
The Prudential Insurance Company of
America(5)
Prudential Plaza, 751 Broad St. Newark NJ
07102-3777................................ 4,658,409 5.35
Paul D. Levy(6)............................ 1,364,998 1.54
Michael T. Devlin(7)....................... 1,407,933 1.59
Robert H. Dickerson(8)..................... 516,160 *
David H. Bernstein(9)...................... 393,122 *
John R. Lovitt(10)......................... 444,488 *
James S. Campbell(11)...................... 79,839 *
Daniel H. Case III(12)..................... 381,963 *
Leslie G. Denend(13)....................... 93,332 *
John E. Montague(14)....................... 102,600 *
Allison R. Schleicher(15).................. 136,332 *
All current Directors and current Executive
Officers as a group (16 persons)(16)...... 6,258,746 5.92
</TABLE>
- --------
* Represents less than one percent of the outstanding shares of Common
Stock.

(1) The percent owned is calculated based on a total of 87,029,872 shares of
Common Stock outstanding. This number does not include 8,128,234 shares
repurchased by the Company prior to the Record Date under the Company's
stock repurchase program, which, pursuant to Delaware law, are not
entitled to vote nor be counted for quorum purposes.

(2) Includes all shares held by Kopp Investment Advisors, Inc., and
affiliated persons as reported on Form 13-G/A filed February 3, 1999.

(3) Includes all shares held by Wellington Management Company, LLP and
affiliated persons as reported on Form 13-G/A filed February 10, 1999.

(4) Includes all shares held by VGH Partners, LLC and affiliated persons as
reported on Form 13-G filed May 18, 1999.

3
<PAGE>

(5) Includes all shares held by The Prudential Insurance Company of America
and affiliated persons as reported on Form 13-G/A filed January 27, 1999.

(6) Includes 1,352,000 shares purchasable within 60 days of the Record Date
pursuant to outstanding options, 462,936 of which are subject to vested
options and 889,064 of which are subject to unvested options.

(7) Includes 1,403,211 shares purchasable within 60 days of the Record Date
pursuant to outstanding options, 514,147 of which are subject to vested
options and 889,064 of which are subject to unvested options.

(8) Includes 473,000 shares purchasable within 60 days of the Record Date
pursuant to outstanding options, 259,457 of which are subject to vested
options and 213,543 of which are subject to unvested options.

(9) Includes 388,800 shares purchasable within 60 days of the Record Date
pursuant to outstanding options, 131,714 of which are subject to vested
options and 257,086 of which are subject to unvested options.

(10) Includes 396,332 shares purchasable within 60 days of the Record Date
pursuant to outstanding options, 237,371 of which are subject to vested
options and 158,961 of which are subject to unvested options.

(11) Includes 67,666 shares purchasable within 60 days of the Record Date
pursuant to outstanding options, 37,916 of which are subject to vested
options and 29,750 of which are subject to unvested options.

(12) Includes 71,834 shares purchasable within 60 days of the Record Date
pursuant to outstanding options, 42,084 of which are subject to vested
options and 29,750 of which are subject to unvested options. Includes
123,460 shares registered in the name of Hambrecht & Quist LLC, of which
Mr. Case is the Chairman and Chief Executive Officer. Mr. Case disclaims
beneficial ownership of such shares except to the extent of his pecuniary
interest therein. Also includes 93,800 shares held directly or indirectly
by members of Mr. Case's family as to which Mr. Case exercises sole or
shared investment control but disclaims beneficial ownership.

(13) Includes 64,332 shares purchasable within 60 days of the Record Date
pursuant to outstanding options, 34,582 of which are subject to vested
options and 29,750 of which are subject to unvested options.

(14) Includes 102,000 shares purchasable within 60 days of the Record Date
pursuant to outstanding options, 59,500 of which are subject to vested
options and 42,500 of which are subject to unvested options.

(15) Includes 108,332 shares purchasable within 60 days of the Record Date
pursuant to outstanding options, 78,582 of which are subject to vested
options and 29,750 of which are subject to unvested options.

(16) Includes 5,664,863 shares purchasable within 60 days of the Record Date
pursuant to outstanding options, 2,264,531 of which are subject to vested
options and 3,400,332 of which are subject to unvested options.

4
<PAGE>

PROPOSAL 1

ELECTION OF DIRECTORS

The Company's bylaws provide for a Board of seven directors. The Company's
Certificate of Incorporation provides that the Board of Directors be divided
into three classes as nearly equal in number as possible. The term of the
Class I directors expires in 1999, the term of the Class II directors expires
in 2000, and the term of the Class III directors expires in 2001. The two
Class I directors who were serving as directors at the end of fiscal year 1999
are nominated for re-election. Directors elected at the Annual Meeting will
hold office for a three-year term expiring in 2002 or until their successors
are elected and qualified. The other directors will continue in office for the
remainder of their terms as indicated below. Unless authority so to vote is
withheld, proxies received pursuant to this solicitation will be voted for the
election of the two nominees named below. If any of the nominees should for
any reason not be available for election, proxies will be voted for the
election of the remaining nominees and such substitute nominees as may be
designated by the Board of Directors.

Nominees for Election at the Annual Meeting

Michael T. Devlin, age 44, co-founded the Company in 1981, has been a
director since the inception of the Company, and is currently Chief Executive
Officer. From September 1996 to April 1999, Mr. Devlin served as President of
the Company. Prior to September 1996, Mr. Devlin served as Chairman of the
Board of the Company.

Leslie G. Denend, age 58, has been a director of the Company since 1993.
Since December 1997, he has served as a Director of Networks Associates, Inc.,
a supplier of products that protect, manage and monitor corporate networks.
From December 1997 until May 1998, he served as President of Networks
Associates, Inc. From 1993 until December 1997, he served as President and
Chief Executive Officer of Network General Corporation, a supplier of local
and wide area computer network communications management systems, which
through a strategic business combination with McAfee Associates, Inc. in
December 1997, formed Networks Associates, Inc. He currently serves as a
director of Proxim, Inc. and Informix Software, Inc.

Directors Continuing in Office in the Class of 2000

Paul D. Levy, age 43, co-founded the Company in 1981, has been a director
since the inception of the Company, and is currently Chairman of the Board.
From September 1996 to April 1999, Mr. Levy served as Chairman of the Board
and Chief Executive Officer. Prior to September 1996, Mr. Levy served as
President and Chief Executive Officer of the Company. Mr. Levy is a director
of Genesys Telecommunications Laboratories, Inc. Mr. Levy is the son-in-law of
Mr. James Campbell, a director of the Company.

Daniel H. Case III, age 41, has been a director of the Company since 1993.
Since January 1998, he has been Chairman and Chief Executive Officer of
Hambrecht & Quist Group, an investment banking firm. From October 1994 to
December 1997, he served as President and Chief Executive Officer of Hambrecht
& Quist Group. From 1992 to 1994 he served as President and Co-Chief Executive
Officer of Hambrecht & Quist Group. Previously he held various positions with
Hambrecht & Quist Group. He is also a director of Electronics Arts, Inc. and
AMB Property Corporation.

John E. Montague, age 45, has been a director of the Company since 1994.
Since September 1998, he has been Vice President and Chief Financial Officer
of Lockheed Martin Global Telecommunications. From March 1995 to September
1998, he served as Vice President, Financial Strategies at Lockheed Martin
Corporation, a diversified manufacturer of aerospace products. Previously, he
was Vice President, Corporate Development and Investor Relations at Martin
Marietta Corporation. He is a director of L-3 Communications Corporation.

Directors Continuing in Office in the Class of 2001

James S. Campbell, age 72, has been a director of the Company since 1990.
Mr. Campbell is a retired Corporate Vice President of Xerox Corporation. He is
a Director of Applied Voice Technology, Inc. Mr. Campbell is the father-in-law
of Paul Levy, the Company's Chairman of the Board.

5
<PAGE>

Allison R. Schleicher, age 55, has been a director of the Company since
1990. From 1967 to 1999 he has been with IBM Corporation in various executive
and management positions. Most recently, he has served as Vice President,
Finance & Planning, Sales and Distribution Group. In 1997, he served as Vice
President, Finance & Planning, Personal Systems Technology Group. From 1994 to
1997, he served as Vice President, Finance of IBM Credit Corporation.

THE BOARD OF DIRECTORS RECOMMENDS A VOTE "FOR" THE NOMINATED DIRECTORS.

Because the two nominees who receive the greatest number of votes will be
elected to serve as Class I directors, abstentions and broker non-votes will
have no effect on the outcome of the election of directors.

Board Meetings and Committees

The Company's Board of Directors held four regular meetings (and took two
actions by unanimous written consent) during fiscal year 1999. Each incumbent
director attended at least 75% of the meetings held during the part of fiscal
year 1999 during which he was a director, in the aggregate, by the Board and
each committee of the Board of which he was a member. The Company's Board of
Directors has a Compensation Committee and Audit Committee. The Company does
not have a Nominating Committee.

The Compensation Committee (consisting of Messrs. Denend and Schleicher)
reviews and recommends to the Board action with respect to compensation of and
benefits granted to officers and other key employees of the Company and
administers the Company's several stock option plans and stock purchase plan.
The Compensation Committee held meetings during fiscal year 1999.

The Audit Committee (consisting of Messrs. Case and Montague) nominates the
Company's independent auditors, reviews with the Company's independent
auditors matters relating to the scope and plan of the audit, the adequacy of
internal controls, and the preparation of the Company's financial statements,
reports and makes recommendations to the Board with respect thereto, and
reviews related party transactions for conflicts of interest. The Audit
Committee held one meeting during fiscal year 1999.

Board Member Compensation

The Company pays directors' fees only to directors who are not employees of
the Company. During fiscal 1999, non-employee directors were compensated at a
rate of $1,250.00 per Board meeting attended, with no additional fee being
payable for attendance at committee meetings. Directors are also reimbursed
reasonable out-of-pocket expenses in connection with attending meetings.
Directors who are not employees of the Company participate in the Directors'
Stock Option Plan.

Compensation Committee Interlocks and Insider Participation

The Compensation Committee during the 1999 fiscal year consisted of Messrs.
Denend and Schleicher, neither of whom is or has been an officer or employee
of the Company. No interlocking relationship exists between the Company's
Board of Directors or Compensation Committee and the board of directors or
compensation committee of any other company.

6
<PAGE>

PROPOSAL 2

AMENDMENT TO THE 1997 STOCK OPTION PLAN RESERVING AN ADDITIONAL 6,000,000
SHARES OF THE COMPANY'S AUTHORIZED BUT UNISSUED COMMON STOCK

The stockholders are being asked to approve an amendment to the 1997 Stock
Option Plan (the "1997 Plan") reserving an additional 6,000,000 shares of the
Company's authorized but unissued Common Stock for issuance thereunder. The
Board of Directors believes that this amendment to the 1997 Plan is important
to the continued functioning of the 1997 Plan, which has proved an effective
means of motivating and encouraging the continued employment of the employees
of Rational and its subsidiaries. In the past several years the labor markets
in which the Company operates have become more intensely competitive, and
recruiting and retaining the highly skilled employees the Company needs has
become increasingly difficult. As a result, the Board believes that the
proposed increase is necessary to allow grants of new options to existing
employees whose present options are becoming fully vested, and to recruit new
employees or increase existing employees' equity stakes in the Company. For a
description of the 1997 Plan, see "Description of the 1997 Plan," elsewhere in
this Proxy Statement. This proposed increase in the number of shares of Common
Stock reserved for issuance under the 1997 Plan is in addition to the increase
proposed in Proposal 3 of this Proxy Statement.

