PARKING FACILITY AND DRIVING DIRECTIONS

September 29, 2008

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, 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, 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 Web site at www.microsoft.com/msft. In addition, the 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.

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, 2008

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, at 8:00 a.m. for the following purposes:

Only shareholders of record at the close of business on September 5, 2008 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, 2008

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 us 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.

Important Notice Regarding the Availability of Proxy Materials for the Shareholder Meeting to be Held on November 19, 1008. Our Proxy Statement and Annual Report to Shareholders are available at www.microsoft.com/msft/reports/default.mspx.

MICROSOFT CORPORATION

ONE MICROSOFT WAY

REDMOND, WASHINGTON 98052

PROXY STATEMENT FOR ANNUAL MEETING OF SHAREHOLDERS

TO BE HELD NOVEMBER 19, 2008

This Proxy Statement was first mailed to shareholders on or about October 3, 2008. 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, 2008 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, 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, 2008 will be entitled to vote at the meeting on the basis of one vote for each share held. On September 5, 2008, there were 9,055,478,726 shares of common stock outstanding, held of record by 145,633 shareholders.

PROPOSAL 1

ELECTION OF DIRECTORS AND MANAGEMENT INFORMATION

The Company’s Board of Directors currently consists of ten members. Jon A. Shirley is retiring from the Board effective as of the date of the Annual Meeting. In connection with Mr. Shirley’s retirement, the Board has authorized a reduction in the size of the Board to nine members effective as of November 19, 2008, as permitted by the Bylaws of Microsoft Corporation (“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 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 a contested election, the directors will be elected by the vote of a plurality of the votes cast.

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) 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 at http://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, 52, 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 continue 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, has been a director since 2000. Mr. Ballmer has headed several Microsoft divisions during the past 28 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 of the board of directors of The Chubb Corporation, General Electric Company, Phase Forward Incorporated, and Wal-Mart Stores, Inc.

Dina Dublon, 55, has been 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, has been 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 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, 47, 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, 59, 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, 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, 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., Automatic Data Processing, Inc., and Morgan Stanley.

Dr. Helmut Panke, 62, 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 is a member of the supervisory board of Bayer AG.

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 2008 annual meeting.

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 our General Counsel. 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.

DIRECTOR INDEPENDENCE

Our Board of Directors has adopted director independence guidelines to assist in determining each director’s independence. These guidelines are available on our Web site at http://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 determined that the following directors meet the standards of independence under our 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, and Ms. Dublon. 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.

CORPORATE GOVERNANCE PRINCIPLES AND PRACTICES

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, and adopts policies designed to strengthen our corporate governance framework. Microsoft’s corporate governance guidelines were most recently updated in August 2007. Highlights of Microsoft’s corporate governance framework include:

Board Independence

CEO, Chairman and Lead Independent Director

Board Committees

Shareholder Authority

Compensation

Stock Ownership

MICROSOFT CORPORATE GOVERNANCE WEBSITE

If you would like additional information about Microsoft’s corporate governance practices, you may view the following documents at http://www.microsoft.com/about/companyinformation/corporategovernance/default.mspx:

We will provide any of the foregoing information without charge upon written request to the 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 committees of the Board of Directors describe our corporate governance practices. 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 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 requirements contained in the NASDAQ listing standards and otherwise enhance our corporate governance policies.

MEETINGS AND MEETING ATTENDANCE

Our Board of Directors holds regularly scheduled quarterly meetings. Typically, committee meetings occur the day prior to the Board meeting. One quarter each year, the Committee and Board 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 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 Board meeting, time is set aside for the independent directors to meet without management present. Our Board met eleven times during fiscal year 2008.

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. Eight directors attended the 2007 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 11 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 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 2008 meeting information for each of the Board committees. Committee memberships changed during the fiscal year. In March 2008, Dina Dublon stepped down from the Finance Committee.

