PARKING FACILITY AND DRIVING DIRECTIONS

Washington State Convention and Trade Center

October 6, 2006September 28, 2007

Dear Shareholder:

You are cordially invited to attend the Annual Meeting of Shareholders of Microsoft Corporation, which will be held at the MeydenbauerWashington State Convention and Trade Center, 11100 NE 6th Street, Bellevue, Washington 98004,800 Convention Place, Seattle, WA 98101, on November 14, 2006,13, 2007, at 8:00 a.m. DrivingDoors open at 7:00 a.m. and a product fair will also open at that time. You can find driving directions to the MeydenbauerWashington State Convention and Trade Center can be found on the inside front cover of this document. Parking will be validated only for the MeydenbauerWashington State Convention and Trade Center garage. Please note that parking is limited, so plan ahead if you are driving to the meeting.

DetailsThe attached Notice of Annual Meeting and Proxy Statement contains details of the business to be conducted at the Annual Meeting are given in the attached Notice of Annual Meeting and Proxy Statement.Meeting.

Whether or not you attend the Annual Meeting, it is important that your shares be represented and voted at the meeting. Therefore, I urge you to promptly vote and submit your proxy by phone, via the Internet, or by signing, dating, and returning the enclosed proxy card in the enclosed envelope. If you decide to attend the Annual Meeting, you will be able to vote in person, even if you have previously submitted your proxy.

We will provide live coverage of the Annual Meeting from the Microsoft Investor Relations websiteWeb site atwww.microsoft.com/msft. Additionally,In addition, the transcript along with video and audio of the entire Annual Meeting of Shareholders will be available on the Investor Relations websiteWeb site after the meeting. We hope this will allow those of you who are unable to attend the meeting to hear Microsoft executives discuss the year’s results.

On behalf of the Board of Directors, I would like to express our appreciation for your continued interest in the affairs of the Company.Microsoft. I look forward to greeting as many of our shareholders as possible.

Sincerely,

Steven A. Ballmer

Chief Executive Officer

The use of cameras at the Annual Meeting is prohibited and they will not be allowed into the meeting or any other related areas, except by credentialed media. We realize that many cellular phones have built-in digital cameras, andcameras; while these phones may be brought into the venue, the camera function may not be used at any time.

MICROSOFT CORPORATION

NOTICE OF ANNUAL MEETING OF SHAREHOLDERS

November 14, 200613, 2007

To the Shareholders:

The Annual Meeting of the shareholdersShareholders of Microsoft Corporation will be held at the MeydenbauerWashington State Convention and Trade Center, 11100 NE 6th Street, Bellevue, Washington 98004,800 Convention Place, Seattle, WA 98101, on November 14, 2006,13, 2007, at 8:00 a.m. for the following purposes:

Only shareholders of record at the close of business on September 8, 2006,7, 2007 are entitled to notice of, and to vote at, this meeting.

By order of the Board of Directors

Bradford L. Smith

Secretary

Redmond, Washington

October 6, 2006September 28, 2007

IMPORTANT

Whether or not you expect to attend the Annual Meeting in person, we urge you to vote your shares at your earliest convenience. This will ensure the presence of a quorum at the meeting. Promptly voting your shares by telephone, via the Internet, or by signing, dating, and returning the enclosed proxy card will save the Companyus the expenses and extra work of additional solicitation. An addressed envelope for which no postage is required if mailed in the United States is enclosed if you wish to vote by mail. Submitting your proxy now will not prevent you from voting your shares at the meeting if you desire to do so, as your proxy is revocable at your option.

MICROSOFT CORPORATION

ONE MICROSOFT WAY

REDMOND, WASHINGTON 98052

PROXY STATEMENT FOR ANNUAL MEETING OF SHAREHOLDERS

TO BE HELD NOVEMBER 14, 200613, 2007

This Proxy Statement which was first mailed to shareholders on or about October 6, 2006,September 28, 2007. It is furnished in connection with the solicitation of proxies by the Board of Directors of Microsoft Corporation, (the “Company” or “Microsoft”), to be voted at the Annual Meeting of the shareholders of the Company, which will be held at 8:00 a.m. on November 14, 2006, at the Meydenbauer Center, 11100 NE 6th Street, Bellevue, Washington 98004,Shareholders for the purposes set forth in the accompanying Notice of Annual Meeting of Shareholders. The Annual Meeting of Shareholders will be held at 8:00 a.m. on November 13, 2007 at the Washington State Convention and Trade Center, 800 Convention Place, Seattle, WA 98101. Shareholders who execute proxies retain the right to revoke them at any time before the shares are voted by proxy at the meeting. A shareholder may revoke a proxy by delivering a signed statement to theour Corporate Secretary of the Company at or prior to the Annual Meeting or by timely executing and delivering, by mail, Internet, telephone or in person at the Annual Meeting, another proxy dated as of a later date. The CompanyMicrosoft will pay the cost of solicitation of proxies.

Shareholders of record at the close of business on September 8, 2006,7, 2007 will be entitled to vote at the meeting on the basis of one vote for each share held. On September 8, 2006,7, 2007, there were 9,844,159,0609,401,751,654 shares of common stock outstanding, held of record by 149,012145,945 shareholders.

1. PROPOSAL 1

ELECTION OF DIRECTORS AND MANAGEMENT INFORMATION

The Company’s Board of Directors currently consists of ten members. Ann McLaughlin Korologos is retiring from the Board effective as of the date of the Annual Meeting. In connection with Mrs. Korologos’ retirement, the Board has authorized a reduction in the size of the Board to nine members effective as of November 14, 2006, as permitted by the Company’s Bylaws.

NineTen directors are to be elected at the Annual Meeting to hold office until the next annual meeting of shareholders, and until their respective successors are elected and qualified. If, for any reason, the directors are not elected at an annual meeting, they may be elected at a special meeting of shareholders called for that purpose in the manner provided by the Bylaws of Microsoft Corporation (“Bylaws”). The accompanying proxy will be voted in favor of the nominees named below to serve as directors unless the shareholder indicates to the contrary on the proxy. All of the nominees are current directors.

In August 2006, the Board of Directors acted to change the method by which directors are elected by amending the Company’s Bylaws. The new procedures apply to an uncontested election, which is one in which the number of nominees does not exceed the number of directors to be elected. In an uncontested election, any nominee who does not receive a majority of the shares cast shall promptly offer his or her resignation to the Board following certification of the shareholder vote. A vote of the majority of shares cast means that the number of shares voted “for” exceeds the number of votes “against” that director. The Governance and Nominating Committee will promptly consider the resignation offer and make a recommendation to the Board. The Board will act on the Governance and Nominating Committee’s recommendation within 90 days following certification of the shareholder vote. Thereafter, the Board will promptly disclose publicly its decision whether to accept the director’s resignation offer. The director who tenders his or her resignation pursuant to this provision will not participate in the Governance and Nominating Committee recommendation or Board decision whether to accept his or her resignation offer.

The Board of Directors expects that each of the nominees will be available for election, but if any of them is unable to serve at the time the election occurs, the proxy will be voted for the election of another nominee to be designated by the Board of Directors.

ADOPTION OF MAJORITY VOTE STANDARD FOR DIRECTOR ELECTIONS

Recent amendments to the Washington Business Corporation Act give publicly-held corporations incorporated in Washington greater flexibility in the standards used for voting for directors, including providing the ability to amend their bylaws to adopt a majority vote standard for directors in uncontested elections.

The Board of Directors amended our Bylaws effective August 1, 2007 to change the method by which directors are elected. Under section 2.2 of the amended Bylaws, in an uncontested election each director will be elected by the vote of the majority of the votes cast. A majority of votes cast means that the number of shares cast “for” a director’s election exceeds the number of votes cast “against” that director. A share whose ballot is marked as withheld, which is otherwise present at the meeting but for which there is an abstention, or to which a shareholder gives no authority or direction shall not be considered a vote cast. In an election in which the number of nominees exceeds the number of directors to be elected (a contested election) the directors will be elected by the vote of a plurality of the votes cast.

In an uncontested election, a nominee who does not receive a majority vote will not be elected. Except as explained in the next paragraph, an incumbent director who is not elected because he or she does not receive a majority vote will continue to serve as a holdover director until the earliest of: (a) 90 days after the date on which an inspector determines the voting results as to that director; (b) the date on which the Board of Directors appoints an individual to fill the office held by that director; or (c) the date of the director’s resignation.

The Board of Directors may fill any vacancy resulting from the non-election of a director as provided in our Bylaws. The Governance and Nominating Committee will consider promptly whether to fill the office of a nominee who fails to receive a majority vote and make a recommendation to the Board of Directors about filling the office. The Board of Directors will act on the Governance and Nominating Committee’s recommendation and within ninety (90) days after the certification of the shareholder vote and will disclose publicly its decision. Except as provided in the next

sentence, no director who fails to receive a majority vote for election will participate in the Governance and Nominating Committee recommendation or Board decision about filling his or her office. If no director receives a majority vote in an uncontested election, then the incumbent directors (a) will nominate a slate of directors and hold a special meeting for the purpose of electing those nominees as soon as practicable, and (b) may in the interim fill one or more offices with the same director(s) who will continue in office until their successors are elected.