As of the Record Date, June 30, 1999, and without giving effect to this
Proposal 2 or Proposal 3, 10,290,000 shares have been reserved for issuance
under the 1997 Plan, of which 935,457 have been issued pursuant to option
exercises, 9,239,894 are subject to outstanding options and 109,649 are
available for grant. As of the Record Date, of the shares issued pursuant to
option exercises, 14,911 are subject to a lapsing right of repurchase in favor
of the Company as of the Record Date. Proposal 2 was adopted by the Board of
Directors on June 18, 1999, subject to stockholder approval. As of the Record
Date, there were approximately 2,230 employees of Rational and its
subsidiaries who are eligible to participate in the 1997 Plan. As of the
Record Date, under the Company's other option plans 6,316,429 shares are
subject to outstanding but unexercised options, and there are no shares that
are outstanding but subject to a lapsing right of repurchase in favor of the
Company pursuant to exercised unvested options. Pursuant to the terms of the
1997 Plan, as of the Record Date an aggregate of 1,667,665 shares either
subject to outstanding options or issued but subject to a lapsing right of
repurchase under the 1994 Stock Option Plan could be rolled over to the 1997
Plan if the outstanding options under the 1994 Stock Option Plan expire,
terminate unexercised, or are otherwise returned to the Company or if the
outstanding shares are repurchased by the Company.

VOTE REQUIRED

While all Directors are eligible for option grants under the terms of the
1997 Plan, the Company has adopted the policy of granting non-employee
Directors options only out of the Directors' Stock Option Plan. However,
Directors who are employees of the Company may benefit from adoption of this
amendment, and to that extent may have a conflict of interest in recommending
the amendment. Because approval of this proposal requires the affirmative vote
of the majority of shares of Common Stock present in person or represented by
proxy at the Annual Meeting and entitled to vote on the proposal, abstentions
will have the same effect as a vote against the proposal, and broker non-votes
will have no effect on the outcome of the proposal.

THE BOARD OF DIRECTORS RECOMMENDS A VOTE "FOR" PROPOSAL 2.

7
<PAGE>

PROPOSAL 3

AMENDMENT TO THE 1997 STOCK OPTION PLAN PROVIDING FOR RESERVATION FOR ISSUANCE
OF UP TO 12,000,000 SHARES OF COMMON STOCK REPURCHASED UNDER THE COMPANY'S
STOCK REPURCHASE PROGRAM FOR ISSUANCE UNDER THE 1997 STOCK OPTION PLAN

The stockholders are being asked to approve a second amendment to the 1997
Plan reserving for issuance under the 1997 Stock Option Plan, up to 12,000,000
shares of Common Stock repurchased under the Company's stock repurchase
program (the "Repurchase Program"). The Board of Directors believes that this
amendment to the 1997 Plan, like the amendment being proposed under Proposal
2, is important to the continued functioning of the 1997 Plan, which has
proven an effective means of motivating and encouraging the continued
employment of the employees of the Company and its subsidiaries. This proposed
increase in the number of shares reserved for issuance under the 1997 Plan is
in addition to the increase proposed in Proposal 2 of this Proxy Statement.
For a description of the 1997 Plan, see "Description of the 1997 Plan,"
elsewhere in this Proxy Statement.

The Repurchase Program authorizes the Company to repurchase up to 12,000,000
shares of its Common Stock in the open market from time to time. To date, the
Company has repurchased 8,128,234 shares of Common Stock under the Repurchase
Program. The adoption of this amendment would authorize the reservation for
issuance under the 1997 Plan of the shares of Common Stock already
repurchased, plus any additional shares repurchased in the future under the
Repurchase Program, up to a total of 12,000,000 shares of Common Stock.

VOTE REQUIRED

THE BOARD OF DIRECTORS RECOMMENDS A VOTE "FOR" PROPOSAL 3.

8
<PAGE>

PROPOSAL 4

RATIFICATION OF INDEPENDENT AUDITORS

Action is to be taken at the Annual Meeting with respect to the ratification
of independent auditors, who were nominated by the Audit Committee, to examine
the financial statements of the Company for fiscal year 2000. Unless otherwise
directed therein, proxies received pursuant to this solicitation will be voted
for the ratification of Ernst & Young LLP, who served as the Company's
auditors for fiscal year 2000. Although the ratification of independent
auditors is not required to be submitted to a vote of the stockholders, the
Board of Directors believes that such ratification is a matter on which the
stockholders should express their opinion. If the stockholders do not ratify
Ernst & Young LLP, the selection of independent auditors will be reconsidered
by the Audit Committee of the Board of Directors. Ernst & Young LLP has
advised the Company that no member of its firm has any direct or indirect
material financial interest in the Company. Representatives of
Ernst & Young LLP are expected to be present at the Annual Meeting, will have
the opportunity to make a statement if they so desire, and will be available
to respond to appropriate questions from the stockholders. Because approval of
this proposal requires the affirmative vote of the majority of shares of
Common Stock present in person or represented by proxy at the Annual Meeting
and entitled to vote on the proposal, abstentions will have the same effect as
a vote against the proposal, and broker non-votes will have no effect on the
outcome of the proposal.

THE BOARD OF DIRECTORS RECOMMENDS A VOTE "FOR" PROPOSAL 4.

9
<PAGE>

OTHER MATTERS

No business other than that set forth above is expected to come before the
Annual Meeting or any adjournment thereof. Should other business properly come
before the meeting or any adjournment thereof, the proxy holders will vote
upon the same according to their discretion and best judgment.

Compliance with the Beneficial Ownership Reporting Requirements of Section
16(a) of the Securities Exchange Act of 1934, as Amended

Section 16(a) of the Securities Exchange Act of 1934, as amended, requires
the Company's directors and executive officers and the holders of 10% or more
of the Company's Common Stock to file with the SEC initial reports of
ownership and reports of changes in ownership of equity securities of the
Company. David H. Bernstein filed a Form 5 in connection with an option grant
late. Based solely upon a review of copies of reports of beneficial ownership
provided to the Company by officers and directors and 10% stockholders of the
Company, the Company believes that all reports required pursuant to Section
16(a) with respect to the 1998 fiscal year were timely filed.

10
<PAGE>

EXECUTIVE COMPENSATION

Summary Compensation Table

The Securities and Exchange Commission requires the following table setting
forth for the fiscal years ending March 31, 1999, 1998 and 1997, the cash
compensation paid by the Company to the Chief Executive Officer and each of
the four other most highly compensated executive officers during the last
fiscal year.

<TABLE>
<CAPTION>
Annual
Compensation Long-Term
------------------ Compensation
Name and Principal Stock Option All Other
Position Year Salary($) Bonus($) Awarded(#) Compensation($)
------------------ ---- --------- -------- ------------ ---------------
<S> <C> <C> <C> <C> <C>
Paul D. Levy(1)......... 1999 385,000 196,700 1,000,000 348(2)
Chairman of the Board 1998 354,170 250,000 500,000 348(2)
1997 325,000 180,000 725,000 348(2)

Michael T. Devlin(1).... 1999 385,000 196,700 1,000,000 348(2)
Chief Executive Officer 1998 354,170 250,000 500,000 348(2)
1997 325,000 180,000 725,000 348(2)

Robert H. Dickerson..... 1999 335,000 95,700 190,000 57,117(2)(3)
Senior Vice President 1998 270,000 40,625 200,000 162,504(2)(3)
and General Manager, 1997 145,000 38,100 200,000 348(2)
Products

David H. Bernstein...... 1999 335,000 95,700 290,000 348(2)
Senior Vice President 1998 333,284 125,000 100,000 1,938,405(2)(4)
and General Manager, 1997 275,000 78,000 90,000 348(2)
Products

John R. Lovitt.......... 1999 300,000 215,523 240,000 348(2)
Senior Vice President, 1998 295,176 150,000 100,000 348(2)
Worldwide Field 1997 195,000 135,000 90,000 3,348(2)(5)
Operations
</TABLE>
- --------
(1) Throughout fiscal year 1999, Mr. Levy was Chief Executive Officer and Mr.
Devlin was President. Effective in April 1999, Mr. Devlin was named Chief
Executive Officer.

(2) Includes $348 in premiums paid pursuant to a long-term disability plan
through which the Company provides long-term disability income insurance
for all its employees. In the event of an insured officer's disability,
the officer may be eligible after three consecutive months of disability
for a monthly benefit of 60% of his tax-free monthly earnings up to a
$6,000 per month maximum.

(3) Includes $56,769 and $162,504 in fiscal 1999 and fiscal 1998 respectively
paid to Mr. Dickerson in connection with his relocation to Seattle
Washington to cover expenses incurred in connection with the relocation.

(4) Includes $1,938,057 paid to Mr. Bernstein in connection with his
relocation to Boston, Massachusetts, consisting of a relocation bonus of
$1,000,000, a payment of $800,000 sufficient to pay Mr. Bernstein's
federal and state income taxes and a payment of $138,057 to cover expenses
incurred in connection with the relocation. See Certain Transactions.

(5) Includes $3,000 earned by Mr. Lovitt as an award for ten years of service
with the Company.

11
<PAGE>

Option Grants in Last Fiscal Year

The following table sets forth information with respect to each of the named
executive officers of the Company concerning the grant of stock options during
the last fiscal year and the potential realizable value at certain assumed
annual rates of stock price appreciation.

The total number of shares of Common Stock subject to options granted in
fiscal year 1999 was 6,137,937 (does not include "repriced" options as new
grants).
<TABLE>
<CAPTION>

Individual Grants
--------------------------- Potential Realizable Value
Number of Percent of at Assumed Annual Rates of
Shares of Total Options Stock Price Appreciation
Common Stock Granted to Exercise For Option Term(1)
Underlying Employees in Price Expiration ---------------------------
Name Options (#) Fiscal Year ($/Share) Date 5% ($) 10% ($)
- ---- ------------ ------------- --------- ---------- ------------- -------------
<S> <C> <C> <C> <C> <C> <C>
Paul D. Levy............ 200,000(2) 3.36 $13.3750 8/28/06 $1,223,778.15 $3,088,579.90
300,000(2) 5.04 $13.3750 3/18/07 $1,995,728.81 $5,101,128.26
200,000(2) 3.36 $13.3750 1/2/07 $1,539,764.85 $4,036,308.62
300,000 5.04 $11.1250 8/31/08 $2,098,935.82 $5,319,115.46

Michael T. Devlin....... 200,000(2) 3.36 $13.3750 8/28/06 $1,223,778.15 $3,088,579.90
300,000(2) 5.04 $13.3750 3/18/07 $1,995,728.81 $5,101,128.26
200,000(2) 3.36 $13.3750 1/2/07 $1,539,764.85 $4,036,308.62
300,000 5.04 $11.1250 8/31/08 $2,098,935.82 $5,319,115.46

Robert H. Dickerson..... 90,000(2) 1.52 $13.3750 11/21/06 $ 570,748.07 $1,448,071.12
100,000 1.68 $11.1250 8/31/08 $ 699,645.28 $1,773,038.49

David H. Bernstein...... 90,000(2) 1.51 $13.3750 8/27/06 $ 692,894.18 $1,816,338.88
100,000(2) 1.68 $13.3750 9/25/07 $ 769,882.42 $2,018,154.31
100,000 1.68 $11.1250 8/31/08 $ 699,645.27 $1,773,038.49

John R. Lovitt.......... 90,000(2) 1.51 $13.3750 8/28/06 $ 550,700.17 $1,389,860.96
100,000(2) 1.68 $13.3750 9/25/07 $ 717,033.88 $1,855,731.00
50,000 0.84 $11.1250 8/31/08 $ 349,822.64 $ 886,519.24
</TABLE>
- --------
(1) The Potential Realizable Value is calculated based on the fair market
value of the Common Stock on the date of grant, which is equal to the
exercise price of fiscal year 1999 granted options, assuming that the
Common Stock appreciates in value from the date of grant until the end of
the option term at the annual rate specified (5% and 10%). Potential
Realizable Value is net of the option exercise price. The assumed rates of
appreciation are specified in rules of the Securities and Exchange
Commission, and do not represent the Company's estimate or projection of
future Common Stock price. Actual gains, if any, resulting from stock
option exercises and Common Stock holdings are dependent on the future
performance of the Common Stock and overall stock market conditions, as
well as the option holder's continued employment through the
exercise/vesting period. There can be no assurance that the amounts
reflected in this table will be achieved.

