PARKING FACILITY AND DRIVING DIRECTIONS

September 29, 20082009

Dear Shareholder:

You are cordially invited to attend the Annual Meeting of Shareholders of Microsoft Corporation, which will be held at the Meydenbauer Center, 11100 NE 6th Street, Bellevue, Washington 98004, on November 19, 2008,2009 at 8:00 a.m. Doors open at 7:00 a.m. and a product fair will also open at that time. Driving directions to the Meydenbauer Center can be found on the inside front cover of this document. Parking will be validated only for the Meydenbauer Center garage. Please note that parking is limited, so plan ahead if you are driving to the meeting.

The attached Notice of Annual Meeting and Proxy Statement contain details of the business to be conducted at the Annual Meeting.

As he announced earlier this year, Jon Shirley is retiring from the Board of Directors and will not be standing for re-election. Jon has helped lead the Company for 25 years through his service as President and Chief Operating Officer from 1983 to 1990, and as a director since 1983. We want to express our sincere appreciation to Jon for his many valuable contributions to the success of the Company; we wish him the very best for the future.

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, by phone, 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 a live coveragewebcast of the Annual Meeting from the Microsoft Investor Relations Web site atwww.microsoft.com/msft. In addition, theThe transcript along with video and audio of the entire Annual Meeting of Shareholders will be available on the Investor Relations Web 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. In addition, we make available at our Investor Relations Web site free of charge a variety of information for investors. Our goal is to maintain the Investor Relations Web site as a portal through which investors can easily find or navigate to pertinent information about us.

On behalf of the Board of Directors, I would like to express our appreciation for your continued interest in the affairs of 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; 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 19, 20082009

To the Shareholders:

The Annual Meeting of the Shareholders of Microsoft Corporation will be held at the Meydenbauer Center, 11100 NE 6th Street, Bellevue, Washington 98004, on November 19, 2008,2009 at 8:00 a.m. for the following purposes:

Only shareholders of record at the close of business on September 5, 20084, 2009 are entitled to notice of, and to vote at, this meeting.

By order of the Board of Directors

Bradford L. Smith

Secretary

Redmond, Washington

September 29, 20082009

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, by telephone, or by signing, dating, and returning the enclosed proxy card will save us the expenses and extra work of additional solicitation. AnIf you wish to vote by mail, we have enclosed an addressed envelope for which no postage is required if mailed in the United States is enclosed if you wish to vote by mail.States. 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.

Important Notice Regarding the Availability of Proxy Materials for the Shareholder Meeting to be Held on November 19, 1008.2009.Our Proxy Statement and Annual Report to Shareholders are available at www.microsoft.com/msft/reports/default.mspx.annualreports.

Proxy Statement Table of Contents

MICROSOFT CORPORATION

ONE MICROSOFT WAY

REDMOND, WASHINGTON 98052

PROXY STATEMENT FOR ANNUAL MEETING OF SHAREHOLDERS

TO BE HELD NOVEMBER 19, 20082009

This Proxy Statement was first mailed to shareholders on or about October 3, 2008.5, 2009. It is furnished in connection with the solicitation of proxies by the Board of Directors of Microsoft Corporation, to be voted at the Annual Meeting of 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 19, 20082009 at the Meydenbauer Center, 11100 NE 6th Street, Bellevue, Washington 98004. 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 our Corporate Secretary at or prior to the Annual Meeting or by timely executing and delivering, by mail, Internet, telephone, mail, or in person at the Annual Meeting, another proxy dated as of a later date. Microsoft will pay the cost of solicitation of proxies.

Shareholders of record at the close of business on September 5, 20084, 2009 will be entitled to vote at the meeting on the basis of one vote for each share held. On September 5, 2008,4, 2009, there were 9,055,478,7268,928,107,654 shares of common stock outstanding, held of record by 145,633142,195 shareholders.

PROPOSAL 11:

ELECTION OF DIRECTORS AND MANAGEMENT INFORMATION

The Company’s Board of Directors currently consists of ten members. Jon A. ShirleyJames I. Cash, Jr. is retiring from the Board effective as of the date of the Annual Meeting. In connection with Mr. Shirley’sDr. Cash’s retirement, the Board has authorized a reduction in the size of the Board to nine members effective as of November 19, 2008,2009, as permitted by the Bylaws of Microsoft Corporation (“Bylaws”).Company’s Bylaws.