Below is a description of each 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, 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. Cash, Jr., Dina Dublon, and Charles H. 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:

The Compensation Committee annually 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. 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 January 2008, the Committee retained Dan Marcus, Managing Principal, Semler Brossy Consulting Group LLC to advise the Committee on marketplace trends in executive compensation, management proposals for compensation programs, and determination of named executive officer compensation. Mr. Marcus also consulted with the Committee about its recommendations to the Board on director compensation. Mr. Marcus is directly accountable to the Committee. To maintain the independence of the firm’s advice, Semler Brossy does not provide any other services for Microsoft. 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 annually performs an assessment of its consultant’s independence. In performing the assessment, the Committee considers 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 prepares 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. Marcus has been independent during his service for the Committee. Before January 2008, the Committee’s advisor was Mike Halloran, Worldwide Partner, Mercer. The Committee believes that Mr. Halloran was independent during his service for the Committee.

The Compensation Committee Charter describes the specific responsibilities and functions of the Compensation Committee. See “Process for Determining Named Executive Officer Compensation” below on page 13 for more information about the Committee’s work.

Governance and Nominating Committee.    The principal responsibilities of the Governance and Nominating Committee are to:

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 our Chief Executive Officer. The Governance and Nominating Committee 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.

Finance Committee.    The Finance Committee is responsible for overseeing and making recommendations to the Board about our financial affairs and policies including:

The Finance Committee’s role includes designating officers and employees who can execute documents and act on our behalf 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.

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 in State 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 our Chief Executive Officer, and may be removed by our Chief Executive Officer only with the concurrence of the Committee. The Antitrust Compliance Committee Responsibilities Checklist attached to the Antitrust Compliance Committee 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 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 our 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 our 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 our 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

During fiscal year 2008 Messrs. Gates and Ballmer received no compensation for serving as directors, except that they, like all directors, are eligible to be reimbursed for any expenses incurred in attending Board and committee meetings. Each director, other than Messrs. Gates and Ballmer, is entitled to receive compensation for serving on our Board of Directors and committees of the Board as follows:

Effective January 1, 2008, the Board changed the timing of payment of the director retainer from annually in advance to quarterly in arrears. Quarterly service periods are measured beginning on the date of the annual shareholders meeting and each three months after that date. At the end of each quarterly period each director is paid 25% of the total annual retainer, provided he or she continues to serve as a director as of the payment date.

Our non-employee directors may elect to defer and convert to equity all or part of their annual cash retainer, and to defer receipt of all or part of their annual equity retainer, under our 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 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 form of our common stock, with payments

either in installments beginning on separation from Board service or in a lump amount 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. Stock deferred under the Deferred Compensation Plan for Non-Employee Directors counts towards the minimum ownership requirement.

Note concerning 2008 Director Compensation Table:    As described above, in fiscal year 2008 we changed the timing of payment of the director retainer. As a result, each non-employee director received two quarterly payments during fiscal year 2008, amounting to 50% of the total annual retainer. The Director Compensation Table below reflects these two payments. In future years the Director Compensation Table will reflect the full year’s retainer. The overall annual compensation amount for non-employee directors did not change from fiscal year 2007 to 2008.

In addition, to assist directors in developing an in-depth understanding of our business, products, and 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 personal 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 Communication 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. We will initially receive and process communications before forwarding them to the addressee. We also may refer communications to other departments in Microsoft. We generally will not forward to the directors a communication that is primarily commercial in nature, relates to an improper or irrelevant topic, or requests Microsoft general information.

Concerns about accounting or auditing matters or possible violations of our Standards of Business Conduct should be reported pursuant to the procedures outlined in the Microsoft Standards of Business Conduct, which are available on our Web site at www.microsoft.com/mscorp/legal/buscond.

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

The following table sets forth, as of September 5, 2008, information about the beneficial ownership of our common stock by all directors, our Chief 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.

NAMED EXECUTIVE OFFICER COMPENSATION

COMPENSATION DISCUSSION AND ANALYSIS

Introduction

This Compensation Discussion and Analysis provides information about the fiscal year 2008 compensation program for the principal executive officer, the principal financial officer, and the three 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:

These executive officers are referred to in this Compensation Discussion and Analysis as our named executive officers for fiscal year 2008.