For additional information, the complete Bylaws are available on our Web site athttp://www.microsoft.com/about/companyinformation/corporategovernance/default.mspx.

Our Board recommends a vote FOR the election to the Board of each of the following nominees:

NOMINEES

William H. Gates III, 50,51, a co-founder of the Company,Microsoft, has served as Chairman since the Company’sour incorporation in 1981. Mr. Gates served as the Company’s Chief Software Architect from January 2000 until June 2006, when he announced a two-year plan for his transition out of a day-to-day role, in the Company after which he will continue to serve as Chairman and an advisor on key development projects. Mr. Gates served as the Company’sour Chief Executive Officer from 1981 until January 2000, when he resigned as Chief Executive Officer and assumed the position of Chief Software Architect. Mr. Gates is also a director of Berkshire Hathaway Inc.

Steven A. Ballmer, 50,51, has been a director of the Company since 2000. Mr. Ballmer has headed several Microsoft divisions during the past 2627 years, including operations, operating systems development, and sales and support. In July 1998, he was promoted to President, a role that gave him day-to-day responsibility for running Microsoft. He was named Microsoft’s Chief Executive Officer in January 2000, assuming full management responsibility for the Company.

responsibility.

James I. Cash Jr., Ph.D., 58,59, has been a director of the Company since 2001. Dr. Cash is formerly The James E. Robison Professor of Business Administration at Harvard Business School, where he also served as Senior Associate Dean and Chairman of HBS Publishing. Dr. Cash is also a member of the board of directors of The Chubb Corporation, General Electric Company, Phase Forward Incorporated, and Wal-Mart Stores, Inc.

Dina Dublon, 53,54, has been a director of the Company since 2005. From December 1998 until her retirement in September 2004, Ms. Dublon served as Executive Vice President and Chief Financial Officer of JPMorgan Chase. Ms. Dublon joined Chemical Bank’s capital markets group as a trainee on the trading floor in 1981. Prior to joining Chemical Bank, Ms. Dublon worked for the Harvard Business School and Bank Hapoalim in Israel. Ms. Dublon is also a member of the board of directors of Accenture Ltd. and PepsiCo, Inc.

Raymond V. Gilmartin, 65,66, has been a director of the Company since 2001. Mr. Gilmartin served as the Chairman of the Board, President, and Chief Executive Officer of Merck & Co., Inc. from 1994 to May 2005, when he relinquished those titles as part of the succession planning process leading up to his planned retirement in April 2006. In the interim, he served as Special Advisor to the Executive Committee of the Merck Boardboard of Directors.directors. Prior to joining Merck, Mr. Gilmartin was Chairman, President, and Chief Executive Officer of Becton Dickinson and Company. He joined that company in 1976 as Vice President, Corporate Planning, taking on positions of increasing responsibility over the next 18 years. In July 2006, Mr. Gilmartin joined the faculty of Harvard Business School as Professor of Management Practice teaching in the MBA program. Mr. Gilmartin also serves on the board of directors of General Mills, Inc.

Reed Hastings, 46, has been a director since March 2007. Mr. Hastings co-founded Netflix, Inc., in 1997 and has served as Chairman of the Board from its inception. Mr. Hastings was named Chief Executive Officer of Netflix, Inc., in September 1998. Prior to Netflix, from 1991 to 1997 Mr. Hastings was founder, Chief Executive Officer, and Chairman of Pure Software.

David F. Marquardt, 57,58, has served as a director of the Company since 1981. Mr. Marquardt is a founding general partner of August Capital, a venture capital firm formed in 1995, and has been a general partner of various Technology Venture Investors entities, which are private venture capital limited partnerships, since August 1980. He is a director of Seagate Technology, Inc., and various privately-held companies.

Charles H. Noski, 54,55, has served as a director of the Company since 2003. From December 2003 to March 2005, Mr. Noski served as Corporate Vice President and Chief Financial Officer of Northrop Grumman Corporation and served as a director from November 2002 to May 2005. Mr. Noski joined AT&T in 1999 as Senior Executive Vice President and Chief Financial Officer and was named Vice Chairman of AT&T’s Boardboard of Directorsdirectors in 2002. Mr. Noski retired from AT&T upon the completion of its restructuring in November 2002. Prior to joining AT&T, Mr. Noski was President, Chief Operating Officer, and a member of the board of directors of Hughes Electronics Corporation, a publicly-tradedpublicly traded subsidiary of General Motors Corporation in the satellite and wireless communications business. He is a member of the American Institute of Certified Public Accountants, and Financial Executives International, and the Standing Advisory Group of the Public Company Accounting Oversight Board, and is a past member of the Financial Accounting Standards Advisory Council. Mr. Noski is also a director of Air Products and Chemicals, Inc., and Morgan Stanley.

Dr. Helmut Panke, 60,61, has served as a director of the Company since 2003. Dr. Panke served as Chairman of the Board of Management of BMW Bayerische Motoren Werke AG from May 2002 through August 2006. From 1999 to 2002, he served as Member of the Board of Management for Finance. From 1996 to 1999, Dr. Panke was Member of the Board of Management for Human Resources and Information Technology. In his role as Chairman and Chief Executive Officer of BMW (US) Holding Corp. from 1993 to 1996, he was responsible for the company’s North American activities. He joined BMW in 1982. Dr. Panke is also a director of UBS AG and is a member of the supervisory board of Bayer AG.

Jon A. Shirley, 68,69, served as President and Chief Operating Officer of Microsoft from 1983 to 1990. He has been a director of the Company since 1983. Prior to joining Microsoft, Mr. Shirley was with Tandy Corporation in a variety of positions.

RETIRING DIRECTOR

Ann McLaughlin Korologos, 64, has been a director of the Company since 2000, and has announced her intention to retire from the Board as of the 2006 Annual Meeting. Mrs. Korologos serves as Chairman of the Board of Trustees of RAND Corporation, an international public policy research organization. Mrs. Korologos served as the United States Secretary of Labor from 1987 to 1989. She currently serves as a member of the board of directors of AMR Corporation (and its subsidiary, American Airlines), Harman International Industries, Inc., Host Hotels & Resorts, Inc. (formerly Host Marriott Corporation), and Kellogg Company.

NOMINATION OF DIRECTORS

The Governance and Nominating Committee annually reviews with the Board of Directors the applicable skills and characteristics required of Board nominees, in the context ofconsidering current Board composition and Company circumstances. In making its recommendations to the Board, the Governance and Nominating Committee considers, among other things, the qualifications of individual director candidates. The Committee retains any search firms and approves payment of their fees. The Governance and Nominating Committee works with the Board to determine the appropriate characteristics, skills, and experiences for the Board as a whole and its individual members with the objective of having a Board with diverse backgrounds and experience in business, education, and public service. Characteristics expected of all directors include independence, integrity, high personal and professional ethics, sound business judgment, and the ability and willingness to commit sufficient time to the Board. In evaluating the suitability of individual Board members, the Board takes into account many factors, including general understanding of marketing, finance, and other disciplines relevant to the success of a large publicly-tradedpublicly traded company in today’s business environment; understanding of the Company’sour business and technology; educational and professional background; personal accomplishment; and geographic, gender, age, and ethnic diversity. The Board evaluates each individual in the context of the Board as a whole, with the objective of recommending a group that can best perpetuate the success of the Company’sour business and represent shareholder interests through the exercise of sound judgment using its diversity of experience. In determining whether to recommend a director for re-election, the Governance and Nominating Committee also considers the director’s past attendance at meetings, participation in and contributions to the activities of the Board, and the results of the most recent Board self-evaluation. Shareholders have previously elected each of the directors submitted at the 2007 annual meeting, except Mr. Hastings. A director search firm recommended Mr. Hastings for membership on the Board, which appointed him in March 2007.

The Governance and Nominating Committee will consider shareholder recommendations for candidates for the Board. The name of any recommended candidate for director, together with a brief biographical sketch, a document indicating the candidate’s willingness to serve, if elected, and evidence of the nominating shareholder’s ownership of Company stock should be sent to the attention of the Deputyour General Counsel, Finance and Operations, of the Company.Counsel. If a shareholder wishesyou wish to formally nominate a candidate he or sheyou must follow the procedures described in Section 1.12 of the Company’sour Bylaws.