Nine 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. 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.

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.

MAJORITY VOTE STANDARD FOR DIRECTOR ELECTIONS

Microsoft’s Bylaws require that in an uncontested election each director will be elected by thea 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 shareWe will not treat as cast any shares (a) whose ballot is marked as withheld, which is(b) that are otherwise present at the meeting but for which there is an abstention, or (c) to which a shareholder gives no authority or direction shall not be considered a vote cast.direction. In a contested election, the directors will be elected by the vote of a plurality of the votes cast.cast, meaning the directors receiving the largest number of “for” votes are elected to the open positions.

As provided in Section 2.2 of our Bylaws, a contested election is one in which:

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)90 days after the certification of the shareholder vote 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.corporategovernance.

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

NOMINEES

William H. Gates III, 52,53, a co-founder of Microsoft, has served as Chairman since our incorporation in 1981. Mr. Gates retired as an employee effective July 1, 2008, but will continuecontinues to serve as Chairman and an advisor on key development projects. Mr. Gates served as Chief Software Architect from January 2000 until June 2006, when he announced his two-year plan for transition out of a day-to-day full-time employee role. Mr. Gates served as our 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, 52,53, has beenserved as a director since 2000. Mr. Ballmer has headed several Microsoft divisions during the past 2829 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.

James I. Cash, Jr., Ph.D., 60, has been a director since 2001. Dr. Cash is Emeritus James E. Robison Professor of Business Administration at Harvard Business School, where he served as Senior Associate Dean and Chairman of HBS Publishing. Dr. Cash is also a member ofresponsibility for the board of directors of The Chubb Corporation, General Electric Company, Phase Forward Incorporated, and Wal-Mart Stores, Inc.Company.

Dina Dublon, 55,56, has beenserved as a director 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, 67,68, has beenserved as a director 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 board of directors. Prior toBefore 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, 47,48, has beenserved as 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.

Maria Klawe, Ph.D., 58, has served as a director since March 2009. Since 2006, Dr. Klawe has been president of Harvey Mudd College, a private liberal arts college in Claremont, California that focuses on engineering, science, and mathematics. Dr. Klawe served as dean of engineering and a professor of computer science at Princeton University from 2003 to 2006, and held several positions at the University of British Columbia from 1988 to 2002 including dean of science, vice president of student and academic services, and head of the Department of Computer Science.

David F. Marquardt, 59,60, has served as a director 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, 56,57, has served as a director 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 board of directors 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 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 is a past member of the Financial Accounting Standards Advisory Council of the Financial Accounting Standards Board and the Standing Advisory Group of the Public Company Accounting Oversight Board, and is a past member of the Financial Accounting Standards Advisory Council.Board. Mr. Noski is also a director of Air Products and Chemicals, Inc., Automatic Data Processing, Inc., and Morgan Stanley.

Dr. Helmut Panke, 62,Ph.D., 63, has served as a director 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 Singapore Airlines Limited, and is a member of the supervisory board of Bayer AG.

RETIRING DIRECTOR

James I. Cash, Jr., Ph.D., 61, has served as a director since 2001. Dr. Cash is the James E. Robison Professor & Senior Associate Dean, Emeritus, at Harvard Business School where he also served as Chairman of HBS Publishing. Dr. Cash is also a member of the board of directors of The Chubb Corporation, General Electric Company, and Wal-Mart Stores, Inc.

PROCEDURES FOR NOMINATION OF DIRECTORS

The Governance and Nominating Committee annually reviews with the Board of Directors the applicable skills and characteristics required of Board nominees, considering 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 traded company in today’s business environment; understanding of our 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 our 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 20082009 annual meeting.meeting, except Dr. Klawe. As part of the recruitment process leading to Dr. Klawe’s election by the Board, the Governance and Nominating Committee requested that members of the Microsoft Research division leadership recommend potential candidates from academia and Dr. Klawe was selected from those recommendations.

The Governance and Nominating Committee will consider shareholder recommendations for candidates for the Board.Board, using the same criteria described in the preceding paragraph. 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 our General Counsel.MSC 123/9999, Corporate Secretary, Microsoft Corporation, One Microsoft Way, Redmond, WA 98052-6399. If you wish to formally nominate a candidate you must follow the procedures described in Sections 1.3, 1.13, and 1.14 of our Bylaws.