Compensation Philosophy

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

Process for Determining Named Executive Officer Compensation

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 and approving the compensation for the other named executive officers. At the beginning of each fiscal year, the 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.

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. If the review shows that our executive compensation program is not competitive, we may recommend changes to the Compensation Committee. We may also recommend changes to the compensation program if Microsoft’s business environment or strategic goals warrant a change.

Further, the Compensation Committee periodically reviews the components of our executive compensation program, including any incentive compensation and stock-based compensation plans, 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. As described in more detail below, we have adopted a new executive officer incentive plan for fiscal year 2009.

Assessing Performance and Determining Compensation – Chief Executive Officer

At the beginning of each fiscal year, the Compensation Committee recommends to the independent members of the Board of Directors any adjustment to Mr. Ballmer’s base salary and his proposed annual cash bonus for the previous fiscal year. The Compensation Committee, which meets in executive session to determine its recommendations, does not apply a formula to determine any proposed base salary adjustment and annual cash bonus amount. Instead, the Compensation Committee exercises its judgment in formulating its recommendations, taking into consideration the following factors:

The evaluation conducted by 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, strategic, and company culture/leadership objectives. The independent members of the Board of Directors assist the Governance and Nominating Committee in the evaluation process. Mr. Ballmer provides the independent members of the Board of Directors with a self-evaluation of his performance. The independent members of the Board of Directors conduct in-depth interviews with Mr. Ballmer’s direct reports and other executives to evaluate his performance. In addition, as part of Microsoft’s 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 direct reports and the other executives is compiled and provided to the Governance and Nominating Committee for consideration as part of its evaluation.

Mr. Ballmer for many years has been a significant shareholder of Microsoft. Because his interests are already closely aligned with shareholders’ interests, the Compensation Committee and Mr. Ballmer have agreed that he should not receive equity compensation. Accordingly, he receives just a base salary and an annual cash bonus opportunity of up to 200% of his base salary. As a result, Mr. Ballmer’s base salary and total compensation have been below competitive levels for the information technology industry and large market capitalization U.S. companies. For fiscal year 2007 (the last period for which such information is available), the average base salary and annual bonus compensation for the CEOs of our peer group companies were $1.4 million and $5.2 million, respectively. During this period, the average total compensation for the CEOs of our peer group companies was $14.6 million. In contrast, Mr. Ballmer’s total compensation for fiscal year 2008 was $1.35 million.

As the principal leader of Microsoft, Mr. Ballmer focuses on building the company’s long-term success, and, as a significant shareholder, his personal wealth is tied directly to sustained increases in Microsoft’s value. While the Compensation Committee believes that 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.

Assessing Performance and Determining Compensation – Other Named Executive Officers

Target Compensation.     At the beginning of fiscal year 2008, the Compensation Committee approved the target total direct compensation (consisting of base salary, target annual cash bonus opportunity, and target equity awards) for our named executive officers (with the exception of Mr. Ballmer, whose compensation is determined as described above), based on the following factors:

Actual Compensation.    Following the end of fiscal year 2008, the Compensation Committee approved base salary adjustments for our named executive officers, as well as the amount of each officer’s annual cash bonus for the just-completed fiscal year, and the amount of his discretionary restricted stock unit awards (called Performance Pool SPSAs) after considering:

As part of the compensation-setting process following fiscal year 2008, the Compensation Committee also reviewed tally sheets prepared by our Human Resources division that set forth each named executive officer’s historical earnings, the value of his outstanding and unvested equity awards, his current holdings of Microsoft common stock, any perquisites and benefits, and, if applicable, any potential severance payments and benefits.

Annual Compensation-Setting Process

The following table outlines the annual process that is used to assess the performance of the named executive officers and determine their compensation, and identifies the individual(s) or committee of the Board of Directors that is responsible for that action. Except as otherwise noted, these actions typically take place in August and September of each year following our fiscal year end.

Competitive Positioning

The Compensation Committee targets the total direct compensation (base salary, annual cash bonus opportunity, and equity awards) for our named executive officers (other than Mr. Ballmer) above the median total direct compensation of our peer group companies for similar positions. Even though some of our peer group companies offer sig-

nificant executive perquisites or other special executive benefits programs, we do not. Accordingly, we do not consider the value of such items in our review of their compensation programs.