(2) Includes shares subject to options that were granted prior to fiscal year
1998 and repriced at $13.375 per share effective April 3, 1998.

12
<PAGE>

OPTION EXERCISES IN LAST FISCAL YEAR AND YEAR-END VALUES

The following table sets forth information with respect to each of the named
executive officers of the Company concerning the exercise of stock options
during the last fiscal year and the fiscal year 1999 year-end value of all
unexercised options held by such individuals.

<TABLE>
<CAPTION>
Number of Securities
Underlying Unexercised Dollar Value of Unexercised,
Number of Options Held at In-the-money Options Held at
Shares March 31, 1999(1) March 31, 1999(1)(2)
Acquired on Dollar Value ------------------------- ----------------------------
Name Exercise Realized Exercisable Unexercisable Exercisable Unexercisable
- ---- ----------- ------------- ----------- ------------- -------------- -------------
<S> <C> <C> <C> <C> <C> <C>
Paul D. Levy............ 125,000 $2,012,525.00 1,550,000 0 $43,477,249.98 $0.00
Michael T. Devlin....... 234,076 $4,256,755.09 1,440,924 0 $40,246,418.86 $0.00
Robert H. Dickerson..... 70,500 $1,896,407.50 513,000 0 $16,398,963.74 $0.00
David H. Bernstein...... 31,200 $ 956,280.00 338,800 0 $ 9,774,297.98 $0.00
John R. Lovitt.......... 20,334 $ 342,709.87 346,332 0 $10,373,132.99 $0.00
</TABLE>
- --------
(1) Includes unvested options which may be exercised subject to a lapsing
right of repurchase in favor of the Company.

(2) Value based on market value of the Company's Common Stock at March 31,
1999 (the last business day of the fiscal year), minus the exercise price.
The market value at March 31, 1999, was $26.81 per share.

DESCRIPTION OF THE 1997 PLAN

General. The purpose of the 1997 Plan is to attract and retain the best
available personnel for positions of substantial responsibility with Rational,
to provide additional incentive to the employees and consultants of Rational
and to promote the success of Rational's business. Options and stock purchase
rights may be granted under the 1997 Plan. Options granted under the 1997 Plan
may be either "incentive stock options," as defined in Section 422 of the
Internal Revenue Code of 1986, as amended (the "Code"), or nonstatutory stock
options. As of the Record Date, the number of shares of Common Stock reserved
for issuance under the 1997 Plan is 10,290,000. In addition, approval of
Proposal 2 and Proposal 3 would increase the number of shares of Common Stock
reserved for issuance under the 1997 Plan by 6,000,000 shares and 12,000,000
shares, respectively.

Administration. The 1997 Plan may be administered by the Board of Directors
or a committee of the Board (the "Administrator"), which Administrator shall,
in the case of options intended to qualify as "performance-based compensation"
within the meaning of Section 162(m) of the Code, consist of two or more
"outside directors" within the meaning of Section 162(m) of the Code. The
Administrator has the power to determine the terms of the options or stock
purchase rights granted, including the exercise price, the number of shares
subject to each option or stock purchase right, the exercisability thereof,
and the form of consideration payable upon such exercise. In addition, the
Administrator has the authority to amend, suspend or terminate the 1997 Plan,
provided that no such action may affect any shares of Common Stock previously
issued and sold or any option previously granted under the 1997 Plan.

Eligibility; Limitations. Nonstatutory stock options and stock purchase
rights may be granted under the 1997 Plan to directors, employees and
consultants of Rational and any parent or subsidiary of Rational, although
Rational has adopted the policy of granting non-employee directors options
only out of the Company's Directors stock option plan. Incentive stock options
may be granted only to employees. The Administrator, in its discretion,
selects the employees and consultants to whom options and stock purchase
rights may be granted, the time or times at which such options and stock
purchase rights shall be granted, and the number of shares subject to each
such grant.

Section 162(m) of the Code places limits on the deductibility for federal
income tax purposes of compensation paid to certain executive officers of
Rational. In order to preserve Rational's ability to deduct the

13
<PAGE>

compensation income associated with options and stock purchase rights granted
to such persons, the 1997 Plan currently provides that no employee may be
granted, in any fiscal year of Rational, options and stock purchase rights to
purchase more than 1,000,000 shares of Common Stock (as appropriately adjusted
for changes in the capitalization of Rational), except in the case of a new
employee joining Rational, in which case such employee may be granted options
for an additional 500,000 shares in connection with the start of employment.

Terms and Conditions of Options. Each option is evidenced by a stock option
agreement between Rational and the optionee, and is subject to the following
additional terms and conditions:

(a) Exercise Price. The Administrator determines the exercise price of
options at the time the options are granted. The exercise price of an
incentive stock option may not be less than 100% of the fair market value
of the Common Stock on the date such option is granted; provided, however,
the exercise price of an incentive stock option granted to a 10%
stockholder may not be less than 110% of the fair market value of the
Common Stock on the date such option is granted. The exercise price of a
non-statutory stock option may not be less that 100% of the fair market
value of the Common Stock on the date such option is granted if the option
is intended to qualify as "performance-based compensation" under Section
162(m) of the Code. Otherwise, there is no restriction on the exercise
price of non-statutory stock options. The fair market value of the Common
Stock is generally determined with reference to the closing sale price for
the Common Stock (or the closing bid if no sales were reported) on the last
market trading day prior to the date the option is granted.

(b) Exercise of Option; Form of Consideration. The Administrator
determines when options become vested and may, in its discretion,
accelerate the vesting of any outstanding option. Stock options granted
under the 1997 Plan generally vest over four (4) years. Such options are
exercisable prior to the time when they have vested, subject to a lapsing
right of repurchase in favor of the Company. The means of payment for
shares issued upon exercise of an option is specified in each option
agreement. The 1997 Plan permits payment to be made by cash, check,
promissory note, other shares of Common Stock of Rational (with some
restrictions), cashless exercises, a reduction in the amount of any Company
liability to the optionee, any other form of consideration permitted by
applicable law, or any combination thereof.

(c) Term of Option. The term of an incentive stock option may be no more
than ten (10) years from the date of grant; provided that in the case of an
incentive stock option granted to a 10% stockholder, the term of the option
may be no more than five (5) years from the date of grant. No option may be
exercised after the expiration of its term.

(d) Termination of Employment. If an optionee's employment or consulting
relationship terminates for any reason (other than death or disability),
then all options held by the optionee under the 1997 Plan expire on the
earlier of (i) the date set forth in his or her notice of grant or, in the
absence thereof, three (3) months after the date of termination or (ii) the
expiration date of such option. To the extent the option is exercisable at
the time of such termination, the optionee may exercise all or part of his
or her option at any time before termination.

(e) Death or Disability. If an optionee's employment or consulting
relationship terminates as a result of death or disability, then all
options held by such optionee under the 1997 Plan expire on the earlier of
(i) the date set forth in his or her notice of grant or, in the absence
thereof, twelve (12) months from the date of such termination or (ii) the
expiration date of such option. The optionee (or the optionee's estate or
the person who acquires the right to exercise the option by bequest or
inheritance), may exercise all or part of the option at any time before
such expiration to the extent that the option was exercisable at the time
of such termination.

(f) Nontransferability of Options. Options granted under the 1997 Plan
are not transferable other than by will or the laws of descent and
distribution, and may be exercised during the optionee's lifetime only by
the optionee.

(g) Other Provisions. The stock option agreement may contain other terms,
provisions and conditions not inconsistent with the 1997 Plan as may be
determined by the Administrator.

14
<PAGE>

Stock Purchase Rights. A stock purchase right gives the purchaser a period
as determined by the Administrator from the date of grant to purchase Common
Stock. A stock purchase right is accepted by the execution of a restricted
stock purchase agreement between Rational and the purchaser, accompanied by
the payment of the purchase price for the shares. Unless the Administrator
determines otherwise, the restricted stock purchase agreement shall give
Rational a repurchase option exercisable upon the voluntary or involuntary
termination of the purchaser's employment or consulting relationship with
Rational for any reason (including death and disability). The purchase price
for any shares repurchased by Rational shall be the original price paid by the
purchaser. The repurchase option lapses at a rate determined by the
Administrator. A stock purchase right is nontransferable other than by will or
the laws of descent and distribution, and may be exercised during the
optionee's lifetime only by the grantee thereof.

Changes in Capitalization. In the event that the stock of Rational changes
by reason of any stock split, reverse stock split, stock dividend,
combination, reclassification or other similar change in the capital structure
of Rational effected without the receipt of consideration, appropriate
adjustments shall be made in the number and class of shares of stock subject
to the 1997 Plan, the number and class of shares of stock subject to any
option or stock purchase right outstanding under the 1997 Plan, and the
exercise price of any such outstanding option or stock purchase right.

In the event of a liquidation or dissolution, any unexercised options or
stock purchase rights will terminate. The Administrator may, in its discretion
provide that each optionee shall have the right to exercise all of the
optionee's options and stock purchase rights, including those not otherwise
exercisable, until the date ten (10) days prior to the consummation of the
liquidation or dissolution, or that any rights of repurchase in Rational with
respect to stock purchase rights shall lapse provided the proposed dissolution
or liquidation takes place at the time and in the manner anticipated.

In connection with any merger, consolidation, acquisition of assets or like
occurrence involving Rational, each outstanding option or stock purchase right
shall be assumed or an equivalent option or right substituted by the successor
corporation. If the successor corporation refuses to assume the options and
stock purchase rights or to substitute substantially equivalent options and
stock purchase rights, the optionee shall have the vested right to exercise
the option or stock purchase right as to all the optioned stock, including
shares not otherwise vested. In such event, the Administrator shall notify the
optionee that the option or stock purchase right is fully exercisable for
fifteen (15) days from the date of such notice and that the option or stock
purchase right terminates upon expiration of such period.