CEO, Chairman, and Lead Independent Director

Board Committees

We will provide any of the foregoing information without charge upon written request to theMSC 123/9999, Corporate Secretary, at Microsoft Corporation, One Microsoft Way, Redmond, WA 98052-6399.

CORPORATE GOVERNANCE GUIDELINES AND COMMITTEE CHARTERS

The Corporate Governance Guidelines and the charters of the five standing committees of the Board of Directors describe our corporate governance practices.framework. The Corporate Governance Guidelines and charters are intended to ensure that our Board has the necessary authority and practices in place to review and evaluate our business operations and to make decisions that are independent of management. The Corporate Governance Guidelines also are intended to align the interests of directors and management with those of our 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 withadherence to 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 requirements contained in the NASDAQ listing standards and otherwise enhance our corporate governance policies.

BOARD COMMITTEES

Our Board has five standing committees: an Audit Committee, a Compensation Committee, a Governance and Nominating Committee, a Finance Committee, and an Antitrust Compliance Committee. Each committee has a written charter. The table below provides current membership and fiscal year 20082009 meeting information for each of the Board committees. Committee memberships changed during the fiscal year. In MarchJon A. Shirley retired from the Board as of the Company’s Annual Meeting on November 19, 2008. Following the election of directors at the Company’s Annual Meeting on November 19, 2008, Dina DublonMr. Marquardt stepped down from and Dr. Cash was appointed to the FinanceGovernance and Nominating Committee and Dr. Cash stepped down from and Mr. Hastings was appointed to the Compensation Committee.

Below is a description of each standing committee of our Board of Directors. Each committee has authority to engage legal counsel or other advisors or consultants as it deems appropriate to carry out its responsibilities.

Audit Committee.    The Audit Committee assists the Board of Directors in its oversight of the quality and integrity of our accounting, auditing, and reporting practices. The Audit Committee’s role includes:

The Audit Committee is responsible for the appointment, compensation, retention, and oversight of the independent auditor engaged to prepare or issue audit reports on our financial statements and internal control over financial reporting. The Audit Committee relies on the expertise and knowledge of management, the internal auditors,auditor, and the independent auditor in carrying out its oversight responsibilities. The Audit Committee Responsibilities Calendar accompanying the Audit Committee Charter 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 James I.Dr. Cash, Jr., DinaMs. Dublon, and Charles H.Mr. Noski are “audit committee financial experts” as defined by Securities and Exchange Commission (“SEC”) rules.

Compensation Committee.    The primary responsibilities of the Compensation Committee are to:

regularly reviews the charters of Board committees and, after consultation with the respective committee chairs, makes recommendations, if necessary, about changes to the charters. The Governance and Nominating Committee Charter describes the specific responsibilities and functions of the Governance and Nominating Committee.

tainer. Amounts deferred by non-employee directors are maintained in bookkeeping accounts that are deemed invested in Microsoft common stock, and dividends paid on our common stock are deemed to be invested in our common stock. Accounts in the Plan are distributed in the formshares of ourMicrosoft common stock, with payments

INFORMATION REGARDING BENEFICIAL OWNERSHIP OF PRINCIPAL SHAREHOLDERS, DIRECTORS, AND MANAGEMENT

The following table sets forth, as of September 5, 2008,4, 2009, information about the beneficial ownership of our common stock by all directors, our Chief Executive Officer, Chief Financial Officerchief executive officer, chief financial officer and the three other highest paid executive officers (collectively, the “named executive officers”), and our directors and all executive officers as a group.

In computing the number of shares beneficially owned and the percentage ownership, shares of common stock that may be acquired within 60 days of September 4, 2009 pursuant to the exercise of options or the vesting of stock awards are deemed to be outstanding for that person. Such shares, however, are not deemed outstanding for the purpose of computing the percentage ownership of any other person.