DIRECTOR INDEPENDENCE

TheOur Board of Directors has adopted director independence guidelines to assist in determining each director’s independence. These guidelines are available on our Web site athttp://www.microsoft.com/about/companyinformation/corporategovernance/default.mspx. The guidelines include, and either meet or exceed, the independence requirements of the NASDAQ listing standards. The guidelines identify categories of relationships that the Board has determined would not affect a director’s independence, and therefore are not considered by the Board in determining director independence.

Under the director independence guidelines, the Board must affirmatively determine that a director has no relationship that would interfere with the exercise of independent judgment in carrying out the responsibilities of a director. To facilitate this determination, annually each director completes a questionnaire that provides information about relationships that might affect the determination of independence. Management provides the Governance and Nominating Committee and Board with relevant facts and circumstances of any relationship bearing on independence of a director or nominee that are outside the categories permitted under the director independence guidelines.

Based on the review and recommendation by the Governance and Nominating Committee, the Board of Directors analyzed the independence of each director and nominee and has determined that the following directors meet the standards of independence under theour Corporate Governance Guidelines, director independence guidelines, and applicable NASDAQ Stock Market (“NASDAQ”) listing standards, including that each member is free of any relationship that would interfere with his or her individual exercise of independent judgment: Messrs. Cash, Gilmartin, Hastings, Marquardt, Noski, Panke, and Shirley;Shirley, and Mmes. Dublon and Korologos. The Board considered that certain board members have in the past and may in the future invest in investment funds of which Mr. Marquardt is a general partner or that are managed directly or indirectly by the firm of which Mr. Marquardt is a partner.

INFORMATION ABOUT THE BOARDCORPORATE GOVERNANCE AT MICROSOFT CORPORATION

Microsoft’s Board of Directors is committed to maintaining strong corporate governance principles and practices. The Board periodically reviews evolving legal, regulatory, and best practice developments to determine those that will best serve the interests of our shareholders. In support of this commitment, in the past 12 months we have adopted policies designed to strengthen our corporate governance framework including:

CORPORATE GOVERNANCE RESOURCES

If you would like additional information about Microsoft’s corporate governance practices, you may view the following documents athttp://www.microsoft.com/about/companyinformation/corporategovernance/default.mspx or request them in print by sending a written request to the Corporate Secretary at Microsoft Corporation, One Microsoft Way, Redmond, WA 98052-6399:

CORPORATE GOVERNANCE GUIDELINES AND ITS COMMITTEESCOMMITTEE CHARTERS

The Microsoft Corporation Corporate Governance Guidelines and the charters of the five committees of the Board of Directors describe theour corporate governance practices the Company follows.practices. The Corporate Governance Guidelines and charters are intended to ensure that theour Board has the necessary authority and practices in place to review and evaluate the Company’sour business operations and to make decisions that are independent of the Company’s management. The Corporate Governance Guidelines also are intended to align the interests of directors and management with those of Microsoft’sour shareholders. The Corporate Governance Guidelines establish the practices the Board follows with respect to board composition and selection, board meetings and involvement of senior management, chief executive officer performance evaluation, succession planning, board committees, and director compensation. The Board annually conducts a self-evaluation to assess compliance with the Corporate Governance Guidelines and identify opportunities to improve Board performance.

The Corporate Governance Guidelines and committee charters are reviewed periodically and updated as necessary to reflect changes in regulatory requirements and evolving oversight practices. The Corporate Governance Guidelines comply with corporate governance requirements contained in both the NASDAQ and New York Stock Exchange listing standards and make other enhancements to the Company’sotherwise enhance our corporate governance policies, including creating the role of lead independent director. The chair of the Governance and Nominating Committee serves as the lead independent director. The lead independent director is responsible for coordinating the activities of the independent directors, coordinating with the chief executive officer to set the agenda for Board meetings, chairing meetings of the independent directors, and leading the Board’s review of the chief executive officer. If you would like additional information about Microsoft’s corporate governance practices, the following documents may be viewed athttp://www.microsoft.com/about/companyinformation/corporategovernance/default.mspxand are available in print to our shareholders by writing to our Corporate Secretary at Microsoft Corporation, One Microsoft Way, Redmond, WA 98052-6399:policies.

MEETINGS AND MEETING ATTENDANCE

TheOur Board of Directors holds regularly scheduled quarterly meetings. Typically, committee meetings occur the day prior to the boardBoard meeting. One quarter each year, the committeeCommittee and boardBoard meetings occur on a single day so that the evening and following day can be devoted to presentations and discussions with senior management about Microsoft’s long-term Company strategy as part of the Board’s annual retreat. In addition to the quarterly meetings, typically there are two other regularly scheduled meetings and several special meetings each year. At each quarterly boardBoard meeting, time is set aside for the independent directors to meet without management present. TheOur Board of Directors met nine12 times during fiscal year 2006. 2007.

All incumbent directors attended 75% or more of the Board meetings and meetings of the committees on which they served during the last fiscal year. Directors are encouraged to attend the Annual Meeting of Shareholders. Four directors attended the 20052006 Annual Meeting.

LEAD INDEPENDENT DIRECTOR

The Chair of our Governance and Nominating Committee serves as the lead independent director. The lead independent director is responsible for coordinating the activities of the independent directors, coordinating with the Chief Executive Officer to set the agenda for Board meetings, chairing meetings of the independent directors, and leading the Board’s review of the Chief Executive Officer. See “Shareholder Communication with Directors” below on page 10 for information on how to communicate with the lead independent director.

BOARD COMMITTEES

Our Board has five committees: an Audit Committee, a Compensation Committee, a Finance Committee, a Governance and Nominating Committee, and an Antitrust Compliance Committee. Each committee has a written charter. The table below provides current membership and fiscal year 20062007 meeting information for each of the Board committees. Committee memberships changed during the fiscal year. In November 2005, Ms.2006, Dina Dublon became the Chair of the Compensation Committee and Dr. Panke became a member of the Antitrust Compliance Committee. When Mr. Hastings joined the Board in March 2007, he became a member of the Finance Committee.

Below is a description of each committee of theour Board of Directors. Each of the committeescommittee has authority to engage legal counsel or other advisors or consultants as it deems appropriate to carry out its responsibilities. The Board of Directors has determined that each member of each committee meets the standards of independence under the Governance Guidelines and applicable NASDAQ listing standards, including that each member is free of any relationship that would interfere with his or her individual exercise of independent judgment.

Audit Committee.    The Audit Committee assists the Board of Directors in its oversight of the quality and integrity of theour accounting, auditing, and reporting practices of the Company.practices. The Audit Committee’s role includes overseeing the work of the Company’sour internal accounting and internal control over financial reporting and internal auditing processes and discussing with management the Company’sour processes to manage business and financial risk, and for compliance with significant applicable legal, ethical, and regulatory requirements. The Audit Committee is responsible for the appointment, compensation, retention, and oversight of the independent auditor engaged to prepare or issue audit reports on the Company’sour financial statements and internal control over financial reporting. The Audit Committee relies on the expertise and knowledge of management, the internal auditors, and the independent auditor in carrying out its oversight responsibilities. The Committee’s specific responsibilities are delineated in the Audit Committee Responsibilities Calendar accompanying the Audit Committee Charter. The Charter and Responsibilities Calendar, as amended and restated effective July 1, 2006, are attached as Exhibit 1 to this Proxy Statement.describes the Committee’s specific responsibilities. The Board of Directors has determined that each Audit Committee member has sufficient knowledge in financial and auditing matters to serve on the Committee. In addition, the Board has determined that each ofJames I. Cash, Jr., Dina Dublon, and Charles H. Noski is anare “audit committee financial expert”experts” as defined by Securities and Exchange Commission (“SEC”) rules.

Compensation Committee.    The primary responsibilities of the Compensation Committee are: (a) assist the Board in establishing the annual goals and objectives of the chief executive officer; (b) recommend to the independent members of the Board the compensation of the chief executive officer; (c) oversee the performance evaluation of the Company’s other executive officers and approve their compensation; (d) oversee and advise the Board on the adoption of policies that govern the Company’sour compensation programs;programs and other compensation-related polices; (e) oversee the Company’s administration of itsour equity-based compensation and other benefit plans; and (f) approve and authorize grants of equity compensation awards under the Company’sour stock plan. The Compensation Committee periodicallyannually reviews the compensation paid to non-employee directors, and makes recommendations to the Board for any adjustments.

The Committee may delegate the authority to make equity compensation grants to eligible individuals who are not executive officers. The delegation to make equity compensation grants applies principally to awards to new employees, promotions and administrative corrections. The delegation does not cover grants made to executive officers.

Our Senior Vice President, Human Resources and General Manager of Compensation, Benefits, and Performance Management support the Committee in its work. In November 2005, the Committee retained Michael J. Halloran, Worldwide Partner, Mercer Human Resources to advise the Committee on marketplace trends in executive compensation, management proposals for compensation programs, and determination of named executive officer compensation. He also consulted with the Committee about its recommendations to the Board on director compensation. Mr. Halloran is directly accountable to the Committee. To maintain the independence of his advice, he does not provide any other services for Microsoft. Mercer Human Resources Consulting does advise the Company on other matters. In June 2007, the Committee adopted a policy about compensation consultant independence that is included as section 16 of our Corporate Governance Guidelines. This policy requires that the Committee’s compensation consultant be independent as assessed by the Committee annually. A consultant satisfying the following requirements will be considered independent.