Our philosophy is to link a significant portion of each named executive officer’s total direct compensation to performance that we believe will create long-term shareholder value and encourage the named executive officers to act as owners with an equity stake in Microsoft. Consistent with this philosophy, for fiscal year 2008, the total cash compensation for the named executive officers was below the median for total cash compensation of our peer group companies for similar positions. A significant portion of the named executive officers’ total compensation (with the exception of Mr. Ballmer) is delivered through awards of restricted stock units with a value tied to individual, corporate, and division or group performance. The Compensation Committee has targeted an above-median position for the overall value of these equity awards. This position helps ensure our ability to attract and retain the senior executive talent required to achieve our business strategies in the competitive environment of the information technology industry, and reflects the fact we do not offer executive perquisites and benefits that are offered by many of our competitors.

When assessing the competitive position of our executive compensation program, as well as making decisions about individual compensation elements, we provide the Compensation Committee with the results of our review of third-party surveys, as well as publicly available executive compensation data, for two specific groups of peer companies:

Technology peer group.    These are companies operating in the information technology industry that focus on producing software or hardware or providing online services, and that employ work forces with skill sets and professional backgrounds similar to those of our work force.

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 the information technology industry.

Compensation Committee Advisors

During fiscal year 2008, the Compensation Committee retained independent compensation consultants to advise it on Microsoft’s executive compensation program and to assist in determining the appropriate base salary levels, annual cash bonuses, and equity awards for the named executive officers by providing industry competitive analyses and assessing the reasonableness of individual compensation elements and total direct compensation.

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:

Components of Compensation

Through fiscal year 2008, the components of compensation for the named executive officers included base salary, annual cash bonus, equity awards, and certain personal and welfare benefits. As described in more detail below, we have adopted a new executive officer incentive plan for fiscal year 2009.

The following diagram illustrates the total target direct compensation mix for the named executive officers (including Mr. Ballmer, who does not receive any stock-based compensation) for fiscal year 2008 by component (base salary, target annual cash bonus opportunity, and target equity awards).

Base Salary

The base salaries of the named executive officers are reviewed annually by the Compensation Committee to ensure they fairly and competitively compensate these executives for the jobs they perform. In evaluating adjustments to base salaries for fiscal year 2008, the Compensation Committee considered the factors described on page 15 above. In adjusting the base salaries of the named executive officers (other than Mr. Ballmer), the Compensation Committee also considered the recommendations of Mr. Ballmer. The Compensation Committee recommended the adjustment to Mr. Ballmer’s base salary to the independent members of the Board of Directors for their final review and approval.

Annual Cash Bonus

Annual cash bonuses are awarded to the named executive officers for success in achieving corporate and/or division or group business results measured against individual annual performance commitments and to deliver cash as part of each individual’s overall compensation package that is competitive in the marketplace.

In fiscal year 2008, the annual cash bonus opportunities for the named executive officers were based on a percentage of each individual’s base salary. In September 2007, the Compensation Committee approved increases to the target bonus opportunities for each named executive officer for fiscal year 2008 (from 60% to 100% of base salary or, for Mr. Liddell, from 60% to 75% of base salary). The maximum target bonus opportunity for each named executive officer was set at twice his target bonus opportunity. The Compensation Committee determined that these increases were necessary to maintain the total cash compensation of the named executive officers at levels that were appropriately competitive with our peer group companies in the context of the mix of total compensation provided to the named executive officers.

Each named executive officer established his performance commitments for fiscal year 2008 at the beginning of the fiscal year in consultation with Mr. Ballmer. These performance objectives varied for each named executive officer based on his individual responsibilities and the business function or division or group that he manages, and included one or more quantitative and qualitative financial or strategic measures, including:

Mr. Ballmer’s individual performance commitments, which included corporate financial and strategic objectives related to Microsoft’s operating plan for fiscal year 2008, as well as qualitative culture and leadership objectives, were established at the beginning of the fiscal year in consultation with the independent members of the Board of Directors and after review by the Compensation Committee. The performance commitments for our other named executive officers included:

After the end of fiscal year 2008, the Compensation Committee, in its discretion, approved the bonus amount for each named executive officer (other than Mr. Ballmer) based on recommendations presented to the Committee by Mr. Ballmer. Mr. Ballmer’s recommendations reflected his assessment of each executive’s actual performance as measured against his performance commitments for fiscal year 2008. In evaluating these recommendations and determining each named executive officer’s bonus amount, the Compensation Committee also considered the factors described on page 15.