NAMED EXECUTIVE OFFICER COMPENSATION

COMPENSATION DISCUSSION AND ANALYSIS

IntroductionExecutive Summary

Purpose of Compensation Discussion and Analysis

This Compensation Discussion and Analysis provides information about the fiscal year 20082009 compensation program for the principal executive officer, the principal financial officer, and the threeour fiscal year 2009 named executive officers, (other than the principal executive officer and principal financial officer) who were the most highly compensated executives of Microsoft. During fiscal year 2008, these individuals were:are:

TheseFiscal Year 2009 Corporate Performance

A worldwide economic recession that created the most difficult business environment in decades made fiscal 2009 a challenging year for us. As consumers and businesses reset their spending at lower levels, PC sales and corporate information technology investments fell. As a result, we saw our first-ever drop in annual revenue, from $60.4 billion in fiscal 2008 to $58.4 billion in fiscal 2009, a decline of 3 percent. Operating income was $20.4 billion, down 9 percent. Earnings per share fell 13 percent to $1.62. Responding to these changes, we focused on opportunities to cut costs and use resources more effectively. We reduced expenses by more than $3 billion compared with our original fiscal 2009 plan.

We also sharpened our focus on our most important opportunities for growth. To drive innovation, we maintained our commitment to smart, long-term investment in research and development. We increased our investment in research and development by 10% in fiscal 2009 and made significant progress in key areas of product development and technology innovation that position us for growth in the years ahead. We launched new releases of some of our flagship products and services, including Internet Explorer 8, our new Web search technology Bing, SQL Server 2008, and software-plus-services offerings such as Office Online and Exchange Online. Our development groups also positioned other important offerings for release in fiscal year 2010 including Windows 7, Office 2010, Windows Azure, Windows Server 2008 R2, Windows Mobile 6.5, and Silverlight 3.0.

Our compensation decisions for fiscal year 2009 reflect the difficult economic environment, the impact of that environment on company financial performance, and the degree of success each executive officer achieved in meeting these challenges.

Base Salary Freezes

Given the uncertainty surrounding the impact of the current economic climate, in January 2009 we announced that all of our employees, including Mr. Ballmer and all of our executive officers, would not receive merit-based salary increases for fiscal year 2010. Accordingly, base salaries for our named executive officers in effect at the end of fiscal year 2009 remain the same for fiscal year 2010.

New Incentive Compensation Program

In fiscal year 2009, we changed how we deliver cash and stock-based incentive compensation to our executive officers. Previously, our executive officer incentive compensation consisted of annual cash bonuses and annual grants of performance-based restricted stock units (“stock awards”) that vested over multiple years. Our new Executive Officer Incentive Plan (“Incentive Plan”) replaced the prior separate cash bonus and stock award programs. The Incentive Plan provides a unified framework for assessing executive officer performance and determining the appropriate cash and stock-based compensation for that performance.

Awards under the Incentive Plan are referrednot derived under a formula. Instead, the Compensation Committee uses its business judgment to determine Incentive Plan awards. The Committee approves Incentive Plan awards after considering executive officer performance across a wide range of financial, operational, and strategic measures,

Mr. Ballmer’s recommendations for awards, and other relevant information, as described on pages 22 and 23. As in previous years, Mr. Ballmer’s incentive compensation for fiscal year 2009 was limited to a cash payment of up to 200% of his fiscal year 2009 base salary, consistent with his request that we not award him equity compensation. The fiscal year 2009 Incentive Plan awards for other executive officers were payable:

Reflecting the company’s performance during the severe economic downturn, our executive officers, taken as a group, received Incentive Plan awards equal to 77% of their target awards and 29% lower than the comparable cash bonus and stock awards for fiscal year 2008.

Total Direct Compensation Awarded Named Executive Officers for Fiscal Year 2009

The table below is intended to provide insight into the compensation that our named executive officers were awarded for their performance in fiscal year 2009. The table sets forth their base salaries and the cash and stock-based incentive compensation they were awarded for fiscal years 2008 and 2009, providing a simple year-over-year comparison.

This table is intended to supplement, not replace, the Summary Compensation Table on page 27, which lists our fiscal year 2009 named executive officers and reports their compensation in the format required by SEC rules. Because the Summary Compensation Table definition of compensation for fiscal year 2009 includes the value of stock-based compensation that was awarded in previous fiscal years, and includes only a portion of the value of the stock-based compensation we awarded for fiscal year 2009 performance, we believe this alternative table should help investors to understand our fiscal year 2009 compensation actions.

More information about our fiscal year 2009 Incentive Plan awards can be found beginning on page 22.

Contents of Compensation Discussion and Analysis as

Section 1  describes our compensation philosophy and overall goals of our compensation programs for our executive officers.

Section 2  explains how we make decisions on the design and operation of our compensation program for executive officers.