The consultant and their firm or other organization employing the consultant:

The Committee must approve any other services performed by the consultant. The Compensation Committee’s role includes producingCommittee annually will perform an assessment of its consultant’s independence. In performing the report on executive compensation required by SEC rules. assessment, the Committee will consider the nature and amount of work performed for the Committee during the year, the nature of any unrelated services performed for the Company, and the amount of fees paid for those services in relation to the firm’s total revenues. The consultant annually will prepare for the Committee an independence letter providing appropriate assurances and confirmation of the consultant’s independent status pursuant to the policy. The Committee believes that Mr. Halloran’s advice has been fully independent during his service for the Committee. However, because Mercer Human Resources Consulting and its affiliated companies perform services for Microsoft, the Committee is in the process of selecting a new consultant.

The Compensation Committee Charter describes the specific responsibilities and functions of the Compensation Committee. See “Determining Executive Compensation” and “Discussion of Elements of Compensation” below on pages 12 and 15, respectively for more information about the Committee’s work.

Finance Committee.    The Finance Committee is responsible for overseeing and making recommendations to the Board about theour financial affairs and policies of the Company including: (a) policies relating to the Company’sour cash flow, cash management, and working capital, shareholder dividends and distributions, and share repurchases and investments; (b) financial strategies; (c) policies for managing financial risk; (d) tax planning and compliance; and (e) proposed mergers, acquisitions, divestitures, and strategic investments. The Finance Committee’s role includes designating officers and employees who can execute documents and act on our behalf of the Company in the ordinary course of business under previously approved banking, borrowing, and other financing agreements. The Finance Committee Charter describes the specific responsibilities and functions of the Finance Committee.

Governance and Nominating Committee.    The principal responsibilities of the Governance and Nominating Committee are to: (a) determine the slate of director nominees for election to the Company’sour Board of Directors; (b) identify and recommend candidates to fill vacancies occurring between annual shareholder meetings; (c) review the composition of Board committees; (d) monitor compliance with, review, and recommend changes to the Company’s Corporate Governance Guidelines; and (e) review the Company’sour policies and programs that relate to matters of corporate responsibility, including public issues of significance to the Companyus and itsour stakeholders. In addition, the Chair of the Governance and Nominating Committee acts as the lead independent director and is responsible for leading the Board of Directors’ annual performance review of the chief executive officer’s performance.our Chief Executive Officer. The Governance and Nominating Committee regularly reviews the chartersCharters of Board committees and, after consultation with the respective committee chairs, makes recommendations, if necessary,neces-

sary, about changes to the charters.Charters. The Governance and Nominating Committee Charter describes the specific responsibilities and functions of the Governance and Nominating Committee.

Antitrust Compliance Committee.    The Antitrust Compliance Committee oversees the performance of the Compliance Officer, who is charged under the Final Judgment entered by the District Court for the District of Columbia inState of New York et al. v. Microsoft Corp., No. 98-1232 (the “Final Judgment”) with developing and supervising Microsoft’s internal programs and processes to ensure compliance with antitrust laws and the Final Judgment. The Compliance Officer reports directly to the Antitrust Compliance Committee and theour Chief Executive Officer, and may be removed by theour Chief Executive Officer only with the concurrence of the Committee. The specific responsibilities in carrying out the Antitrust Compliance Committee’s oversight role are delineated in the Antitrust Compliance Committee Responsibilities Checklist attached to the Antitrust Compliance Committee Charter.Charter describes the Committee’s specific responsibilities in carrying out its oversight role. The Compliance Officer is required to maintain a record of complaints received and actions taken by the Company with respect to them and to report credible evidence of violations of the Final Judgment to the Final Judgment plaintiffs. The Antitrust Compliance Committee receives regular reports from the Compliance Officer about existing and planned internal compliance programs and processes, complaints received and the Company’sour response to them, and violations reported to the Final Judgment plaintiffs. In addition, the Antitrust Compliance Committee receives reports from the General Counsel and from other members of management about compliance with the Final Judgment and about other issues that may arise concerning the Company’sour compliance with antitrust and competition laws. The Antitrust Compliance Committee can authorize further inquiries into matters reported to it for the purpose of ensuring the adequacy of the Company’sour processes and programs for fulfilling its obligations under the Final Judgment and antitrust laws. The Antitrust Compliance Committee provides guidance to the Compliance Officer and to management and reports regularly to the Board of Directors.

Director Compensation.    DIRECTOR COMPENSATION

Messrs. Gates and Ballmer receive no compensation for serving as directors, except that they, like all directors, are eligible to receive reimbursement ofbe reimbursed for any expenses incurred in attending Board and committee meetings. During fiscal year 2006,2007, each director, other than Messrs. Gates and Ballmer, received compensation for serving on theour Board of Directors and committees of the Board as follows:

Payment of the annual retainer is contingent on service on the date the annual retainer is approved by the Board, typicallypayable, which was in January of each year.2007.

Non-employee members of theour Board may elect to defer receipt of partall or allpart of their annual equity retainer, and to defer and convert to equity partall or allpart of their annual cash retainer, under the Company’sour Deferred Compensation Plan for Non-Employee Directors. Under this Plan amounts deferred by non-employee directors are maintained in bookkeeping accounts that are deemed invested in CompanyMicrosoft common stock, and dividends paid on Companyour common stock are deemed to be invested in Companyour common stock. Accounts in the Plan are distributed in the form of Companyour common stock, as elected by the by the non-employee director, with payments either in installments commencing upon separation from Board service or in a lump sumamount paid no later than the fifth anniversary after separation from Board service.

To align the interests of our directors and shareholders, our Board believes that directors should have a significant financial stake in Microsoft. As provided in section 24 of our Corporate Governance Guidelines, each director should own Microsoft shares equal in value to a minimum of three times the base annual retainer payable to a director. Directors should achieve this ownership level by the later of February 28, 2011 or five years after the director has become a board member. Each director currently meets this ownership guideline. Stock deferred under the Deferred Compensation Plan for Non-Employee Directors counts towards the minimum ownership requirement.

All of the directors were awarded their annual compensation on January 31, 2007, except for Reed Hastings who joined the Board effective March 26, 2007.

In addition, to assist directors in developing an in-depth understanding of the Company’sour business, products, and products,services, and to facilitate the efficient operation of the Board through the use of computing devices that feature Microsoft software, if requested directors are provided with a Tablet PCpersonal computer, printer, and associated peripherals for their use while they serve on the Board. Each year, directors also may receive an additional personal computing device and a game or media player device, each with associated peripherals, and Microsoft software and subscription services with an aggregate value of less than $10,000.

Shareholder Communications to the BoardCommunication with Directors

Shareholders may contact an individual director, the lead independent director, the Board as a group, or a specified Board committee or group, including the non-employee directors as a group, by the following means:

Each communication should specify the applicable addressee or addressees to be contacted as well as the general topic of the communication. The CompanyWe will initially receive and process communications before forwarding them to the addressee. CommunicationsWe also may also be referredrefer communications to other departments in the Company. The CompanyMicrosoft. We generally will not forward to the directors a shareholder communication that is primarily commercial in nature, relates to an improper or irrelevant topic, or requests Microsoft general information about the Company.information.

Concerns about accounting or auditing matters or possible violations of the Microsoftour Standards of Business Conduct should be reported pursuant to the procedures outlined in the Microsoft Standards of Business Conduct, which are available on the Company’s websiteour Web site atwww.microsoft.com/mscorp/legal/buscondbuscond..

INFORMATION REGARDING BENEFICIAL OWNERSHIP

OF PRINCIPAL SHAREHOLDERS, DIRECTORS, AND MANAGEMENT

The following table sets forth, as of September 8, 2006,7, 2007, information regardingabout the beneficial ownership of the Company’sour common sharesstock by all directors, the Company’sour Chief Executive Officer, the Chief Financial Officer and the fourthree other highest paid executive officers (collectively, the “Named Executive Officers”“named executive officers”), and theour directors and all executive officers as a group.

NAMED EXECUTIVE OFFICER COMPENSATION

COMPENSATION DISCUSSION AND ANALYSIS

Microsoft’s Compensation Philosophy

We designed the compensation program for our named executive officers to attract, motivate, and retain key executives who drive Microsoft’s success and industry leadership. We achieve these objectives through a compensation package that:

Determining Executive Compensation

Determining the chief executive officer’s compensation.    The independent members of the Board approve the compensation of the chief executive officer.