Amendment and Termination of the 1997 Plan. The Board may amend, alter,
suspend or terminate the 1997 Plan, or any part thereof, at any time and for
any reason. However, Rational shall obtain stockholder approval for any
amendment to the 1997 Plan to the extent necessary to comply with Rule 16b-3,
Section 162(m) and Section 422 of the Code, or any similar rule or statute. No
such action by the Board or stockholders may alter or impair any option or
stock purchase right previously granted under the 1997 Plan without the
written consent of the optionee. Unless terminated earlier, the 1997 Plan
shall terminate ten years from the date of its initial approval by the
stockholders or the Board of Rational, whichever is earlier.

Federal Income Tax Consequences

Incentive Stock Options. An optionee who is granted an incentive stock
option does not recognize taxable income at the time the incentive stock
option is granted or upon its exercise, although the exercise may subject the
optionee to the alternative minimum tax. Upon a disposition of the shares more
than two years after grant of the incentive stock option and one year after
exercise of the incentive stock option, any gain or loss is treated as long-
term capital gain or loss. If these holding periods are not satisfied, the
optionee recognizes ordinary income at the time of disposition equal to the
difference between the exercise price and the lower of (i) the fair market
value of the shares at the date of the option exercise or (ii) the sale price
of the shares. Any gain or loss recognized on such a premature disposition of
the shares in excess of the amount treated as ordinary income is treated as
long-term or short-term capital gain or loss, depending on the holding period.
A different rule for

15
<PAGE>

measuring ordinary income upon such a premature disposition may apply if the
optionee is also an officer, director, or 10% stockholder of Rational.
Rational is entitled to a deduction in the same amount as the ordinary income
recognized by the optionee.

Nonstatutory Stock Options. An optionee does not recognize any taxable
income at the time he or she is granted a nonstatutory stock option. Upon
exercise, the optionee recognizes taxable income generally measured by the
excess of the then fair market value of the shares over the exercise price.
Any taxable income recognized in connection with an option exercise by an
employee or former employee of Rational is subject to tax withholding by
Rational. Rational is entitled to a deduction in the same amount as the
ordinary income recognized by the optionee. Upon a disposition of such shares
by the optionee, any difference between the sale price and the optionee's
exercise price, to the extent not recognized as taxable income as provided
above, is treated as long-term or short-term capital gain or loss, depending
on the holding period.

Stock Purchase Rights. Stock purchase rights will generally be taxed in the
same manner as nonstatutory stock options. However, restricted stock is
generally purchased upon the exercise of a stock purchase right. At the time
of purchase, restricted stock is subject to a "substantial risk of forfeiture"
within the meaning of Section 83 of the Code. As a result, the purchaser will
not recognize ordinary income at the time of purchase. Instead, the purchaser
will recognize ordinary income on the dates when the stock ceases to be
subject to a substantial risk of forfeiture. The stock will generally cease to
be subject to a substantial risk of forfeiture when it is no longer subject to
Rational's right to repurchase the stock upon the purchaser's termination of
employment with Rational. At such times, the purchaser will recognize ordinary
income measured as the difference between the purchase price and the fair
market value of the stock on the date the stock is no longer subject to a
substantial risk of forfeiture.

The purchaser may accelerate his or her recognition of ordinary income, if
any, to the date of purchase and begin the capital gain holding period by
timely filing an election pursuant to Section 83(b) of the Code. In such
event, the ordinary income recognized, if any, is measured as the difference
between the purchase price and the fair market value of the stock on the date
of purchase, and the capital gain holding period commences on such date. The
ordinary income recognized by a purchaser who is an employee or former
employee will be subject to tax withholding by Rational. Different rules may
apply if the purchaser is also an officer, director, or 10% stockholder of
Rational.

THE FOREGOING IS ONLY A SUMMARY OF THE EFFECT OF FEDERAL INCOME TAXATION
UPON OPTIONEES, HOLDERS OF STOCK PURCHASE RIGHTS, AND RATIONAL WITH RESPECT TO
THE GRANT AND EXERCISE OF OPTIONS AND STOCK PURCHASE RIGHTS UNDER THE 1997
PLAN. IT DOES NOT PURPORT TO BE COMPLETE, AND DOES NOT DISCUSS THE TAX
CONSEQUENCES OF THE OPTIONEE'S DEATH OR THE PROVISIONS OF THE INCOME TAX LAWS
OF ANY MUNICIPALITY, STATE OR FOREIGN COUNTRY IN WHICH THE OPTIONEE MAY
RESIDE.

16
<PAGE>

COMPENSATION COMMITTEE REPORT

Pursuant to rules adopted by the SEC designed to enhance disclosure of
public companies' policies toward executive compensation, set forth below is a
report submitted by the Company's Compensation Committee (the "Committee")
addressing the Company's compensation policies with respect to executive
officers.

The Committee reviews and recommends to the Board action with respect to
compensation of and benefits granted to officers and other key employees of
the Company and administers the Company's several stock option plans and stock
purchase plan. During fiscal year 1999, the Committee comprised two non-
employee directors.

General Compensation Policies

The Company structures executive compensation in a manner designed to
provide competitive levels of compensation and to assist the Company in
attracting and retaining qualified executives. The compensation paid to the
Company's executive officers consists primarily of base salary, cash bonuses
under a management incentive bonus plan, and grants of equity incentives
pursuant to the Company's stock option plans.

Base-Salary Compensation

The Committee annually reviews base salaries of executive officers,
including the executive officers named in the Summary Compensation Table.
Industry compensation surveys are used to establish base salaries that are
within the range of those of persons holding comparably responsible positions
at other similar-sized companies, both regionally and nationally. While salary
surveys that directly correspond to the companies included in the "peer group"
used to construct the Performance Graph included in this Proxy Statement are
not available, there is substantial overlap between the companies included in
the salary surveys used by the Company and the companies included in such
"peer group," and the Committee believes that it is appropriate to consider
such surveys in establishing the range of competitive salaries for its
executive officers. The Company's current compensation structure falls
generally within the range of compensation structures adopted by the other
companies in the salary surveys reviewed. In addition, other factors are
considered in setting salaries, such as cost-of-living increases, management
performance, as well as the individual's past performance and potential with
the Company. The consideration of additional factors and the weight given to
any particular factor are within the discretion of the Committee. After
considering the factors described above in connection with salary adjustments,
and giving particular emphasis to competitive factors and individual
performance, the Committee recommended that the base salary of the named
executive officers, including Mr. Levy, who was Chief Executive Officer
throughout fiscal 1999, be increased in fiscal year 1999 as summarized in the
Summary Compensation Table elsewhere in this Proxy Statement.

Bonus Compensation

The Company's management incentive bonus plan ties payment of benefits to
executive officers, including the executive officers named in the Summary
Compensation Table, to corporate profit goals established by the Board of
Directors and a minimum level of profitability must be achieved before any
amounts are paid pursuant to the plan. Payments under the plan are based upon
the following factors: (a) annual base salary; (b) an employee's targeted
percentage (a percentage of base salary that generally increases for higher
positions within the Company, which places a greater percentage of
compensation at risk for those with greater responsibility); and (c) a
corporate performance factor based on a comparison of corporate results to
profitability objectives established by the Board of Directors, based on the
Company's operating plan established each year for the succeeding year.

Equity-Based Compensation

The option incentive component of the total compensation package is intended
to retain and motivate executives to improve long-term stock performance and
to increase value for all stockholders. The Committee

17
<PAGE>

generally grants options under the Company's plans with an exercise price
equal to the market price at the date of grant and, as a result, the options
will have value only if the Company's stock price increases from the time of
the award. Grants are made to executive officers based on salary,
responsibility, and performance of the individual officer. Consistent with the
Committee's philosophy that the award of stock options should be used to
incentivize key executive officers and to further align their interests with
those of the stockholders, during fiscal year 1999 the Committee examined the
stock and option holdings of the Company's executive officers and determined
that the awards set forth in the Option Grants in Last Fiscal Year Table were
appropriate. See also, "Special Measures Taken Since The Beginning Of Fiscal
1998--1997 Stock Option Repricing," and "--1998 Executive Officer Stock Option
Repricing," below.

Special Measures Taken Since The Beginning of Fiscal 1998

In the past three years, the Company has experienced extraordinary growth,
both through the expansion of its core business and through acquisitions,
including the acquisitions of SQA, Inc. in February 1997 and Pure Atria
Corporation in July 1997. In addition, the Company faces intense competitive
challenges from a number of companies, including some with substantially
greater resources than the Company. As a result of these factors the Company's
management team and key personnel have been required to assume increased
responsibilities.

The Committee strongly believes that the current management team has been
highly successful in building the Company and integrating acquisitions,
improving financial results, and creating excellent prospects for long-term
growth in stockholder value. As such, the Committee further believes that it
is in the best interest of the Company's stockholders that the Company retain
and continue to motivate senior management and key personnel. Upon review of
the Company's compensation policies and arrangements, particularly in light of
the decline in the Company's stock price in 1997 and 1998, the Committee
determined that certain aspects of the Company's compensation structure were
no longer competitive with industry standards. With those considerations in
mind, and cognizant of the intensely competitive market for management and
other personnel in which the Company does business and the opportunities
available to management and key personnel with an ever growing number of other
companies, most recently driven by the rapid increase in Internet and Web-
related technology companies, the Committee and the Board took a number of
special measures since the beginning of fiscal 1998 to increase its ability to
retain key personnel. Set forth below is a brief summary of each of these
measures.

Employment Agreements with Key Executives

The Committee believes that one of the most critical elements in planning
for the long-term success of the Company is to ensure that it retains its
senior management team. To determine appropriate measures to retain senior
management, the Company reviewed measures that had been adopted by a large
number of other public companies in the information technology industry. Based
upon this research and the Committee's deliberations on this issue, in fiscal
1998 the Committee determined that it would be in the Company's best interest
to enter into employment agreements with certain members of the senior
management team, namely Paul Levy, Michael Devlin, David Bernstein, Robert
Dickerson, John Lovitt, Kevin Haar, Timothy Brennan and Joseph Marasco, such
that the Company would be able to keep its senior management team focused on
building stockholder value. In addition, in fiscal 1999, the Committee
determined that is was in the best interest of the Company to enter into an
employment agreement with Eric Schurr. The employment agreements provide for
salary, bonus and employee benefits, and for certain additional payments and
benefits in the event of involuntary termination that is not for cause. In
addition, each employee agrees to be bound by certain non-competition and non-
solicitation restrictions. For details on the terms of the employment
agreements, see "Certain Transactions."

1997 Stock Option Repricing

In November 1997, in response to the substantial decline in the Company's
stock price over the previous twelve months, the Company entered into
agreements to reprice "under water" options at an exercise price of

18
<PAGE>

$10 per share, the closing price of the Company's stock on November 14, 1997.
In exchange for the repricing, each employee agreed not to dispose of, and to
grant the Company repurchase rights with respect to, all shares acquired
pursuant to repriced options for a period of one year after the repricing, and
50% of the shares so acquired for a period of two years after the repricing.