Section 3  describes (a) the major components of executive officer compensation and (b) the amount of compensation awarded to our named executive officers for fiscal year 2008.2009 and the reasons for the awards.

Section 4  provides a summary of other aspects of executive officer compensation at Microsoft, including our executive compensation recovery policy, stock ownership policy, perquisites, and severance and change in control arrangements.

Section 1. Compensation Philosophy

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

Section 2. Decision Making

Compensation Program Actions and Governance

Actions under our compensation program for our executive officers fall into three categories:

Process for Determining Named Executive Officer Compensation

The table below depicts the roles of management, the Compensation Committee, is responsible for overseeing and approving our executive compensation philosophy and compensation programs, as well as determining and recommending the compensation for our Chief Executive Officer, Mr. Ballmer, to the independent members of the Board of Directors and determining andin recommending or approving actions relating to the compensation for the other namedof our executive officers. At the beginning of each fiscal year,

Compensation Committee reviews and the independent members of the Board approve the performance commitments for Mr. Ballmer. As described in more detail below, the Compensation Committee assesses the performance of Mr. Ballmer and the other named executive officers with respect to the just-completed fiscal year to determine whether any base salary adjustments are warranted, the amount of each named executive officer’s annual cash bonus, and the amount of any restricted stock unit awards.Program Design

Program Review

We compete with global information technology and large market capitalization U.S. companies for senior executive talent. Each year, we review the market competitiveness of our executive compensation program.relative to technology and broad industry peers (described in detail below). If the review shows that our executive compensation program is not competitive, we maywill recommend changes to the Compensation Committee. We may also recommend changes to the executive compensation program if Microsoft’sbased on changes in our strategic goals or the business environment or strategic goals warrant a change.in which we operate.

Further, theThe Compensation Committee periodically reviews the componentsoverall goals of our executive compensation program and the elements of the program, including any incentive compensationthe mix of cash and stock-based compensation plans,and the mix of short term and long term compensation, to determine whether they are appropriate, properly coordinated, and achieve their intended purposes. From time to time, the Compensation Committee may make modifications or revisions to existing plans and adopt new plans. AsIn reviewing our executive compensation program, our Compensation Committee retains and is advised by an independent compensation consultant, as described in more detail below, we have adopted a new executive officer incentive plan for fiscal year 2009.on page 10.

Dow 30 peer group.    Generally, these are large, diversified companies with significant international operations. As an industry and worldwide business leader, we compete for senior executive talent with top companies across a variety of other industries, not just those in information technology.

The table below represents the information technology industry.peer companies that were in place when we conducted our compensation analysis planning for fiscal year 2009.

Positioning of Pay

The Compensation Committee Advisors

During fiscal year 2008,determines target total direct compensation (base salary and target Incentive Plan awards) for our named executive officers (other than Mr. Ballmer) after considering a variety of data sources that provide information on compensation for similar positions, including surveys and proxies, and considering internal comparisons of the Compensation Committee retained independentexecutive officer’s total compensation consultants to advise it on Microsoft’sthe total compensation of our other executive officers. We do not apply a formula that ties our target compensation program andlevels to assist in determining the appropriate base salaryspecific market percentiles. In general, our target compensation levels annual cash bonuses, and equity awards for the named executive officers by providing industry competitive analyses(other than Mr. Ballmer) will be above median but below the 75^th percentile for similar positions within our peer group companies.

Mix of Pay Elements

As described in Section 1 above, our philosophy is to provide a significant portion of total compensation linked to performance that we believe will create long-term shareholder value. Further, a significant portion of the named executive officers’ total compensation (with the exception of Mr. Ballmer) is delivered through stock awards under the Incentive Plan with a multi-year vesting schedule to align our executive officers to the long-term interests of the Company and assessingshareholders to encourage the reasonableness of individual compensation elements and total direct compensation.named executive officers to act as owners.

From January 1, 2008, the Compensation Committee’s advisor has been Dan Marcus, Managing Principal, Semler Brossy Consulting Group, LLC; before January 1, 2008, the advisor was Mike Halloran, Worldwide Partner, Mercer. Both Messrs. Halloran and Marcus:

consultedThe following chart provides information about the target mix of pay for our named executive officers (excluding the chief executive officer) and the named executive officers of our current peer group as of the end of fiscal year 2009.