In the case of Mr. Ballmer, the Compensation Committee recommended his bonus amount to the independent members of the Board of Directors. In making this recommendation, the Compensation Committee considered the

performance evaluation of Mr. Ballmer conducted by the Governance and Nominating Committee, as described on page 14. The independent members of the Board of Directors considered the Compensation Committee’s recommendation, as well as Mr. Ballmer’s performance evaluation, in determining the amount 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 2008 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:

Award Vesting Schedules

SPSAs are subject to a multi-year vesting schedule before receipt by the named executive officers. Prior to vesting, the named executive officers do not have the right to vote or receive dividends on stock underlying SPSAs. SPSAs are subject to forfeiture if a named executive officer’s employment terminates before the end of the performance period for any reason other than death, disability, or retirement. For the SPSAs granted in fiscal year 2008, 25% of the shares earned under the awards are to vest in August or September 2009, with 25% vesting on August 31 of each of the next three years.

Fiscal year 2008 Target Based SPSAs

At the beginning of fiscal year 2008, the named executive officers (other than Mr. Ballmer) were granted Target Based SPSAs with performance objectives tied to operational and financial measures selected from the following three categories:

The following table shows the weighting of the performance measures (by category) used to determine the number of shares of Microsoft common stock that each named executive officer was eligible to earn under his fiscal year 2008 Target Based SPSA award.

The specific performance measures applied to each named executive officer’s Target Based SPSA award varied according to his role and responsibilities and are described below. The Compensation Committee set the performance target levels for the performance measures underlying the Target Based SPSAs with the intention of either sustaining or improving performance as compared with Microsoft’s actual fiscal 2007 results. Overall, the Compensation Committee believed that the performance required to receive an award payout at the low end of the combined opportunity of all targets was attainable, the performance required to receive an award payout at the midrange of the combined opportunity was challenging but achievable and would exceed actual fiscal year 2007 results, and the performance required to receive an award payout at the top of the range of combined opportunity was very difficult to achieve.

Fiscal year 2008 Performance Pool SPSAs

For fiscal year 2008, the Compensation Committee approved an award pool equal to 0.1% of Microsoft’s fiscal year 2008 operating income for the Performance Pool SPSAs, and set a target and maximum potential share of the award pool for each named executive officer (other than Mr. Ballmer). Following the end of fiscal year 2008, the Compensation Committee considered Mr. Ballmer’s recommendation and, in its discretion, determined the amount of

the award for each named executive officer, subject to the individual’s applicable maximum portion of the award pool. The number of shares awarded under each named executive officer’s Performance Pool SPSA was determined by dividing (1) his allocated amount of the award pool by (2) the closing market price of shares of Microsoft common stock on August 29, 2008.

The Compensation Committee’s determinations of the named executive officers’ potential compensation from Target Based SPSAs and target and maximum Performance Pool SPSAs for fiscal year 2008 were based on Mr. Ballmer’s recommendations and its consideration of the factors described on page 14.

Fiscal year 2008 Equity Award Outcomes

In August and September 2008, the Compensation Committee determined the award payouts under the fiscal year 2008 Target Based SPSAs and approved the award payouts under the fiscal year 2008 Performance Pool SPSAs, resulting in the award of the following number of shares of Microsoft common stock to the named executive officers.

Target Based SPSAs

The most heavily-weighted performance measure, corporate operational performance, was weighted equally for each named executive officer’s Target Based SPSA award. As noted above, this measure contained two components: the amount of activity generated through Microsoft’s Web sites, and growth in sales of Client (Windows PC operating system) units and Office Suite units relative to growth in the personal computer market. The Compensation Committee determined that, for fiscal year 2008, corporate operational performance results exceeded the 150% maximum performance level.