The repricing was open to all employees except certain members of the senior
management team (including Messrs. Levy, Devlin, Bernstein, Dickerson and
Lovitt). In considering the repricing, the Board evaluated the weakened
incentive effects of having a substantial number of options priced above the
prevailing market price, the intensely competitive labor market and the risk
of losing key personnel to other companies in the industry. The Board
determined that the importance of retaining key personnel in the face of the
current challenges facing the Company outweighed the potentially dilutive
effect of the repricing on the Company's stockholders. The senior management
team was excluded from the repricing in November 1997 because the Board felt
that senior management should be required to produce operating results that
would have a positive effect on the stock price prior to participating in any
repricing.

1998 Executive Officer Stock Option Repricing

In April 1998, the Committee, after consulting with all of the outside
directors, approved repricing agreements with each of Messrs. Levy, Devlin,
Bernstein, Dickerson and Lovitt on substantially the same terms, including the
disposition limitations and repurchase provisions, offered to the rest of the
employees in November 1997 to reprice their under water options at $13.375 per
share, the closing price of the Company's stock on April 2, 1998. In
considering the repricing for senior management, the Committee noted the
continuing challenges facing the Company, the fact that the stock price had
risen by more than 30% since the November 1997 repricing, and the critical
contributions to the long term success of the Company that will be required of
each member of the senior management team. Taking into account these factors,
the Committee determined that the executive officer repricing was in the best
interest of the Company in order to incentivize the senior management team to
remain with the Company, and that these benefits outweighed the potentially
dilutive effect of the repricing on the Company's stockholders.

The following table sets forth information with respect to each of the
Company's executive officers concerning all repricings of options held by any
executive officer during the last ten completed fiscal years. This table does
not include options repriced in the 1998 executive officer stock option
repricing, which occurred after the end of the fiscal year.

[remainder of page intentionally left blank]

19
<PAGE>

Ten-Year Option Repricing Table

<TABLE>
<CAPTION>
Number of Market
Securities Price of Exercise Length of Original
Underlying Stock at Price at New Option Term
Repriced Time of Time of Exercise Remaining at Date
Name Date Options Repricing Repricing Price of Repricing
---- -------- ---------- --------- --------- -------- ------------------
<S> <C> <C> <C> <C> <C> <C>
Paul D. Levy.................. 4/3/98 200,000 $13.375 $28.19 $13.375 8 years, 5 months
Chairman of the Board 4/3/98 300,000 $13.375 $18.25 $13.375 8 years, 11 months
4/3/98 200,000 $13.375 $39.56 $13.375 8 years, 9 months

Michael T. Devlin............. 4/3/98 200,000 $13.375 $28.19 $13.375 8 years, 5 months
Chief Executive Officer 4/3/98 300,000 $13.375 $18.25 $13.375 8 years, 11 months
4/3/98 200,000 $13.375 $39.56 $13.375 8 years, 9 months

Robert Dickerson.............. 4/3/98 74,790 $13.375 $26.25 $13.375 8 years, 8 months
Senior Vice President and 4/3/98 15,210 $13.375 $26.25 $13.375 8 years, 8 months
General Manager, Products

David H. Bernstein............ 4/3/98 4,600 $13.375 $28.19 $13.375 8 years, 5 months
Senior Vice President and 4/3/98 85,400 $13.375 $28.19 $13.375 8 years, 5 months
General Manager, Products 4/3/98 100,000 $13.375 $16.00 $13.375 9 years, 6 months

John R. Lovitt................ 4/3/98 90,000 $13.375 $28.19 $13.375 8 years, 5 months
Senior Vice President 4/3/98 100,000 $13.375 $16.00 $13.375 9 years, 6 months
Worldwide Field Operations

Timothy A. Brennan............ 11/17/97 8,935 $10.00 $38.25 $10.00 9 years
Senior Vice President, 11/17/97 1,065 $10.00 $38.25 $10.00 9 years
Chief Financial Officer and
Secretary

Joseph N. Marasco............. 11/17/97 14,606 $10.00 $20.625 $10.00 9 years, 4 months
Senior Vice President and 11/17/97 5,394 $10.00 $20.625 $10.00 9 years, 4 months
General Manager

Kevin J. Haar................. 11/17/97 20,000 $10.00 $22.41 $10.00 8 years, 8 months
Vice President, the Americas 11/17/97 13,613 $10.00 $18.25 $10.00 9 years, 4 months
Field Operations 11/17/97 6,387 $10.00 $18.25 $10.00 9 years, 4 months
11/17/97 150,000 $10.00 $10.38 $10.00 9 years, 11 months

Thomas F. Bogan............... 11/17/97 8,063 $10.00 $23.407 $10.00 3 years, 249 days
Senior Vice President, 11/17/97 64,500 $10.00 $23.407 $10.00 3 years, 249 days
Chief Operating Officer 11/17/97 57,000 $10.00 $18.25 $10.00 9 years, 121 days
11/17/97 8,628 $10.00 $23.407 $10.00 8 years, 249 days

James P. Cluchey.............. 11/17/97 12,760 $10.00 $18.25 $10.00 9 years, 121 days
Vice President, 11/17/97 12,240 $10.00 $18.25 $10.00 9 years, 121 days
International Field
Operations

Eric L. Schurr................ 11/17/97 9,030 $10.00 $34.302 $10.00 3 years, 170 days
Vice President and General 11/17/97 1,042 $10.00 $34.302 $10.00 3 years, 170 days
Manager, Corporate Marketing 11/17/97 6,059 $10.00 $18.25 $10.00 9 years, 121 days
and Suite Products 11/17/97 63,941 $10.00 $18.25 $10.00 9 years, 121 days
</TABLE>

20
<PAGE>

Certain Tax Considerations

The Committee has considered the potential future effects of Section 162(m)
of the Code, as amended. Section 162(m) limits the deductibility by public
companies of certain executive compensation in excess of $1 million per
executive per year, but excludes from the calculation of such $1 million limit
certain elements of compensation, including performance-based compensation,
provided that certain requirements are met. With the exception of Mr.
Bernstein, none of the Company's executive officers approached the $1 million
limit in prior fiscal years nor is any expected to approach such limit in
fiscal year 2000. However, the provisions of Section 162(m) merit current
consideration because, under certain circumstances, the difference between the
fair market value and the exercise price of options granted in the present
time period, measured at the time of exercise, could be included in the
calculation under Section 162(m) of the executive officers' compensation in
the time period in which the exercise occurs. This result can be avoided if
the plans under which such options are granted comply with certain
requirements at the time of grant, including administration by a committee
consisting solely of two or more outside directors and stockholder approval of
the terms of the plan, including approval of an annual limit stated in the
plan on the number of shares with respect to which options may be granted to
any employee. The Company's 1997 Plan, which is the only stock option plan
under which the Company's executive officers are currently eligible to receive
options, has been designed and administered to meet such requirements. The
Company has not attempted to structure other elements of executive
compensation to qualify as performance-based compensation for purposes of
Section 162(m).

Summary

The Compensation Committee believes that the Company's general compensation
policies and the special measures taken since the beginning of fiscal 1998
have been successful in attracting and retaining qualified employees and in
linking compensation directly to corporate performance relative to the
Company's goals. The Company's compensation policies will evolve over time as
the Company moves to attain the near-term goals it has set for itself while
maintaining its focus on building long-term stockholder value.

Leslie G. Denend
Allison R. Schleicher

21
<PAGE>

PERFORMANCE GRAPH

The following graph compares the five-year cumulative total returns for the
Company, the NASDAQ Market Index and an index constructed from a peer group
consisting of 563 companies that are classified in the same Standard Industrial
Classification (SIC) code as the Company.

Compare 5-Year Cumulative Total Return
Among Rational Software Corporation,
Nasdaq Market Index And Sic Code Index

[PERFORMANCE GRAPH APPEARS HERE]

Assumes $100 Invested on April 1, 1994
Fiscal Year Ending March 31, 1999
<TABLE>
<CAPTION>
1995 1996 1997 1998 1999
------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C>
Rational Software Corporation................ 118.00 421.33 440.00 277.33 572.00
SIC Code Index............................... 145.22 205.77 247.34 439.63 636.03
Nasdaq Market Index.......................... 106.09 142.70 159.64 241.26 315.28
</TABLE>

22
<PAGE>

CERTAIN TRANSACTIONS

Daniel H. Case III, a director and stockholder of the Company, is the
President and Chief Executive Officer of Hambrecht & Quist Group ("H&Q"). H&Q
has in the past, and may in the future, provide investment banking services or
financial advisory services to the Company for which the Company has paid or
will pay customary fees and expenses of H&Q. H&Q may also continue to provide
research coverage of the Company or make a market in its publicly traded
securities. There is no agreement between the Company and H&Q relating to such
activities.

In February 1998, the Company entered into employment agreements with each
of Paul Levy, Michael Devlin, David Bernstein, Robert Dickerson, John Lovitt,
Kevin Haar, Timothy Brennan and Joseph Marasco. In December 1998, the Company
entered into an additional employment agreement with Eric Schurr. Each of the
employment agreements provides for annual salary, eligibility for annual
bonuses, and participation in the Company's employee benefit plans. In
addition, the agreements with Messrs. Levy and Devlin provide that in the
event of involuntary termination without cause in certain circumstances,
including, among other things, termination after a change of control of the
Company, Mr. Levy or Mr. Devlin will be entitled to (i) severance payments
equal to two times annual salary plus two times the highest bonus for which
such person is eligible, (ii) immediate vesting of all unvested options
(including release of any shares from disposition restrictions and the
Company's repurchase rights as described in "Compensation Committee Report--
Special Measures Taken Since The Beginning Of Fiscal 1998--Executive Officer
Option Repricing") and extension of the exercise period for certain options,
and (iii) continuation of employee benefits for two years after termination.
In addition, Messrs. Levy and Devlin agreed not to compete with the Company or
solicit any of the Company's employees to leave the Company within two years
after terminating their employment with the Company. In the cases of Messrs.
Bernstein, Lovitt, Dickerson, Haar, Brennan, Marasco and Schurr the agreements
are identical to the agreements with Messrs. Levy and Devlin, except that the
severance payments equal one times salary and bonus, the employee benefits are
continued for one year after termination, and the non-competition and non-
solicitation periods are for one year after the termination of employment.

In September 1997, the Company asked Mr. Bernstein, the Company's Senior
Vice President, Products, to relocate to the Boston, Massachusetts area to
oversee the integration of the recently acquired Massachusetts operations of
SQA, Inc., and Pure Atria Corporation. In connection with Mr. Bernstein's
relocation, the Company and Mr. Bernstein entered into a relocation agreement,
pursuant to which Mr. Bernstein was paid a relocation bonus of $1,000,000 a
gross-up payment of $800,000 sufficient to pay Mr. Bernstein's federal and
state income taxes and of a payment of $138,057 to cover expenses incurred in
connection with the relocation. In the event that Mr. Bernstein leaves the
Company voluntarily or is terminated for cause within four years after the
date of the agreement, he will be required to repay certain amounts of the
relocation payment and the gross-up, depending on how long after the date of
the agreement his employment is so terminated.