Assessment of Risk

By design our compensation program for executive officers does not incentivize excessive risk taking. Our base salary component of compensation does not encourage risk-taking because it is a fixed amount. The current Incentive Plan awards have the following risk-limiting characteristics:

Performance Review Process

Each year, our named executive officers participate in a performance review process that leads to decisions on the size of their Incentive Plan awards for the prior fiscal year and whether their base salaries should be increased.

Chief Executive Officer

Following the end of each fiscal year, the Compensation Committee’s regular meetings,Committee recommends to the independent members of the Board of Directors Mr. Ballmer’s proposed Incentive Plan award based on his performance during the just concluded fiscal year and whether there should be any adjustment to Mr. Ballmer’s base salary for the current fiscal year. The Compensation Committee, which meets in executive session to formulate its recommendations, does not apply a formula to determine any Incentive Plan award or proposed base salary adjustment. Instead, the Compensation Committee exercises its judgment in formulating its recommendations, taking into consideration:

The evaluation conducted by the independent members of the Board of Directors, led by the Chair of the Governance and Nominating Committee, assesses Mr. Ballmer’s success in achieving his performance commitments for the just-completed fiscal year, which typically include financial, operational, strategic, and company culture/leadership objectives. Mr. Ballmer provides the independent members of the Board of Directors with a self-evaluation of his performance. Microsoft provides the Board of Directors with a summary of Mr. Ballmer’s performance on a wide range of quantitative and qualitative financial, operational, and strategic measures that were developed by management and reviewed with the Board of Directors at the beginning of the fiscal year as part of the annual business planning process. The independent members of the Board of Directors also conduct in-depth interviews with Mr. Ballmer’s direct reports to evaluate his performance. In addition, as part of our annual review processes all employees have the opportunity to provide written feedback and ratings on the performance of their direct and next level managers. This information from Mr. Ballmer’s next level reports is compiled and provided to the independent members of the Board of Directors for consideration as part of its evaluation.

Other Named Executive Officers

During the fiscal year, the Compensation Committee discusses on several occasions executive officer performance. Following the end of the fiscal year, the Committee devotes one of its meetings to a comprehensive discussion of all executive officers’ performance and long-term potential. The meeting is attended by the members of the Committee, Mr. Ballmer, Lisa Brummel, our Senior Vice President of Human Resources, and the Committee’s compensation consultant. The Committee also reviews tally sheets prepared by our Human Resources division that set forth each executive officer’s historical earnings, the value of outstanding and unvested equity awards, current holdings of shares of Microsoft common stock, any perquisites and benefits, and, if applicable, any potential severance payments and benefits. Based on its discussions at this meeting and recommendations from Mr. Ballmer, the Committee approves the amount of each executive officer’s Incentive Plan award and any base salary adjustments after considering:

Setting Compensation Opportunities

At the beginning of the fiscal year, the Compensation Committee approves a target Incentive Plan award amount for each of our executive officers based on the following:

As the principal leader of Microsoft, Mr. Ballmer focuses on building our long-term success, and, as a significant shareholder, his personal wealth is tied directly to Microsoft’s value. While the Compensation Committee believes Mr. Ballmer is underpaid for his role and performance, it has accepted his recommendation to continue with Microsoft’s historical practice for setting his total compensation opportunity to exclude any long-term equity compensation award. Based on proxy statement compensation information disclosed by our peer companies as of August 20, 2009, excluding those with founder chief executive officers (Apple, Dell, and Oracle), the average chief executive officer annual base salary was $1.4 million, average bonus compensation was $4.1 million, and average total compensation was $14.0 million. For fiscal year 2009, Mr. Ballmer’s maximum pay opportunity was $1,997,499 consisting of base salary and a potential Incentive Plan award of up to 200% of his base salary for the fiscal year. This maximum pay opportunity will remain the same for fiscal year 2010.

Section 3. Components of Compensation and Fiscal Year 2009 Awards

For fiscal year 2009, the primary components of compensation for the named executive officers were base salary and Incentive Plan awards.