The Compensation Committee makes a recommendation to the independent directors for the chief executive officer’s base salary and bonus. The Compensation Committee meets in executive session to formulate its recommendation for the chief executive officer’s base pay and bonus. These recommendations are based on:

The evaluation is based on the chief executive officer’s success in achieving his performance commitments, which include financial, strategic and company culture/leadership goals. The chief executive officer provides the Board with a self-evaluation of his performance. Members of the Board conduct in-depth interviews with the chief executive officer’s direct reports and other executives. As part of the company’s annual review processes, all employees have the opportunity to provide ratings-based and written feedback on the performance of their direct and next level managers. This information from the chief executive officer’s direct reports and the next layer of management is assembled and given to the Governance and Nominating Committee for consideration as part of its evaluation.

The Board approves Mr. Ballmer’s salary and target bonus range for the current fiscal year and his bonus for the previous fiscal year in the first quarter of the fiscal year.

Because Mr. Ballmer is a significant shareholder in the Company, he does not participate in any of the equity-based compensation programs described below in this Compensation Discussion and Analysis.

Determining compensation for named executive officers (other than the chief executive officer).    The Compensation Committee approves the annual compensation (including salary, bonus, and stock-based compensation) for our named executive officers (excluding Mr. Ballmer), based on:

The Committee approves the salary, bonus range, and equity incentives for the current fiscal year for the named executive officers and their bonuses and equity awards for the preceding fiscal year in the first quarter of the fiscal year after the relevant performance information is available.

The named executive officers, excluding Mr. Ballmer, participate in our Shared Performance Stock Award (“SPSA”) program, which we describe below in this Compensation Discussion and Analysis. Shares are earned under the SPSA based on performance against pre-defined performance criteria.

The Committee also reviews “tally sheets” that detail each named executive officer’s historical earnings, value of unvested equity, holdings of Microsoft stock, benefits and perquisites, and (if any) potential severance payments.

As discussed above, the Committee retained Michael J. Halloran of Mercer Human Resources Consulting to advise the Committee on the Company’s compensation programs. Mr. Halloran consulted with and assisted the Committee in evaluating management’s recommendations for executive pay. He was present at the Committee’s regular meetings and met with the Committee in executive session, where no members of management were present. He also consulted from time to time with the Committee chair outside of its meetings.

Compensation Benchmarking

We compete for senior executive talent with top technology and other leading companies. Prior to our annual performance review process, we review the market competitiveness of our executive officer compensation programs. If the review shows that our executive compensation programs are not competitive, management may recommend changes to the Compensation Committee. The independent consultant of the Compensation Committee reviews the recommendations for design changes and the basis for the recommendations with the Committee.

Our philosophy is to target total compensation (base salary, bonus, and stock) above the median of our competitive peer group for similar positions. A named executive officer’s experience, performance, specific skill set, or the unique nature of the scope of responsibilities, significantly influences that individual’s total pay. We deliver a significant proportion of total compensation through grants of performance-based restricted stock units. We have selected an above-median position to help ensure our ability to attract and retain the talent required to achieve our business strategies in the competitive environment of the high-tech industry.

When assessing the market competitiveness of our compensation programs, we review third-party surveys and publicly available data relating to a specific group of companies. For our executive compensation comparisons, we consider two peer groups.

Technology peer group:    These are companies operating in our industry that are focused on producing software or hardware or providing online services, and employ work forces with skill sets and professional backgrounds similar to those of Microsoft’s work force.

Dow 30 peer group:    These are generally large, diversified companies with significant international operations. As an industry and worldwide business leader, the market in which we compete for executive talent extends beyond our immediate industry to top companies across a variety of other industries.

INFORMATION REGARDING EXECUTIVE OFFICER COMPENSATION

On September 20, 2005, the Company announced that Kevin R. Johnson was appointed as a Co-President of the Platforms & Services Division, Jeffrey S. Raikes was appointed President of the Microsoft Business Division, and Robbie Bach was appointed President of the Entertainment & Devices Division.

The following table discloses compensation received by the Named Executive Officers for the three fiscal years ended June 30, 2006.

SUMMARY COMPENSATION TABLE

Components of Compensation

The components of compensation for named executive officers include salary, bonus, stock-based compensation, certain perquisites, and benefit programs. The total cash compensation for our named executive officers is below the competitive market median for total cash compensation of our key competitors. The large majority of target compensation for our named executive officers (excluding Mr. Ballmer) consists of SPSAs, which are performance-based restricted stock options were granted to anyunits. Stock-based compensation is a key element of our compensation program because (a) it aligns the interests of our executives with those of our shareholders, and (b) the multi-year vesting schedule provides returns over a period aligned with our multi-year development and deployment cycles. To achieve overall competitive compensation, stock-based compensation of our named executive officers is above the competitive market median.

Compensation of the Chief Executive Officer

Mr. Ballmer has for many years been a significant shareholder of Microsoft. Because his interests are already closely aligned with shareholders’ interests, the Compensation Committee and Mr. Ballmer agree that he should not receive equity compensation. His salary and total compensation are below competitive levels for the information technology industry and large market capitalization U.S. companies. The average chief executive officer salary and bonus for the peer group companies we use were $1.4 million in salary and $5.5 million in annual cash bonus and cash incentives. The average chief executive officer total compensation for the peer group companies we use was $13.9 million. Mr. Ballmer is eligible for an annual bonus of up to 120% of his salary based on a review of his performance against objectives for the year. As a leader of Microsoft, he focuses on building long-term success, and as a significant shareholder, his personal wealth is tied directly to sustained increases in our value. The Committee has indicated it believes that Mr. Ballmer is underpaid for his role and performance; however, the Committee has accepted his recommendation to continue with Microsoft’s historical practice for his total compensation opportunity.

There is no Company-sponsored retirement program for Mr. Ballmer other than our 401(k) program, and he receives no benefits or perquisites from us other than the general Company benefits described below. Mr. Ballmer does not have a change of control arrangement.

For fiscal year 2007, our Chairman, Mr. Gates, was not a named executive officer. He does not receive equity compensation and, as a result, his total compensation was substantially less than our three most highly compensated executive officers.

Compensation Mix for Named Executive Officers during

The diagram below illustrates the percentage of fiscal year 2006.2007 target salary, cash bonus, and equity compensation by component for our named executive officers.

AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION VALUES

Discussion of Elements of Compensation

Salary.    Salaries for named executive officers are determined based on a variety of factors, including the executive’s scope of responsibilities, a market competitive assessment of similar roles at peer group companies, and a comparison of salaries to peers in Microsoft. Salaries are reviewed for our named executive officers once each year, and may be adjusted after considering the above factors and the named executive officer’s performance.

Annual Cash Bonus.    In fiscal year 2007, named executive officers (including Mr. Ballmer) had the opportunity to earn a cash bonus up to a maximum of 120% of their salary earned during the fiscal year. Bonuses are provided to reward achieving business results against individual annual performance commitments and to deliver cash as part of an overall compensation package that is competitive in the marketplace.

The following table provides informationCompensation Committee determines bonuses in its discretion based on option exercisesperformance across a combination of qualitative and quantitative objectives during the performance period. Working with our chief executive officer, each named executive officer establishes these objectives annually as performance commitments. The chief executive officer establishes his commitments in fiscalconsultation with the Board. The commitments used to determine bonuses vary for each executive based on his responsibilities and may include financial or strategic measures, including:

For named executive officers other than the chief executive officer, the chief executive officer recommends individual bonus payments based on the executive’s performance against his commitments for the year, 2006the summary of ratings-based and written feedback from direct reports and next level managers, and input from the Senior Vice President, Human Resources. The Compensation Committee considers the recommendations and makes a final decision on the bonus payments.

For Mr. Ballmer, the Compensation Committee recommends a bonus payment to the independent members of the Board. In making this recommendation, the Compensation Committee considers the performance evaluation of Mr. Ballmer conducted by the Governance and Nominating Committee. The Board considers the Committee’s recommendation and Mr. Ballmer’s performance evaluation in determining the bonus for Mr. Ballmer.

Stock-Based Compensation

Shared Performance Stock Awards.Named Executive Officers and the value of their unexercised options at June 30, 2006.

executive officers other than Mr. Turner received the award listed aboveBallmer receive grants under the Company’s shared performance stock awards (“SPSA”)our SPSA program, upon hire in September 2005.a stock-based incentive program linked to Company performance. The SPSA program covering fiscal years 2004-2006 wasis designed to focus our top leaders on shared business goals tothat guide our annual and long-term growth and address our biggestspecific business challenges by rewarding participants based on growth in customer satisfaction, unit volumeswith shares of our Windows products, usagecommon stock depending on our performance. Prior to fiscal year 2007, the number of shares earned under SPSA grants was determined by reference to our developer tools, and desktop application deploymentperformance over a multi-year period. For fiscal year 2007, the number of shares earned was based on our performance period. Metrics were developed to measure performance in each of these areas. Forduring the Named Executive Officers, thefiscal year. We began using a one-year performance period wasin fiscal year 2007 to provide greater flexibility to adjust performance measures year to year in response to changing market and business dynamics and ensure we are rewarding our executives for achieving our key priorities. While we expect that there will be some consistency from year to year in the two-and-one-half year period ended June 30, 2006.types of performance measures we use for the SPSA program performance metrics will shift based on the business priorities of the Company and market dynamics.