EXPENSES OF SOLICITATION

The cost of solicitation of proxies for the Annual Meeting will be paid by
the Company. In addition to solicitation of proxies by mail, the officers,
directors, and regular employees of the Company may solicit proxies in person
or by telegraph or telephone. Brokerage houses, nominees, fiduciaries, and
other custodians will be requested by the Company to forward proxy soliciting
material to beneficial owners of shares held of record by them and the Company
will reimburse them for reasonable out-of-pocket expenses incurred in doing
so. The Company has retained ChaseMellon Shareholder Services, a professional
solicitation firm, to assist in the solicitation of proxies at a cost not to
exceed $12,500, plus reasonable expenses.

23
<PAGE>

STOCKHOLDER PROPOSALS

Pursuant to Rule 14a-8 under the Exchange Act, stockholders may present
proper proposals for inclusion in the Company's Proxy Statement and for
consideration at the next Annual Meeting of stockholders by submitting their
proposals to the Company in a timely manner. In order to be included in the
Company's proxy material for the 2000 Annual Meeting of stockholders,
stockholder proposals must be received by the Company no later than March 25,
2000, and have complied with the requirements of Rule 14a-8 of the Securities
Exchange Act of 1934, as amended. In addition, the Company's proxy for the
2000 Annual Meeting of Stockholders may grant the holder thereof discretionary
authority to vote on any proposals brought before such meeting after June 8,
2000.

VOTING VIA THE INTERNET OR BY TELEPHONE

For shares of Common Stock that are registered in the name of the
stockholder, the stockholder may only vote by returning a signed proxy card or
voting in person at the meeting.

For shares of Common Stock that the stockholder beneficially owns and holds
in "street name" through a broker, or bank, the stockholder may vote by
completing and returning the voting form provided by their broker or bank or
via the internet or by telephone through their broker, or bank, if such a
service is provided. To vote via the Internet or telephone, the stockholder
should follow the instructions on the voting form provided by their broker or
bank. Votes submitted electronically via the Internet or by telephone must be
received by 12:00 a.m. (PST) on August 26, 1999.

The Internet voting procedures are designed to authenticate stockholder
identities, to allow stockholders to give their voting instructions and to
confirm that stockholders' instructions have been recorded properly.
Stockholders voting via the Internet should understand that there may be costs
associated with electronic access, such as usage charges from Internet access
providers and telephone companies, that must be borne by the stockholder.

By Order of the Board of Directors,

Timothy A. Brennan
Secretary

24
<PAGE>

RATIONAL SOFTWARE CORPORATION
1997 STOCK PLAN

1. Purposes of the Plan. The purposes of this Stock Plan are:

(a) to attract and retain the best available personnel for positions of
substantial responsibility,

(b) to provide additional incentive to Employees, Directors and
Consultants, and

Options granted under the Plan may be Incentive Stock Options or
Nonstatutory Stock Options, as determined by the Administrator at the time of
grant. Stock Purchase Rights may also be granted under the Plan.

2. Definitions. As used herein, the following definitions shall apply:

(a) "Administrator" means the Board or any of its Committees as shall be
administering the Plan, in accordance with Section 4 of the Plan.

(b) "Applicable Laws" means the requirements relating to the administration
of stock option plans under U. S. state corporate laws, U.S. federal and state
securities laws, the Code, any stock exchange or quotation system on which the
Common Stock is listed or quoted and the applicable laws of any foreign country
or jurisdiction where Options or Stock Purchase Rights are, or will be, granted
under the Plan.

(d) "Code" means the Internal Revenue Code of 1986, as amended.

(e) "Committee" means a committee of Directors appointed by the Board in
accordance with Section 4 of the Plan.

(f) "Common Stock" means the common stock of the Company.

(g) "Company" means Rational Software Corporation, a Delaware corporation.

(h) "Consultant" means any person, including an advisor, engaged by the
Company or a Parent or Subsidiary to render services to such entity.

(i) "Director" means a member of the Board.

(j) "Disability" means total and permanent disability as defined in Section
22(e)(3) of the Code.

(k) "Employee" means any person, including Officers and Directors, employed
by the Company or any Parent or Subsidiary of the Company. A Service Provider
shall not cease to be an Employee in the case of (i) any leave of absence
approved by the Company or (ii) transfers between locations of the Company or
between the Company, its Parent, any Subsidiary, or any successor. For purposes
of Incentive Stock Options, no such leave may exceed ninety days, unless
reemployment upon expiration of such leave is guaranteed by statute or
contract. If reemployment upon expiration of a leave of absence approved by the
Company is not so guaranteed, on the 181st day of such leave any Incentive
Stock Option held by the Optionee shall cease to be treated as an Incentive
Stock Option and shall be treated for tax purposes as a Nonstatutory Stock
Option. Neither service as a Director nor payment of a director's fee by the
Company shall be sufficient to constitute "employment" by the Company.

(l) "Exchange Act" means the Securities Exchange Act of 1934, as amended.

1
<PAGE>

(m) "Fair Market Value" means, as of any date, the value of Common Stock
determined as follows:

(i) If the Common Stock is listed on any established stock exchange or a
national market system, including without limitation the NASDAQ National
Market or The NASDAQ Small Cap Market of The NASDAQ Stock Market, its Fair
Market Value shall be the closing sales price for such stock (or the
closing bid, if no sales were reported) as quoted on such exchange or
system for the last market trading day prior to the time of determination,
as reported in The Wall Street Journal or such other source as the
Administrator deems reliable;

(ii) If the Common Stock is regularly quoted by a recognized securities
dealer but selling prices are not reported, the Fair Market Value of a
Share of Common Stock shall be the mean between the high bid and low asked
prices for the Common Stock on the last market trading day prior to the day
of determination, as reported in The Wall Street Journal or such other
source as the Administrator deems reliable; or

(iii) In the absence of an established market for the Common Stock, the
Fair Market Value shall be determined in good faith by the Administrator.

(n) "Incentive Stock Option" means an Option intended to qualify as an
incentive stock option within the meaning of Section 422 of the Code and the
regulations promulgated thereunder.

(o) "Nonstatutory Stock Option" means an Option not intended to qualify as
an Incentive Stock Option.

(p) "Notice of Grant" means a written or electronic notice evidencing
certain terms and conditions of an individual Option or Stock Purchase Right
grant. The Notice of Grant is part of the Option Agreement.

(q) "Officer" means a person who is an officer of the Company within the
meaning of Section 16 of the Exchange Act and the rules and regulations
promulgated thereunder.

(r) "Option" means a stock option granted pursuant to the Plan.

(s) "Option Agreement" means an agreement between the Company and an
Optionee evidencing the terms and conditions of an individual Option grant.
The Option Agreement is subject to the terms and conditions of the Plan.

(t) "Option Exchange Program" means a program whereby outstanding Options
are surrendered in exchange for Options with a lower exercise price.

(u) "Optioned Stock" means the Common Stock subject to an Option or Stock
Purchase Right.

(v) "Optionee" means the holder of an outstanding Option or Stock Purchase
Right granted under the Plan.

(w) "Parent" means a "parent corporation," whether now or hereafter
existing, as defined in Section 424(e) of the Code.

(x) "Plan" means this 1997 Stock Option Plan.

(y) "Restricted Stock" means shares of Common Stock acquired pursuant to a
grant of Stock Purchase Rights under Section 11 of the Plan.

(z) "Restricted Stock Purchase Agreement" means a written agreement between
the Company and the Optionee evidencing the terms and restrictions applying to
stock purchased under a Stock Purchase Right. The Restricted Stock Purchase
Agreement is subject to the terms and conditions of the Plan and the Notice of
Grant.

2
<PAGE>

(aa) "Rule 16b-3" means Rule 16b-3 of the Exchange Act or any successor to
Rule 16b-3, as in effect when discretion is being exercised with respect to the
Plan.

(bb) "Section 16(b)" means Section 16(b) of the Exchange Act.

(cc) "Service Provider" means an Employee, Director or Consultant.

(dd) "Share" means a share of the Common Stock, as adjusted in accordance
with Section 13 of the Plan.

(ee) "Stock Purchase Right" means the right to purchase Common Stock
pursuant to Section 11 of the Plan, as evidenced by a Notice of Grant.

(ff) "Subsidiary" means a "subsidiary corporation", whether now or hereafter
existing, as defined in Section 424(f) of the Code.

3. Stock Subject to the Plan. Subject to the provisions of Section 13 of the
Plan, the maximum aggregate number of Shares which may be optioned and sold
under the Plan is 28,290,000 Shares, plus any unused Shares and any forfeited
Shares. For purposes of this Section 3,

(i) "unused Shares" means Shares reserved for issuance but not covered
by grants under the1994 Stock Option Plan (the "1994 Plan") (which 1994
Plan shall be terminated as of the effective date of the Plan), and

(ii) "forfeited Shares" means any Shares covered by grants under the
1994 Plan that are not issued to participants or that are returned to the
Company upon forfeiture of such Shares.

If an Option or Stock Purchase Right expires or becomes unexercisable
without having been exercised in full, or is surrendered pursuant to an Option
Exchange Program, the unpurchased Shares which were subject thereto shall
become available for future grant or sale under the Plan (unless the Plan has
terminated); provided, however, that Shares that have actually been issued
under the Plan, whether upon exercise of an Option or Right, shall not be
returned to the Plan and shall not become available for future distribution
under the Plan, except that if Shares of Restricted Stock are repurchased by
the Company at their original purchase price, such Shares shall become
available for future grant under the Plan.

4. Administration of the Plan.

(a) Procedure.

(i) Multiple Administrative Bodies. The Plan may be administered by
different Committees with respect to different groups of Service Providers.

(ii) Section 162(m). To the extent that the Administrator determines it
to be desirable to qualify Options granted hereunder as "performance-based
compensation" within the meaning of Section 162(m) of the Code, the Plan
shall be administered by a Committee of two or more "outside directors"
within the meaning of Section 162(m) of the Code.

(iii) Rule 16b-3. To the extent desirable to qualify transactions
hereunder as exempt under Rule 16b- 3, the transactions contemplated
hereunder shall be structured to satisfy the requirements for exemption
under Rule 16b-3.

(iv) Other Administration. Other than as provided above, the Plan shall be
administered by (A) the Board or (B) a Committee, which committee shall be
constituted to satisfy Applicable Laws.