With respect to the second most heavily-weighted performance measure, team financial performance, each named executive officer had different measures that were tied to his function, division, or group. These measures were based on net revenue and contribution margin, as defined on page 20.

The actual performance for each of these measures is set forth in the table below:

With respect to the final performance measure, team operational performance, Mr. Johnson’s performance measure was based on growth in MSN Portal page views. The Compensation Committee determined that, for fiscal year 2008, his team’s results exceeded the full target performance level but did not reach the maximum performance level (150% of target). Mr. Raikes’ team operational performance measure was based on growth in Windows Server license net deployments relative to server hardware unit shipments. The Compensation Committee determined that, for fiscal year 2008, his team’s results exceeded the maximum performance level. Mr. Liddell’s team operational performance measure was based on an average of the team operational performance for our other executive officers. The Compensation Committee determined that, for fiscal year 2008, these average results exceeded the full target performance level but did not reach the maximum performance level.

Performance Pool SPSAs

After taking into consideration Mr. Ballmer’s assessment of each named executive officer’s performance during fiscal year 2008, the factors described on page 15, and the amount of the Target Based SPSA award, the Compensation Committee, in its discretion, elected to set the actual number of shares of Microsoft common stock awarded under the Performance Pool SPSAs to each named executive officer at the levels shown in the table on page 21.

Mr. Liddell’s Performance Pool SPSA award in combination with his Target Based SPSA award resulted in an overall SPSA Award that was slightly above target. Mr. Ballmer’s recommendation with respect to the Performance Pool SPSA award for Mr. Liddell was based on several factors, including strong performance of our investment portfolio and effective expense planning and control, and effective management of acquisitions with 21 transactions completed, including our largest acquisition to date, aQuantive.

Mr. Johnson did not receive a Performance Pool SPSA award. Because he left Microsoft in early September 2008, the Compensation Committee determined not to grant him a Performance Pool SPSA award.

Mr. Raikes’ Performance Pool SPSA award in combination with his Target Based SPSA award resulted in an overall SPSA award that was above target. Mr. Ballmer’s recommendation with respect to the Performance Pool SPSA award for Mr. Raikes was based on several factors, including successful transition of a new Division President into Microsoft to manage the Business Division. Mr. Raikes vested in 25% of his Performance Pool SPSA award on August 31, 2008; the balance was forfeited following his retirement.

Mr. Turner’s Performance Pool SPSA award in combination with his Target Based SPSA award resulted in an overall SPSA award that was above target. Mr. Ballmer’s recommendation with respect to the Performance Pool SPSA award for Mr. Turner was based on several factors, including strong progress in productivity and business excellence goals relating to expense management and revenue per computer processing unit.

Fiscal year 2009 Executive Officer Incentive Plan

The Compensation Committee has approved a new Executive Officer Incentive Plan (“EOIP”) for our executive officers, which is effective for fiscal year 2009. The EOIP replaces the annual cash bonus opportunity and equity award plans that have been used in previous fiscal years. The Board of Directors believes the EOIP will be a more effective incentive program than the current annual cash bonus and equity award plans for our executive officers because it will:

Like the former equity award program, the EOIP will enable us to continue to deliver a significant portion of compensation to our named executive officers (excluding Mr. Ballmer) through stock, and, in doing so, we believe that (i) the retention of our executive officers will be enhanced by having a large percentage of total compensation derived from EOIP stock awards and by using a multi-year vesting schedule for awards that are earned, and (ii) the plan will better

align management’s interests with our shareholders’ long-term interests through a broad array of strategic business priorities that we believe will contribute to long-term shareholder value and award value that changes with share price.

The EOIP allows the Compensation Committee to establish award programs for specified performance periods. The amount payable to an EOIP participant is stated as a percentage of an incentive pool for a performance period. The maximum amount that may be paid under the EOIP to any participant for performance periods ending during a fiscal year is limited to $20,000,000.

For fiscal year 2009, the Compensation Committee has determined to grant awards to the executive officers as of July 1, 2009 from an incentive pool with maximum funding of 0.35% of Microsoft’s fiscal year 2009 corporate operating income. Each executive officer’s EOIP award will be limited to a fixed percentage of the pool. The Compensation Committee intends that each executive officer (other than Mr. Ballmer) will receive between zero and 150% of a target award specified by the Committee, subject to the availability of pool funding.

Mr. Ballmer’s participation in the fiscal year 2009 incentive pool will be limited to reflect our past practice of not awarding him equity compensation. Thus his maximum award will be the lesser of 200% of his fiscal year 2009 base salary or the maximum pool percentage assigned to him; his target award is 100% of his fiscal year 2009 base salary; and his award will be payable in cash following the end of fiscal year 2009. Following fiscal year 2009, Mr. Ballmer’s award will be recommended by the 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.

For executive officers other than Mr. Ballmer, following fiscal year 2009 the Compensation Committee will approve EOIP awards in its discretion based on (1) Mr. Ballmer’s recommendations, which will take into account individual performance against annual commitments and any other information Mr. Ballmer finds relevant, and (2) its assessment 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 stock 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.

Executive Benefits and Perquisites

Microsoft’s named executive officers are eligible for the same level and offering of benefits made available to other 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 maintains a non-qualified deferred compensation plan for 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 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.

Perquisites are provided to our named executive officers only in special situations. During fiscal year 2008, we did not provide any significant perquisites to our named executive officers.

Relocation Assistance

Messrs. Liddell and Turner received assistance with relocation expenses that we customarily offer officer hires, including travel, shipping household goods, and temporary housing. As part of the arrangements 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 on page 26.

Severance and Change in Control Arrangements

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

SPSAs granted on hire or as part of the annual performance review to employees more than one year before 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. All employees who retire from Microsoft in the United States who meet these retirement criteria (not just executive officers) are eligible for the continuation of vesting. Mr. Turner is entitled to vest in 160,000 shares of his 320,000 share on-hire stock award upon retirement at age 60 or older, and in the case 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 will vest immediately.

Tax/Accounting Treatment of Compensation

Under Section 162(m) of the Internal Revenue Code, we may not be able to deduct compensation in excess of $1 million paid in one year to certain named executive officers. Certain performance based compensation approved by shareholders is not subject to this deduction limit. Generally, in structuring compensation for the named executive officers, we consider whether a form of compensation will be deductible; however, other factors discussed above may be of greater importance than preserving deductibility for a particular form of compensation. Performance Pool SPSAs and Target Based SPSAs based on corporate and team operational measures 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 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

Accountability is a fundamental value of Microsoft. We have an executive compensation recovery policy that applies to our executive officers and principal accounting officer. Under this policy, we may recover incentive compensation that was paid based on achieving 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 compensation. Incentive compensation includes compensation related to annual bonuses and SPSAs.

Stock Ownership and Holding Requirements for Company Executives

The Compensation Committee adopted stock ownership and holding requirements that require each executive officer 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, and to align executive and shareholder interests. The requirements provide for stock ownership and holding as 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. Following the conclusion of each fiscal year, compliance with the requirements will be measured and executive officers will be notified about their ownership require-

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

At the conclusion of fiscal year 2008, all of our named executive officers complied with these ownership requirements.

SUMMARY COMPENSATION TABLE

The following table contains information about compensation received by the named executive officers for the fiscal years ended June 30, 2008 and June 30, 2007. None of the named executive officers received stock options during fiscal years 2008 and 2007.

ALL OTHER COMPENSATION

GRANTS OF PLAN-BASED AWARDS

FOR FISCAL YEAR ENDED

JUNE 30, 2008

The following table provides information on exercisable and unexercisable options and unvested stock awards held by the named executive officers on June 30, 2008.

OUTSTANDING EQUITY AWARDS

AT FISCAL YEAR END

JUNE 30, 2008

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, 2008 for each of the named executive officers.

OPTION EXERCISES AND STOCK VESTED

FOR FISCAL YEAR ENDED

JUNE 30, 2008