SPSA grants represent the single largest component of overall compensation for named executive officers receiving SPSAs. We believe the SPSA program is an effective element of our compensation program because: (i) the number of shares received depends on performance against key business metrics, (ii) retention of executives is enhanced by having a large percentage of total compensation derived from SPSA awards and by using a multi-year vesting schedule for any shares that are earned, and (iii) the program aligns management’s interests with our shareholders’ long-term interests through performance metrics that we believe will contribute to long-term shareholder value and award value that changes with share price.

At the beginning of the performance period, theeach named executive officer (other than Mr. Ballmer) receives SPSA grants with a target number of shares. The Compensation Committee established objective performance targetsdetermines the size of the target award for each metricnamed executive officer based on the Chief Executive Officer’s recommendations and each executive received athe Committee’s assessment of the executive’s scope of responsibilities and compensation relative to other executives at Microsoft and comparable positions at other companies. The target SPSA award. Atis used to calculate the number of actual shares that a participant receives after the end of the performance period,period. The number of shares awarded to an executive is determined (as a percentage of his target number of SPSAs) by measuring our performance during the fiscal year on the performance formetrics that constitute the metric was measured against the metric target resulting in a percentage score ranging from 0% if the minimum performance level wasn’t achieved to 150% for maximum performance, in increments of 25%Shared Performance Index (the “SPI”). The performance index, consistingmetrics have different weights. For each named executive officer who leads a division or business, 75% of the weightedweight is based on company-wide metrics and 25% is based on the performance of the division or business he leads. For Mr. Liddell, 75% of the weight is based on company-wide metrics and 25% is based on an average of these percentage scores, was multiplied by a participant’s targetthe division performance metrics.

Prior to vesting, executives do not have the right to vote or receive dividends on shares underlying an SPSA. SPSA award to determine the actual SPSA award for the participant.

The 2004-2006 SPSA performance period ended June 30, 2006. The performance index for the current Named Executive Officers resulted in a payout that was 101% of the original SPSA target awards. One-third of the SPSA shares vested on August 31, 2006, and the remaining two-thirds will vest in equal increments on August 31, 2007 and September 1, 2008, subject to continued employment. SPSA awardsgrants are subject to forfeiture if the executive’s employment terminates before the end of the performance period for any reason other than disability or death. Similarly, unpaid amountsOnce earned, shares vest over a multi-year vesting period. Unvested shares are forfeited if the executive’s employment terminates prior to the paymentbefore a vesting date for any reason other than disability, death, or retirement. The shares granted to our Named Executive Officers were designed to qualify as performance-based pay under Internal Revenue Code Section 162(m) and, therefore, to be deductible for federal income tax purposes.

CHANGE IN CONTROL AND SEVERANCE ARRANGEMENTSFiscal Year 2007 SPSAs.    At the beginning of fiscal year 2007, each named executive officer other than Mr. Ballmer received SPSA grants with a target number of shares. The actual number of shares earned under the grants is calculated by multiplying the target number of shares by a percentage from 0% to 150%. The percentage used for this calculation is the weighted average of our performance on performance metrics, expressed in each case as a percentage of targeted performance between 0% and 150%. The number of shares covered by an SPSA grant varies, and the performance metrics applicable to a grant carry different weights, based in part on our business priorities. For the division presidents and the chief operating officer, 25% of the award was based on metrics for the business group led by the executive. For Mr. Liddell, 25% of the award was based on an average of the three divisions and the Sales and Marketing Services Group (“SMSG”).

Below are brief descriptions of the performance metric categories used for our fiscal year 2007 SPSAs:

Net revenue and contribution margin are determined using our internal accounting policies and are similar to, but not the same as, net revenue and operating income, respectively, determined under generally accepted accounting principles. Contribution margin measures contribution to earnings from operations.

The Company does not have change of control arrangements for its Named Executive Officers. Named Executive Officers may be eligible for severance undertable below shows the Company’s severance plan, which provides up to 32 weeks of base salary upon involuntary termination in certain circumstances.

COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION

All membersrelative weight of the Compensation Committee duringperformance metrics in determining the number of shares each named executive officer was entitled to earn under his SPSA awards for fiscal year 2007.

In general, we set targeted levels of performance for the fiscal year 2007 SPSAs with the intention of requiring meaningful improvements in performance as compared with actual fiscal year 2006 were independent directors, and no member was an employee or former employee. No Compensation Committee member had any relationship requiring disclosure under “Certain Relationships and Related Transactions,” beginning on page 16. Duringresults. In some cases, even the minimum level of performance required to earn a payout represented a significant increase over fiscal year 2006 none of our executive officers served onresults. Overall, we believed performance required to qualify for a payout at the compensation committee (or its equivalent) or board of directors of another entity whose executive officer(s) served on our Compensation Committee.

REPORT OF THE MICROSOFT CORPORATION BOARD OF DIRECTORS COMPENSATION COMMITTEE

Role and Compositionlow end of the Committee

The Compensation Committee dischargesrange was more attainable, performance required to qualify for payouts at the Board’s responsibilities relatingmidrange was achievable but challenging, and performance required to compensationqualify for payouts at the top of the Company’s executive officers, including reviewing the competitiveness of executive compensation programs, evaluating the performance of the Company’s executive officers, and approving their annual compensation and equity awards. The Committee also assists the Board in establishing chief executive officer (“CEO”) annual goals and objectives and, after considering the results of the CEO performance review conducted by the Governance and Nominating Committee, recommends CEO compensationrange was very difficult to the other independent Board members for approval. The specific responsibilities and functions of the Compensation Committee are delineated in the Compensation Committee Charter.achieve.

The Compensation Committee has three members. Each Committee member meets the independence requirements established by NASDAQ or, if higher, the New York Stock Exchange, as prescribed by the Company’s Corporate Governance Guidelines and the Committee’s Charter.

Under the Corporate Governance Guidelines and its Charter, the Compensation Committee has the authority to retain outside advisors to assist it in carrying out its duties and responsibilities. In accordance with this authority, the Committee has retained Michael J. Halloran, Worldwide Partner, Mercer Human Resource Consulting as an external consultant to provide insight and advice on matters including market place trends in executive compensation, proposals for compensation programs, and other topics as the Committee deems appropriate. Mr. Halloran is directly accountable to the Committee. He does not provide any other services for the Company; however, Mercer Human Resources Consulting does advise the Company on other matters. Microsoft’s Compensation and Benefits group in the Human Resources Department also supports the Committee.

Compensation Philosophy and Practice

The Company operates in a highly competitive and rapidly changing industry. The key objectives of the Company’s executive compensation programs are to attract, motivate, and retain executives who drive Microsoft’s success and industry leadership. The Company achieves these objectives through a compensation philosophy that provides employees with a distinctive overall compensation package. Outstanding performers have the opportunity to earn very competitive compensation over the long-term through a pay-for-performance approach. The programs are designed to:

In August 2007, the Compensation

The components of the compensation program for executive officers are described below. Generally, compensation is substantially weighted towards equity compensation, Committee reviewed our performance during fiscal year 2007 and in particular towards performance based compensation. For our executives, salary and bonus generally constitute 15% to 40%, and equity compensation generally constitutes 60% to 85%, of total compensation. For our executives, the bonus and shared performance stock awards (“SPSA”) generally constitute 65% to 90% of total compensation. For executives and other senior leaders, the proportion of compensation provideddetermined how many shares were earned by equity and the proportion of total compensation at risk increases with responsibility.

Base Salary.    Base salaries are determined based on a variety of factors, including the executive’s scope of responsibilities, a market competitive assessment of similar roles at other companies, and a comparison of salaries paid to peers within the Company. Base salaries are set at levels that allow the Company to attract and retain superior leaders that will enable the Company to deliver on its business goals. Base salaries are reviewed once each year and may be adjusted after considering the above factors.

The CEO will make recommendations for base salaries for eachnamed executive officer excluding the Chairman and CEO. When setting the base salaries for executive officers, excluding the Chairman and CEO, the Committee considers recommendations from the CEO and makes a final determination based on the factors listed above and the executive officer’s performance during the year.