3
<PAGE>

(b) Powers of the Administrator. Subject to the provisions of the Plan, and
in the case of a Committee, subject to the specific duties delegated by the
Board to such Committee, the Administrator shall have the authority, in its
discretion:

(i) to determine the Fair Market Value;

(ii) to select the Service Providers to whom Options and Stock Purchase
Rights may be granted hereunder;

(iii) to determine the number of shares of Common Stock to be covered by
each Option and Stock Purchase Right granted hereunder;

(iv) to approve forms of agreement for use under the Plan;

(v) to determine the terms and conditions, not inconsistent with the
terms of the Plan, of any Option or Stock Purchase Right granted hereunder.
Such terms and conditions include, but are not limited to, the exercise
price, the time or times when Options or Stock Purchase Rights may be
exercised (which may be based on performance criteria), any vesting
acceleration or waiver of forfeiture restrictions, and any restriction or
limitation regarding any Option or Stock Purchase Right of the shares of
Common Stock relating thereto, based in each case on such factors as the
Administrator, in its sole discretion, shall determine;

(vi) to reduce the exercise price of any Option or Stock Purchase Right
to the then current Fair Market Value if the Fair Market Value of the
Common Stock covered by such Option or Stock Purchase Right shall have
declined since the date the Option or Stock Purchase Right was granted;

(vii) to institute an Option Exchange Program;

(viii) to construe and interpret the terms of the Plan and awards
granted pursuant to the Plan;

(ix) to prescribe, amend and rescind rules and regulations relating to
the Plan, including rules and regulations relating to sub-plans established
for the purpose of qualifying for preferred tax treatment under foreign tax
laws;

(x) to modify or amend each Option or Stock Purchase Right (subject to
Section 15(c) of the Plan), including the discretionary authority to extend
the post-termination exercisability period of Options longer than is
otherwise provided for in the Plan;

(xi) to allow Optionees to satisfy withholding tax obligations by
electing to have the Company withhold from the Shares to be issued upon
exercise of an Option or Stock Purchase Right that number of Shares having
a Fair Market Value equal to the amount required to be withheld. The Fair
Market Value of the Shares to be withheld shall be determined on the date
that the amount of tax to be withheld is to be determined. All elections by
an Optionee to have Shares withheld for this purpose shall be made in such
form and under such conditions as the administrator may deem necessary or
advisable;

(xii) to authorize any person to execute on behalf of the Company any
instrument required to effect the grant of an Option or Stock Purchase
Right previously granted by the Administrator;

(xiii) to make all other determinations deemed necessary or advisable
for administering the Plan.

(c) Effect of Administrator's Decision. The Administrator's decisions,
determinations and interpretations shall be final and binding on all Optionees
and any other holders of Options or Stock Purchase Rights.

5. Eligibility. Nonstatutory Stock Options and Stock Purchase Rights may be
granted to Service Providers. Incentive Stock Options may be granted only to
Employees.

6. Limitations.

(a) Each Option shall be designated in the Option Agreement as either an
Incentive Stock Option or a Nonstatutory Stock Option. However, notwithstanding
such designation, to the extent that the aggregate Fair

4
<PAGE>

Market Value of the Shares with respect to which Incentive Stock Options are
exercisable for the first time by the Optionee during any calendar year (under
all plans of the Company and any Parent or Subsidiary) exceeds $100,000, such
Options shall be treated as Nonstatutory Stock Options. For purposes of this
Section 6(a), Incentive Stock Options shall be taken into account in the order
in which they were granted. The Fair Market Value of the Shares shall be
determined as of the time the Option with respect to such Shares is granted.

(b) Neither the Plan nor any Option or Stock Purchase Right shall confer
upon an Optionee any right with respect to continuing the Optionee's
relationship as a Service Provider with the Company, nor shall they interfere
in any way with the Optionee's right or the Company's right to terminate such
relationship at any time, with or without cause.

(i) No Service Provider shall be granted, in any fiscal year of the
Company, Options to purchase more than 500,000 Shares (as appropriately
adjusted pursuant to Section 13(a) ("Changes in Capitalization") hereof.

(ii) In connection with his or her initial service, a Service Provider
may be granted Options to purchase up to an additional 500,000 Shares which
shall not count against the limit set forth in subsection (i) above (as
appropriately adjusted pursuant to Section 13(a) ("Changes in
Capitalization") hereof.

(iii) The foregoing limitations shall be adjusted proportionately in
connection with any change in the Company's capitalization as described in
Section 13.

(iv) If an Option is canceled in the same fiscal year of the Company in
which it was granted (other than in connection with a transaction described
in Section 13), the canceled Option will be counted against the limits set
forth in subsections (i) and (ii) above. For this purpose, if the exercise
price of an Option is reduced, the transaction will be treated as a
cancellation of the Option and the grant of a new Option.

7. Term of Plan. Subject to Section 19 of the Plan, the Plan shall become
effective upon its adoption by the Board. It shall continue in effect for a
term of ten (10) years unless terminated earlier under Section 15 of the Plan.

8. Term of Option. The term of each Option shall be stated in the Option
Agreement. In the case of an Incentive Stock Option, the term shall be ten (10)
years from the date of grant or such shorter term as may be provided in the
Option Agreement. Moreover, in the case of an Incentive Stock Option granted to
an Optionee who, at the time the Incentive Stock Option is granted, owns stock
representing more than ten percent (10%) of the total combined voting power of
all classes of stock of the Company or any Parent or Subsidiary, the term of
the Incentive Stock Option shall be five (5) years from the date of grant or
such shorter term as may be provided in the Option Agreement.

9. Option Exercise Price and Consideration.

(a) Exercise Price. The per share exercise price for the Shares to be issued
pursuant to exercise of an Option shall be determined by the Administrator,
subject to the following:

(i) In the case of an Incentive Stock Option, (A) granted to an Employee
who, at the time the Incentive Stock Option is granted, owns stock
representing more than ten percent (10%) of the voting power of all classes
of stock of the Company or any Parent or Subsidiary, the per Share exercise
price shall be no less than 110% of the Fair Market Value per Share on the
date of grant, or (B) granted to any Employee other than an Employee
described in paragraph (A) immediately above, the per Share exercise price
shall be no less than 100% of the Fair Market Value per Share on the date
of grant.

(ii) In the case of a Nonstatutory Stock Option, the per Share exercise
price shall be determined by the Administrator. In the case of a
Nonstatutory Stock Option intended to qualify as "performance-based

5
<PAGE>

compensation" within the meaning of Section 162(m) of the Code, the per
Share exercise price shall be no less than 100% of the Fair Market Value
per Share on the date of grant.

(iii) Notwithstanding the foregoing, Options may be granted with a per
Share exercise price of less than 100% of the Fair Market Value per Share
on the date of grant pursuant to a merger or other corporate transaction.

(b) Waiting Period and Exercise Dates. At the time an Option is granted, the
Administrator shall fix the period within which the Option may be exercised and
shall determine any conditions which must be satisfied before the Option may be
exercised.

(c) Form of Consideration. The Administrator shall determine the acceptable
form of consideration for exercising an Option, including the method of
payment. In the case of an Incentive Stock Option, the Administrator shall
determine the acceptable form of consideration at the time of grant. Such
consideration may consist entirely of:

(i) cash;

(ii) check;

(iii) promissory note;

(iv) other Shares which (A) in the case of Shares acquired upon exercise
of an option, have been owned by the Optionee for more than six months on
the date of surrender, and (B) have a Fair Market Value on the date of
surrender equal to the aggregate exercise price of the Shares as to which
said Option shall be exercised;

(v) consideration received by the Company under a cashless exercise
program implemented by the Company in connection with the Plan;

(vi) a reduction in the amount of any Company liability to the Optionee,
including any liability attributable to the Optionee's participation in any
Company-sponsored deferred compensation program or arrangement;

(vii) any combination of the foregoing methods of payment; or

(viii) such other consideration and method of payment for the issuance
of Shares to the extent permitted by Applicable Laws.

10. Exercise of Option.

(a) Procedure for Exercise; Rights as a Shareholder. Any Option granted
hereunder shall be exercisable according to the terms of the Plan and at such
times and under such conditions as determined by the Administrator and set
forth in the Option Agreement. Unless the Administrator provides otherwise,
vesting of Options granted hereunder shall be tolled during any unpaid leave of
absence. An Option may not be exercised for a fraction of a Share.

An Option shall be deemed exercised when the Company receives: (i) written
or electronic notice of exercise (in accordance with the Option Agreement) from
the person entitled to exercise the Option, and (ii) full payment for the
Shares with respect to which the Option is exercised.

Full payment may consist of any consideration and method of payment
authorized by the Administrator and permitted by the Option Agreement and the
Plan. Shares issued upon exercise of an Option shall be issued in the name of
the Optionee or, if requested by the Optionee, in the name of the Optionee and
his or her spouse. Until the Shares are issued (as evidenced by the appropriate
entry on the books of the Company or of a duly authorized transfer agent of the
Company), no right to vote or receive dividends or any other rights as a
shareholder shall exist with respect to the Optioned Stock, notwithstanding the
exercise of the Option. The

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Company shall issue (or cause to be issued) such Shares promptly after the
Option is exercised. No adjustment will be made for a dividend or other right
for which the record date is prior to the date the Shares are issued, except as
provided in Section 13 of the Plan.

Exercising an Option in any manner shall decrease the number of Shares
thereafter available, both for purposes of the Plan and for sale under the
Option, by the number of Shares as to which the Option is exercised.

(b) Termination of Relationship as a Service Provider. If an Optionee ceases
to be a Service Provider, other than upon the Optionee's death or Disability,
the Optionee may exercise his or her Option within such period of time as is
specified in the Option Agreement to the extent that the Option is vested on
the date of termination (but in no event later than the expiration of the term
of such Option as set forth in the Option Agreement). In the absence of a
specified time in the Option Agreement, the Option shall remain exercisable for
three (3) months following the Optionee's termination. If, on the date of
termination, the Optionee is not vested as to his or her entire Option, the
Shares covered by the unvested portion of the Option shall revert to the Plan.
If, after termination, the Optionee does not exercise his or her Option within
the time specified by the Administrator, the Option shall terminate, and the
Shares covered by such Option shall revert to the Plan.

(c) Disability of Optionee. If an Optionee ceases to be a Service Provider
as a result of the Optionee's Disability, the Optionee may exercise his or her
Option within such period of time as is specified in the Option Agreement to
the extent the Option is vested on the date of termination (but in no event
later than the expiration of the term of such Option as set forth in the Option
Agreement). In the absence of a specified time in the Option Agreement, the
Option shall remain exercisable for twelve (12) months following the Optionee's
termination. If, on the date of termination, the Optionee is not vested as to
his or her entire Option, the Shares covered by the unvested portion of the
Option shall revert to the Plan. If, after termination, the Optionee does not
exercise his or her Option within the time specified herein, the Option shall
terminate, and the Shares covered by such Option shall revert to the Plan.

(d) Death of Optionee. If an Optionee dies while a Service Provider, the
Option may be exercised within such period of time as is specified in the
Option Agreement (but in no event later than the expiration of the term of such
Option as set forth in the Notice of Grant), by the Optionee's estate or by a
person who acquires the right to exercise the Option by bequest or inheritance,
but only to the extent that the Option is vested on the date of death. In the
absence of a specified time in the Option Agreement, the Option shall remain
exercisable for twelve (12) months following the Optionee's termination. If, at
the time of death, the Optionee is not vested as to his or her entire Option,
the Shares covered by the unvested portion of the Option shall immediately
revert to the Plan. The Option may be exercised by the executor or
administrator of the Optionee's estate or, if none, by the person(s) entitled
to exercise the Option under the Optionee's will or the laws of descent or
distribution. If the Option is not so exercised within the time specified
herein, the Option shall terminate, and the Shares covered by such Option shall
revert to the Plan.

(e) Buyout Provisions. The Administrator may at any time offer to buy out
for a payment in cash or Shares an Option previously granted based on such
terms and conditions as the Administrator shall establish and communicate to
the Optionee at the time that such offer is made.

11. Stock Purchase Rights.

(a) Rights to Purchase. Stock Purchase Rights may be issued either alone, in
addition to, or in tandem with other awards granted under the Plan and/or cash
awards made outside of the Plan. After the Administrator determines that it
will offer Stock Purchase Rights under the Plan, it shall advise the offeree in
writing or electronically, by means of a Notice of Grant, of the terms,
conditions and restrictions related to the offer, including the number of
Shares that the offeree shall be entitled to purchase, the price to be paid,
and the time within which the offeree must accept such offer. The offer shall
be accepted by execution of a Restricted Stock Purchase Agreement in the form
determined by the Administrator.