Base Salary

The Compensation Committee reviews base salaries of our executive officers annually to ensure they fairly and competitively compensate these individuals for the jobs they perform. Effective September 1, 2008, the fiscal year 2009 base salaries of our named executive officers were increased between 3.2% and 3.9%. These percentage increases were consistent with the range of increases for our U.S.-based employees in September 2008. Based on the challenging economic environment in fiscal year 2009 and our decision that employees would not receive merit increases in fiscal year 2010:

Incentive Plan

In September 2009, the Compensation Committee approved our new Incentive Plan to provide both cash and equity incentive compensation for our executive officers. The Incentive Plan replaces the annual cash bonus opportunity and stock award programs we used in previous fiscal years. Awards under the Incentive Plan are determined following a discretionary evaluation of performance for the fiscal year, and are not based on achievement of pre-established formulaic criteria. The Incentive Plan provides a more flexible framework that:

The Incentive Plan is designed to deliver a significant portion of total direct compensation to our named executive officers (excluding Mr. Ballmer) through shares of Microsoft common stock. We rely on stock-based compensation with a multi-year vesting schedule to enhance retention and align our executive officers to the long-term interests of the Company and shareholders.

For fiscal year 2009, the Incentive Plan awards granted to our named executive officers (excluding Mr. Ballmer) were made in the following steps.

When we assess the performance of our executive officers we do not use a formula or apply specific weights to performance results. Instead, the Compensation Committee in executive session, where no members of management were present, and

performance evaluation of Mr. Ballmer conducted by the Governance and Nominating Committee, as described on page 14. The independent membersBach.Mr. Bach is President of the BoardEntertainment & Devices (“E&D”) Division, which is responsible for developing, producing, and marketing the Xbox video game system and related products and services, games and online services for Windows PCs, the Windows Mobile and Windows Embedded device platforms, the Zune digital music and entertainment device and accessories, the Mediaroom internet protocol television offerings, PC hardware accessories, and Microsoft Office for the Macintosh.

Under Mr. Bach’s leadership, E&D experienced strong performance in the Xbox platform, including unit console sales growing at 30%, year-over-year growth of Directors considered42% in online subscribers, and development of Xbox’s Project Natal technologies. In addition, there were solid results against our customer satisfaction goals, building key strategic partnerships, and strengthening the Compensation Committee’s recommendation, as well asleadership of the Windows Mobile division to address slower progress in Windows Mobile. Consistent with the economy, however, the financial results for E&D were below goal, with operating income decreasing by $328 million. Based on his fiscal year 2009 performance, Mr. Ballmer’s performance evaluation, in determining the amountBach received an Incentive Plan award of $5,600,000, which was 80% of his bonus.

In September 2008, the Compensation Committee approved (and, in the case of Mr. Ballmer, recommended to the independent members of the Board of Directors) the following fiscal year 2008target award and 27% lower than his combined cash bonus amounts for the named executive officers:

Stock-Based Compensation

We consider stock-based compensation to be a key element of our executive compensation program because:

Accordingly, a significant portion of the target total direct compensation for the named executive officers (other than Mr. Ballmer) has been delivered under our Shared Performance Stock Awards (“SPSA”) program, a restricted stock unit incentive program rewarding contributions to Microsoft’s long-term performance. The SPSA program has been designed to focus the named executive officers on shared business goals that guide our annual and long-term growth and address specific business challenges by rewarding them with shares of Microsoft common stock based on corporate and individual performance during a specified performance period. Since we began the program in 2003, SPSA awards have represented the single largest component of total compensation for the named executive officers (other than Mr. Ballmer).

The SPSA program consists of two types of restricted stock unit awards: Target Based SPSAs and, for fiscal year 2008, Performance Pool SPSAs. The principal attributes of these awards are as follows:2008.

Section 4. Other Compensation Topics

Compensation Committee based on his performance appraisal by the Governance and Nominating Committee and other information the Compensation Committee deems relevant. The amount of the award will be determined by the independent members of the Board of Directors.Advisor

For executive officers other than Mr. Ballmer, followingDuring fiscal year 2009, the Compensation Committee will approve EOIP awards in its discretion basedcontinued retaining Dan Marcus, Managing Principal, Semler Brossy Consulting Group, LLC, as an independent compensation consultant. Information on (1) Mr. Ballmer’s recommendations, which will take into account individual performance against annual commitmentsthe role and any other information Mr. Ballmer finds relevant, and (2) its assessmentindependence of the individual performance, corporate performance, and/or relevant group or division performance against annual operating metrics and any other information it deems relevant. Following approval of these EOIP awards, 20% of the EOIP award will be paid to the executive officer in cash and 80% of the EOIP award will be converted into a stock award for shares of Microsoft common stock. The number of shares subject to the stock award will be determined by dividing the value of the 80% of the EOIP award by the closing price of Microsoft common stockcompensation consultant is provided on August 31, 2009. This stock award will vest in four equal annual installments, with the first installment vesting following the Compensation Committee’s approval of the EOIP award. Subsequent installments will vest on August 31 of 2010, 2011, and 2012. The conditions for vesting of the stock awards will be the same as under the SPSA program.page 10.