Bonus.    Executives have the opportunity to earn a bonus up to a maximum of 120% of their base salary. Bonuses are determined based on a combination of qualitative and quantitative measures, the details of which are established annually for each executive as performance “commitments.”under his SPSA. The commitments used to determine bonuses will vary for each executive based on his/her responsibilities and may include financial or strategic measures, including but not limited to: revenue, profitability, innovation, product development and implementation, quality, customer satisfaction, or developer community satisfaction. Individual bonus awards reflect the individual’s performance compared to his/her performance-based commitments for the year.

The CEO will make recommendations for bonus payments for each executive officer, excluding the Chairman and CEO. When determining the bonuses for executive officers, excluding the Chairman and CEO, the Committee considers recommendations from the CEO and makes a final determination based on the performance of the executive and the division or group that he/she leads relative to the performance-based commitments.

Stock-based Incentives

Stock Awards.    Under Microsoft’s equity compensation program, executives are eligible to receive grants of stock awards on an annual basis. A stock award is a right to receive Microsoft common shares over a vesting period. Upon vesting, employees receive Microsoft common shares that they own outright. We believe stock awards are a better way than stock options to provide significant equity compensation to employees that provides more predictable long-term rewards, and aligns the interests of the executive with those of our shareholders. The Committee reviews the stock award guidelines each year, including the maximum guidelines. The stock award guidelines vary by the level of responsibility of the executive. Managers review and recommend stock awards based on an executive’s expected future contributions and past performance. Prior to vesting of Stock Awards, executives do not have any right to vote or receive dividends on the shares underlying the award.

The Committee reviews and approves all stock awards issued as part of the annual employee performance review.

We do not grant regular stock awards to our most senior executives (approximately 15 individuals), as we believe their equity compensation should be tied to the performance of the Company through the shared performance stock awards described in the next paragraph.

Shared Performance Stock Awards.    Executives also receive grants under the Company’s SPSA program, a long-term incentive program for executives and other senior leaders under which a significant portion of stock-based compensation depends on achievement of weighted performance measures. The size of an executive’s SPSA target grant is based on the executive’s level and role assessed against long-term compensation data for competitive positions. Within the Company’s compensation programs, the most heavily weighted component of compensation is the SPSAs,

which is closely linked to the performance of the Company. The SPSA program is an effective compensation component in that: a) the number of shares received depends on performance against key business metrics, b) retention of executivesearned for each named executive officer is enhanced by having a large percentage of total compensation derived from SPSA andshown in the multi-year vesting schedule, and c) the program alignstable below.

We were satisfied with our shareholder’s long term interests through the performance metricsin product acceptance and value that changesSMSG and MBD financial metrics. Our performance in customer satisfaction, while steady, and Internet searches, while growing, fell short of our challenging goals, and we were not satisfied with share price. Messrs. Gates and Ballmer do not participateour performance in the SPSA program.EDD financial metrics.

Fiscal Years 2004-2006 SPSA

The Company initiated the SPSA program in fiscal year 2004. The initial SPSA performance period ended June 30, 2006. The Company made target SPSA awards to eligible executives at the beginningOne-fourth of the period, and to other executives hired during the performance period. The actual number of shares granted for the three-year performance period was based on a performance index determined by the Company’s performance against objective metrics for customer satisfaction, unit volumes of Windows products, usage of Microsoft’s developer tools, and desktop application deployment. The Company exceeded the target in one metric, reached the target in two others, and performed below the target in the fourth. The weighted performance index resulted in a payout that was 101% of the original SPSA target awards. One-third of the SPSA sharesearned vested on August 31, 2006, and2007. We included the SFAS No. 123(R) expense of these shares in the applicable named executive officer’s compensation in the Summary Compensation Table for fiscal year 2007. The remaining two-thirdsthree-fourths will vest in equal increments on August 31, 20072008, August 31, 2009, and September 1, 2008,August 31, 2010, subject to the named executive officer’s continued employment. We will include these future vests in the applicable named executive officer’s compensation as we expense them in accordance with SFAS No. 123(R).

Stock Awards.    In limited circumstances, the Compensation Committee may grant stock awards, including time-vested restricted stock units, to a named executive officer other than Mr. Ballmer. The shares grantedreasons for these grants include:

The Company will continue the SPSA program in fiscal year 2007. The performance period will be one year. The use of a one-year performance period allows the Company the flexibility to adjust performance measures so we can respond to changing market and business dynamics and align executive compensation with the Company’s key priorities. While the change provides additional flexibility, we expect there to be some consistency from year to year in the types of measures used. At the end of the performance period, the actual number of shares of stock subject to an award will be determined by multiplying the target by a percentage ranging from 0% to 150%. The percentage will be determined based on the performance of the Company against weighted objective metrics for customer satisfaction, unit volumes for Windows and Office products, usage of developer tools and platforms, growth in online services, and certain divisional goals, including revenue and profitability. Certain executives, excluding the Named Executive Officers, are eligible to receive additional shares under the SPSA program based on individual performance and contribution. Each stock award is equivalent to one share of Microsoft common stock. Shares of stock will vest and be issued in four equal increments following the end of the performance period and annually over the following three years, subject to continued employment.

The CEO will make recommendations for SPSA target awards for eachchief executive officer excludingrecommends the Chairman and CEO. When setting the SPSA target awards, thegrant of restricted stock units, if any, to a named executive officer. The Compensation Committee considers recommendations from the CEOchief executive officer’s recommendation and makes a final determinationdecision based on the executive’s scope of responsibilities, pay relativefactors listed above.

No stock awards were granted to other executives, and a market competitive assessment of similar roles at other companies.named executive officers in fiscal year 2007.

Executive Benefits

In fiscal year 2006,.    Microsoft’s executives werenamed executive officers are eligible for the same level and offering of benefits made available to other employees, including the Company’sour 401(k) Plan, employee stock purchase plan, health care plan, life insurance plans, and other welfare benefit programs.

In addition to the standard benefits offered to all employees, Microsoft maintains a non-qualified deferred compensation plan. Effective January 1, 2006, Microsoft modifiedplan in which the named executive officers may participate. The plan is unfunded, and participation is voluntary. The non-qualified deferred compensation plan by expanding eligibility and allowingallows participants the opportunity to defer base salary, bonus income, and certain cash payments related to the initiation of employment. Microsoft does not contribute to the non-qualified deferred compensation plan and participation is voluntary.plan.

Effective July 2006, Microsoft revised the terms and conditions of its stock award programs to include a retirement component. Certain stock awards, including stock awards and SPSAs granted on-hireon hire or atas part of the annual performance review to employees more than one year prior to termination of employment, will continue vesting when the recipient retires at the earlier of (a) age 65, or (b) age 55 with 15 years of service, in countries where this is legally permissible. Prior to the addition of this provision, stock awards were forfeited at retirement. The Committee believes that the addition of this provision is an appropriate way to incentivize and reward long-term service. All employees in the United States who meet the retirement criteria (not just executives)executive officers) are eligible for the continuation of vesting.

How Executive Pay Levels are DeterminedPerquisites.    We do not routinely provide any significant perquisites to our named executive officers.

Microsoft participates in executive compensation benchmarking surveysRelocation Assistance.    Messrs. Liddell and Turner received the assistance with relocation expenses that provide summarized data on levels of base salary, target annual incentives,we customarily offer officer hires, including travel, shipping household goods, and stock-based and other long-term incentives. These surveys also provide benchmark information on compensation practices such as the prevalence of types of compensation plans and the proportion of the types of pay components astemporary housing. As part of the totalar-

rangements negotiated to induce Messrs. Liddell and Turner to accept employment offers and reflecting the specific circumstances of their hiring, they also received assistance with the sale of their prior homes. For more information see Note 1 to the All Other Compensation table below at page 21.

Tax/Accounting Treatment of Compensation

Under Section 162(m) of the Internal Revenue Code, we may not be able to deduct certain forms of compensation package. These surveys are supplementedin excess of $1 million paid to certain named executive officers that we employ at year-end. Certain performance-based compensation approved by other publicly available information and input fromstockholders is not subject to this deduction limit. Generally, in structuring compensation consultants onfor the named executive officers, we consider whether the form of compensation will be deductible, however, other factors may be of greater importance than preserving deductibility of annual incentive and long-term performance awards. SPSAs based on non-financial metrics such as recentcustomer satisfaction, product acceptance, and search share are expected to qualify as performance-based compensation under Section 162(m). In accordance with SFAS No. 123(R), we measure the fair value of SPSAs based on the market trends. The entire comparison group includes approximately 40 companies across the information technology sector and large market capitalization U.S. companies with whom Microsoft competes for executive talent. Someprice of the companies thatunderlying common stock as of the date of grant, reduced by the present value of estimated future dividends. These awards are included inamortized over their applicable vesting period using the comparison group are Adobe, Amazon, American Express, Apple, Boeing, Cisco, Coca-Cola, ExxonMobil, General Electric, Google, Hewlett Packard, International Business Machines, Intel, Oracle, Sun Microsystems, and Wal-Mart. The Committee uses tally sheets that ascribe dollar amounts to the components of executive officer compensation, including salary, bonus, stock awards, SPSAs, and executive benefits. Information about the Company’s severance arrangements is provided on page 11. Messrs. Gates and Ballmer do not receive equity-based pay from the Company because they already own a significant amount of Company stock.straight-line method.

How Microsoft’s Use of Stock-Based Awards is DeterminedSeverance/Change in Control

As described above,Our named executive officers are not entitled to any payments upon termination of employment or following a change of control, except that they may continue to vest in fiscal year 2006 the Company’s compensation and retention strategy included the use ofcertain stock awards and SPSAs. The levelSPSAs following their retirement, as described above. If Mr. Turner leaves Microsoft of usage was determined based on factors such as compensation levelshis own volition or due to termination for cause by us after completing 24 months but prior to completing 36 months of employment, $2.3 million of his signing bonus must be returned to Microsoft. He is entitled to vest in 160,000 shares of his 320,000 share on-hire stock award upon retirement at comparison companies relative to Microsoft’s target total compensation levels and the desired mix of cash and equity pay. Each year, the Committee and management determine the appropriate usage, balancing these factors against the projected needs of the business as well as financial considerations, including the projected impact on shareholder dilution. The Company emphasizes differentiation in executive stock compensationage 60 or older, and in the broad-basedcase of termination of employment by Microsoft for any reason other than for cause, up to 160,000 shares of his 320,000 share on-hire stock award program.will vest immediately.

Executive Compensation Recovery Policy

The Committee has adoptedAccountability is a fundamental value of Microsoft. We have an executive compensation recovery policy applicablethat applies to our executive officers and the principal accounting officer. Under this policy, the Companywe may recover incentive income that was based on achievement ofachieving quantitative performance targets if an executive officer or the principal accounting officer engaged in intentional misconduct that resulted in an increase in his or her incentive income. Incentive income includes income related to annual bonuses and SPSAs.

CompensationStock Ownership and Holding Requirements for the Chairman and Chief Executive OfficerCompany Executives

In June 2007, the Compensation Committee adopted stock ownership and holding requirements that require each executive officer to maintain a minimum equity stake in Microsoft. The independent members ofrequirements formalize the Board approveCommittee’s belief that our executive officers should maintain a material personal financial stake in Microsoft to promote a long-term perspective in managing the compensation of William H. Gates III, Chairmanenterprise, and Steven A. Ballmer, Chief Executive Officer.to align shareholder and executive interests. The Committee recommends salaryrequirements provide for stock ownership and bonus amounts to the Board. The compensation of Messrs. Ballmer and Gates reflects their statusholding as significant shareholders of the Company. Their salaries and total compensation are significantly below competitive levels for the information technology industry and large market capitalization U.S. companies. The average CEO salary and bonus for the comparison group the Company uses were $1.329 million in base salary and $3.216 million in bonus. Messrs. Gates and Ballmer do not participate in the Company’s equity compensation program. They are eligible for an annual bonus of up to 120% of their salary based on a review of performance against objectives for the year. As the leaders of the Company, they are focused on building long-term success, and as significant shareholders in the Company, their personal wealth is tied directly to sustained increases in the Company’s value.follows:

Minimum share ownership levels will be determined annually using the base pay rate as of the end of the fiscal year, and the average daily closing share price for the fiscal year. Each year in July, compliance with the requirements will be measured and executive officers will be notified about their ownership requirement, current holdings, and whether they must hold additional shares. In general, we believe the ownership requirements are slightly higher than those of our peer group.

For the purposes of determining ownership levels, the following forms of equity interests in Microsoft count towards the stock ownership requirement:

SUMMARY COMPENSATION TABLE

The following table contains information about compensation received by the named executive officers for the fiscal year ended June 30, 2007. None of the named executive officers received stock options during fiscal year 2007.

ALL OTHER COMPENSATION

GRANTS OF PLAN-BASED AWARDS

FOR FISCAL YEAR ENDED

JUNE 30, 2007

The following table provides information on exercisable and unexercisable options and unvested stock awards held by the named executive officers on June 30, 2007.

OUTSTANDING EQUITY AWARDS

AT FISCAL YEAR END

JUNE 30, 2007

The following table provides information, on an aggregate basis, about stock options that were exercised and stock awards that vested during the fiscal year ended June 30, 2007 for each of the named executive officers.

OPTION EXERCISES AND STOCK VESTED

FOR FISCAL YEAR ENDED

JUNE 30, 2007

The following table provides information relating to the Microsoft Corporation Deferred Compensation Plan, which provides for the deferral of compensation on a basis that is not tax-qualified. Microsoft does not make matching contributions under this plan. No named executive officer contributed to the plan or had any withdrawal or distribution in fiscal year 2007.

NONQUALIFIED DEFERRED COMPENSATION

EQUITY COMPENSATION PLAN INFORMATION

COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION

All members of the Board based on an evaluation of his performance against his annual objectives including achievement of revenue and profit plans, achievement of major product development objectives, progress in improving the number and satisfaction of Company customers, progress in business growth initiatives, and development of senior leadership. The Summary Compensation Table sets forth all compensation received by Mr. BallmerCommittee during fiscal years 2004, 2005,year 2007 were independent directors, and 2006. There is no Company-sponsored retirement program for Mr. Ballmer other thanmember was an employee or former employee. No Compensation Committee member had any relationship requiring disclosure under “Certain Relationships and Related Transactions,” beginning on page 25. During fiscal year 2007, none of our executive officers served on the Company’s 401(k) program, and he receives no benefitscompensation committee (or its equivalent) or perquisites from the Company other than the general Company benefits described above. Mr. Ballmer does not have a changeboard of control arrangement. He may be eligible for severance under the Company’s general severance plan, which provides up to 32 weeksdirectors of base salary upon involuntary termination in certain circumstances.another entity whose executive officer served on our Compensation Committee.

Tax Deductibility under Section 162(m)COMPENSATION COMMITTEE REPORT

Under Section 162(m) of the Internal Revenue Code, the Company may not be able to deduct certain forms of compensation in excess of $1,000,000 paid to any of the Named Executive Officers that are employed by the Company at year-end. The Committee believes that it is generally in the Company’s best interests to satisfy the requirements for deductibility under Section 162(m). Accordingly, theCompensation Committee has taken appropriate actions,reviewed and discussed with management the Compensation Discussion and Analysis provided above. Based on its review and discussions, the Compensation Committee recommended to the extent it believes feasible, to preserveBoard of Directors that the deductibility of annual incentiveCompensation Discussion and long-term performance awards. However, notwithstandingAnalysis be included in this general policy, the Committee also believes there may be circumstances in which the Company’s interests are best served by maintaining flexibility in the way compensation is provided, whether or not compensation is fully deductible under Section 162(m).proxy statement.

COMPENSATION COMMITTEE

Ann McLaughlin KorologosDina Dublon (Chair)

James I. Cash, Jr.

Helmut Panke

The chart below compares the five-year cumulative total return, assuming the reinvestment of dividends, on Microsoft common stock with that of the S&P 500 Index and the NASDAQ Computer Index. This graph assumes $100 was invested on June 30, 2001, in each of Microsoft common stock, the S&P 500 companies, and the companies in the NASDAQ Computer Index.

Note: Microsoft management cautions that the stock price performance shown in the graph below should not be considered indicative of potential future stock price performance.

COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN

AMONG MICROSOFT CORPORATION, THE S&P 500 INDEX

AND THE NASDAQ COMPUTER INDEX

CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

We are a global software company with extensive operations in the U.SU.S. and many foreign countries. In fiscal 2006year 2007 we purchased approximately $9over $10 billion of goods and services from third parties. We have over 70,00079,000 employees and the authority to purchase goods and services is widely dispersed. Because of these far-reaching activities, we encounter transactions and business arrangements with businesses and other organizations in which one of our directors, executive officers, or nominees for director, or their immediate families, or a greater than 5% owner of our stock, may also be a director, executive officer, or investor, or have some other direct or indirect material interest. We will refer to these relationships generally as related-party transactions.

Related-party transactions have the potential to create actual or perceived conflicts of interest between Microsoft and its directors and executive officers or their immediate family members. The Audit Committee has established a written policy and procedures for review and approval of related-party transactions that meet certain criteria.transactions. If a related party transaction subject to review directly or indirectly involves a member of the Audit Committee (or an immediate family member or domestic partner), the remaining Committee members will conduct the review. In deciding whether to approveevaluating a related-party transaction involving a director, executive officer, or their immediate family members, the Audit Committee considered, among other factors:

A brother-in-law of Robert J. (Robbie) Bach, an executive officer of the Company, was employed by the Company or one of its subsidiaries in fiscal year 2006 and he received fiscal year 2006 compensation that exceeded $60,000. Microsoft’s Audit Committee has reviewed and approved this arrangement.