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<PAGE>

(b) Repurchase Option. Unless the Administrator determines otherwise, the
Restricted Stock Purchase Agreement shall grant the Company a repurchase option
exercisable upon the voluntary or involuntary termination of the purchaser's
service with the Company for any reason (including death or Disability). The
purchase price for Shares repurchased pursuant to the Restricted Stock Purchase
Agreement shall be the original price paid by the purchaser and may be paid by
cancellation of any indebtedness of the purchaser to the Company. The
repurchase option shall lapse at a rate determined by the Administrator.

(c) Other Provisions. The Restricted Stock Purchase Agreement shall contain
such other terms, provisions and conditions not inconsistent with the Plan as
may be determined by the Administrator in its sole discretion.

(d) Rights as a Shareholder. Once the Stock Purchase Right is exercised, the
purchaser shall have the rights equivalent to those of a shareholder, and shall
be a shareholder when his or her purchase is entered upon the records of the
duly authorized transfer agent of the Company. No adjustment will be made for a
dividend or other right for which the record date is prior to the date the
Stock Purchase Right is exercised, except as provided in Section 13 of the
Plan.

12. Non-Transferability of Options and Stock Purchase Rights. Unless
determined otherwise by the Administrator, an Option or Stock Purchase Right
may not be sold, pledged, assigned, hypothecated, transferred, or disposed of
in any manner other than by will or by the laws of descent or distribution and
may be exercised, during the lifetime of the Optionee, only by the Optionee. If
the Administrator makes an Option or Stock Purchase Right transferable, such
Option or Stock Purchase Right shall contain such additional terms and
conditions as the Administrator deems appropriate.

13. Adjustments Upon Changes in Capitalization, Dissolution, Merger or Asset
Sale.

(a) Changes in Capitalization. Subject to any required action by the
shareholders of the Company, the number of shares of Common Stock covered by
each outstanding Option and Stock Purchase Right, and the number of shares of
Common Stock which have been authorized for issuance under the Plan but as to
which no Options or Stock Purchase Rights have yet been granted or which have
been returned to the Plan upon cancellation or expiration of an Option or Stock
Purchase Right, as well as the price per share of Common Stock covered by each
such outstanding Option or Stock Purchase Right and the limitations on issuance
as set forth in Sections 6(c)(i) and 6(c)(ii) hereof, shall be proportionately
adjusted for any increase or decrease in the number of issued shares of Common
Stock resulting from a stock split, reverse stock split, stock dividend,
combination or reclassification of the Common Stock, or any other increase or
decrease in the number of issued shares of Common Stock effected without
receipt of consideration by the Company; provided, however, that conversion of
any convertible securities of the Company shall not be deemed to have been
"effected without receipt of consideration." Such adjustment shall be made by
the Board, whose determination in that respect shall be final, binding and
conclusive. Except as expressly provided herein, no issuance by the Company of
shares of stock of any class, or securities convertible into shares of stock of
any class, shall affect, and no adjustment by reason thereof shall be made with
respect to, the number or price of shares of Common Stock subject to an Option
or Stock Purchase Right.

(b) Dissolution or Liquidation. In the event of the proposed dissolution or
liquidation of the Company, the Administrator shall notify each Optionee as
soon as practicable prior to the effective date of such proposed transaction.
The Administrator in its discretion may provide for an Optionee to have the
right to exercise his or her Option until ten (10) days prior to such
transaction as to all of the Optioned Stock covered thereby, including Shares
as to which the Option would not otherwise be exercisable. In addition, the
Administrator may provide that any Company repurchase option applicable to any
Shares purchased upon exercise of an Option or Stock Purchase Right shall lapse
as to all such Shares, provided the proposed dissolution or liquidation takes
place at the time and in the manner contemplated. To the extent it has not been
previously exercised, an Option or Stock Purchase Right will terminate
immediately prior to the consummation of such proposed action.

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<PAGE>

(c) Merger or Asset Sale. In the event of a merger of the Company with or
into another corporation, or the sale of substantially all of the assets of
the Company, each outstanding Option and Stock Purchase Right shall be assumed
or an equivalent option or right substituted by the successor corporation or a
Parent or Subsidiary of the successor corporation. In the event that the
successor corporation refuses to assume or substitute for the Option or Stock
Purchase Right, the Optionee shall fully vest in and have the right to
exercise the Option or Stock Purchase Right as to all of the Optioned Stock,
including Shares as to which it would not otherwise be vested or exercisable.
If an Option or Stock Purchase Right becomes fully vested and exercisable in
lieu of assumption or substitution in the event of a merger or sale of assets,
the Administrator shall notify the Optionee in writing or electronically that
the Option or Stock Purchase Right shall be fully vested and exercisable for a
period of fifteen (15) days from the date of such notice, and the Option or
Stock Purchase Right shall terminate upon the expiration of such period. For
the purposes of this paragraph, the Option or Stock Purchase Right shall be
considered assumed if, following the merger or sale of assets, the option or
right confers the right to purchase or receive, for each Share of Optioned
Stock subject to the Option or Stock Purchase Right immediately prior to the
merger or sale of assets, the consideration (whether stock, cash, or other
securities or property) received in the merger or sale of assets by holders of
Common Stock for each Share held on the effective date of the transaction (and
if holders were offered a choice of consideration, the type of consideration
chosen by the holders of a majority of the outstanding Shares); provided,
however, that if such consideration received in the merger or sale of assets
is not solely common stock of the successor corporation or its Parent, the
Administrator may, with the consent of the successor corporation, provide for
the consideration to be received upon the exercise of the Option or Stock
Purchase Right, for each Share of Optioned Stock subject to the Option or
Stock Purchase Right, to be solely common stock of the successor corporation
or its Parent equal in fair market value to the per share consideration
received by holders of Common Stock in the merger or sale of assets.

14. Date of Grant. The date of grant of an Option or Stock Purchase Right
shall be, for all purposes, the date on which the Administrator makes the
determination granting such Option or Stock Purchase Right, or such other
later date as is determined by the Administrator. Notice of the determination
shall be provided to each Optionee within a reasonable time after the date of
such grant.

15. Amendment and Termination of the Plan.

(a) Amendment and Termination. The Board may at any time amend, alter,
suspend or terminate the Plan.

(b) Shareholder Approval. The Company shall obtain shareholder approval of
any Plan amendment to the extent necessary and desirable to comply with
Applicable Laws.

(c) Effect of Amendment or Termination. No amendment, alteration,
suspension or termination of the Plan shall impair the rights of any Optionee,
unless mutually agreed otherwise between the Optionee and the Administrator,
which agreement must be in writing and signed by the Optionee and the Company.
Termination of the Plan shall not affect the Administrator's ability to
exercise the powers granted to it hereunder with respect to Options granted
under the Plan prior to the date of such termination.

16. Conditions Upon Issuance of Shares.

(a) Legal Compliance. Shares shall not be issued pursuant to the exercise
of an Option or Stock Purchase Right unless the exercise of such Option or
Stock Purchase Right and the issuance and delivery of such Shares shall comply
with Applicable Laws and shall be further subject to the approval of counsel
for the Company with respect to such compliance.

(b) Investment Representations. As a condition to the exercise of an Option
or Stock Purchase Right, the Company may require the person exercising such
Option or Stock Purchase Right to represent and warrant at the time of any
such exercise that the Shares are being purchased only for investment and
without any present

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<PAGE>

intention to sell or distribute such Shares if, in the opinion of counsel for
the Company, such a representation is required.

17. Inability to Obtain Authority. The inability of the Company to obtain
authority from any regulatory body having jurisdiction, which authority is
deemed by the Company's counsel to be necessary to the lawful issuance and sale
of any Shares hereunder, shall relieve the Company of any liability in respect
of the failure to issue or sell such Shares as to which such requisite
authority shall not have been obtained.

18. Reservation of Shares. The Company, during the term of this Plan, will
at all times reserve and keep available such number of Shares as shall be
sufficient to satisfy the requirements of the Plan.

19. Shareholder Approval. The Plan shall be subject to approval by the
shareholders of the Company within twelve (12) months after the date the Plan
is adopted. Such shareholder approval shall be obtained in the manner and to
the degree required under Applicable Laws.

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<PAGE>

RATIONAL SOFTWARE CORPORATION
ANNUAL MEETING OF STOCKHOLDERS
AUGUST 26, 1999

THIS PROXY IS SOLICITED ON BEHALF OF THE BOARD OF DIRECTORS

The undersigned stockholder of Rational Software Corporation hereby
acknowledges receipt of the Notice of Annual Meeting of Stockholders and Proxy
Statement, each dated July 23, 1999, and hereby appoints Michael T. Devlin and
Timothy A. Brennan, and each of them, with full power of substitution, as Proxy
or Proxies, to vote all shares of the Common Stock of the undersigned at the
Annual Meeting of Stockholders of Rational Software Corporation to be held on
August 26, 1999, and at any adjournments thereof, upon the proposals set forth
on this form of proxy and described in the Proxy Statement, and in their
discretion with respect to such other matters as may be properly brought before
the meeting or any adjournments thereof.

1. To elect two Class I members of the Board of Directors:

[_] FOR all nominees listed below [_] WITHHOLD authority to vote
(except as indicated) for all nominees listed below

If you wish to withhold authority to vote for an individual nominee,
strike a line through that nominee's name in the list below:

Michael T. Devlin, Leslie G. Denend

2. To approve an amendment to the 1997 Stock Option Plan reserving an
additional 6,000,000 shares of the Company's authorized but unissued
Common Stock for issuance thereunder:

[_] FOR [_] AGAINST [_] ABSTAIN

3. To approve an amendment to the 1997 Stock Option Plan providing that
up to 12,000,000 shares of Common Stock repurchased by the Company in
the open market pursuant to the Company's stock repurchase program be
reserved for issuance under the 1997 Stock Option Plan:

[_] FOR [_] AGAINST [_] ABSTAIN

4. To ratify the appointment of Ernst & Young LLP as the Company's
independent auditors to examine the financial statements of the
Company for the fiscal year ending March 31, 2000:

[_] FOR [_] AGAINST [_] ABSTAIN
<PAGE>

Either of such Proxies or substitutes shall have and may exercise all of
the powers of said proxies hereunder.
Dated:_______________________________________________________________________

____________________________

____________________________
(Signature)

(This proxy should be marked, dated, signed by the
stockholder or stockholders exactly as the
stockholder's or stockholders' names appear
hereon, and returned promptly in the enclosed
envelope. Persons signing in a fiduciary or
representative capacity should so indicate. If
shares are held by joint tenants, as community
property or otherwise by more than one person, all
should sign.)

THIS PROXY WILL BE VOTED AS DIRECTED OR, IF NO DIRECTION IS INDICATED, WILL BE
VOTED FOR EACH OF THE PROPOSALS LISTED ABOVE, AND AS SAID PROXIES DEEM ADVISABLE
ON SUCH OTHER MATTERS AS MAY COME BEFORE THE MEETING.