Executive Benefits and Perquisites

Microsoft’sOur named executive officers are eligible for the same level and offering of benefits made available to our other United States-based full-time regular employees, including our 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 maintainswe maintain a non-qualified deferred compensation plan for executives and senior managers and executives in which the named executive officers may participate. The plan is unfunded, and participation is voluntary. The non-qualified deferred compensation plan allows participantsour named executive officers the opportunity to defer their base salary, bonus income,the cash portion of their Incentive Plan awards, and certain cash payments related to the initiation of employment. Microsoft doeson-hire bonuses. We do not contribute to the non-qualified deferred compensation plan. None of our named executive officers participated or had a balance outstanding in the deferred compensation plan in fiscal year 2009.

Perquisites are provided to our named executive officers only in special situations.situations, including relocation for newly hired executive officers. During fiscal year 2008,2009, other than relocation assistance, we did not provide any significant perquisites to our named executive officers.

Relocation Assistance

Messrs. Liddell and TurnerMr. Elop received assistance with relocation expenses that we customarily offer officer hires,candidates, including travel, shipping household goods, and temporary housing. As part of the arrangements negotiated to induce Messrs. Liddell and TurnerMr. Elop to accept an employment offersoffer and reflecting the specific circumstances of theirhis hiring, theyhe also received assistance with the sale of theirhis prior homes.home. For more information see Note 1 to the All“All Other CompensationCompensation” table below on page 26.28.

Severance, Retirement, and Change in Control Arrangements

Our named executive officers do not have employment contracts, and (other than Mr. Turner) are not entitled to any payments upon termination of their employment or following a change of control of Microsoft, except that certain stock awards, including stock awards and

In accordance with SFAS No. 123(R), we measure the fair value of SPSAsstock awards, including those under the Incentive Plan, based on the market price of the underlying common stock as of the date of grant, reduced by the present value of estimated future dividends. These awards are amortized over their applicable vesting period using the straight-line method.

Other Compensation Policies

Executive Compensation Recovery Policy

Accountability is a fundamental value of Microsoft. We haveTo reinforce this value through our executive compensation program, the Compensation Committee maintains an executive compensation recovery policy that applies to our executive officers and principalour chief accounting officer. UnderIn fiscal year 2009, the Compensation Committee amended this policy weto expand the circumstances that would permit the recovery of incentive compensation. Under the amended policy, the Compensation Committee may seek to recover payments of incentive compensation if the performance results leading to the payment are later subject to a downward adjustment or restatement of financial or nonfinancial performance. The Committee may use its judgment in determining the amount of the incentive compensation to be recovered where the incentive compensation was awarded on a discretionary basis, as with awards under the Incentive Plan for fiscal year 2009. Further, the Compensation Committee may recover incentive compensation that was paid based on achieving quantitative performance targets ifwhether or not the executive officer’s actions involve “misconduct.” When an executive officer or the principal accounting officerhas engaged in intentional misconduct that resulted in an increase in his or hercontributed to the payment the Compensation Committee may take other remedial action, including seeking to recover the entire payment. Payments of incentive compensation.compensation include awards under the Incentive compensation includesPlan as well as prior year compensation related to annual bonuses and SPSAs.incentive stock awards.

Stock Ownership and Holding Requirements for Company Executives

The Compensation Committee has adopted stock ownership and holding requirements that require each of our executive officerofficers to maintain a minimum equity stake in Microsoft. The requirements formalize the Compensation Committee’s belief that our executive officers should maintain a material personal financial stake in Microsoft to promote a long-term perspective in managing the enterprise,our business, and to align executive and shareholder interests. The requirements ensure the alignment of executive and shareholder interests, which reduces the incentives for excessive short-term risk-taking. The requirements provide for stock ownership and holding as follows: