PARKING FACILITY AND DRIVING DIRECTIONS

September 30, 2010

Dear Shareholder:

You are cordially invited to attend the Annual Meeting of Shareholders of Microsoft Corporation, which will be held at Meydenbauer Center, 11100 NE 6th Street, Bellevue, Washington 98004, on November 16, 2010 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 Meydenbauer Center can be found on the inside front cover of this document. Parking will be validated only for 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 of Shareholders and Proxy Statement contain details of the business to be conducted at the Annual Meeting.

Whether or not you attend the Annual Meeting, it is important that your shares be represented and voted at the meeting. Therefore, I urge you to promptly vote and submit your proxy 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.

This year’s shareholder question and answer session will include both live questions and questions submitted in advance. You may submit a question in advance by email to ASM@microsoft.com, and we will respond to as many inquiries as time allows.

We will provide a live webcast of the Annual Meeting from the Microsoft Investor Relations Web site at www.microsoft.com/investor. A transcript along with video and audio of the entire Annual Meeting 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

To the Shareholders:

The Annual Meeting of the Shareholders of Microsoft Corporation will be held at Meydenbauer Center, 11100 NE 6th Street, Bellevue, Washington 98004, on November 16, 2010 at 8:00 a.m. for the following purposes:

Only shareholders of record at the close of business on September 3, 2010 are entitled to receive notice of, and to vote at, the Annual Meeting.

By order of the Board of Directors

Bradford L. Smith

Secretary

Redmond, Washington

September 30, 2010

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 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. If you wish to vote by mail, we have enclosed an addressed envelope for which no postage is required if mailed in the United 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 16, 2010. Our Proxy Statement and Annual Report to Shareholders are available at www.microsoft.com/investor.

Proxy Statement Table of Contents

MICROSOFT CORPORATION

ONE MICROSOFT WAY

REDMOND, WASHINGTON 98052

PROXY STATEMENT FOR ANNUAL MEETING OF SHAREHOLDERS

TO BE HELD NOVEMBER 16, 2010

This Proxy Statement was first mailed to shareholders on or about October 1, 2010. 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 16, 2010 at 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 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 3, 2010 will be entitled to vote at the meeting on the basis of one vote for each share held. On September 3, 2010, there were 8,602,554,500 shares of common stock outstanding, held of record by 138,193 shareholders.

PROPOSAL 1:

ELECTION OF DIRECTORS AND MANAGEMENT INFORMATION

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 of Microsoft Corporation (“Bylaws”). The accompanying proxy will be voted in favor of the nominees named below to serve as directors unless the shareholder indicates to the contrary on the proxy. All 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 our Board.

MAJORITY VOTE STANDARD FOR DIRECTOR ELECTIONS

Our Bylaws require that in an uncontested election each director will be elected by a 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. We will not treat as cast any share (a) whose ballot is marked as withheld, (b) that is otherwise present at the meeting but for which there is an abstention, or (c) to which a shareholder gives no authority or direction. In a contested election, the directors will be elected by a plurality of the votes cast, meaning the directors receiving the largest number of “for” votes will be 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 that 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 our Board about filling the office.

The Board of Directors will act on the Governance and Nominating Committee’s recommendation and within 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 www.microsoft.com/investor/ corporategovernance.

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

NOMINEES

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 our 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. During fiscal year 2010 the Committee retained the firm of Spencer Stuart to help identify director prospects, perform candidate outreach, and provide other related services. The Governance and Nominating Committee works with our 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, our 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. Our 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 nominated for election at the 2010 Annual Meeting.

The Governance and Nominating Committee assesses the effectiveness of its efforts to maintain an effective and diverse Board of Directors in the course of its regular responsibilities, which include annually (a) reporting to our Board on the performance and effectiveness of our Board, (b) presenting to our Board individuals recommended for election to the Board at the annual shareholders meeting, and (c) obtaining or performing an assessment of the Committee’s own performance.

The Governance and Nominating Committee will consider shareholder recommendations for candidates for the Board of Directors, 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 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.

DIRECTOR INDEPENDENCE

Our Corporate Governance Guidelines provide that a substantial majority of our directors will be independent. 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 www.microsoft.com/investor/independenceguidelines. The guidelines either meet or exceed the independence requirements of the NASDAQ Stock Market (“NASDAQ”) on which the Company’s shares are traded. The guidelines identify categories of relationships 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 of Directors must affirmatively determine 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 our Board with relevant facts and circumstances of any relationship bearing on the independence of a director or nominee that is 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 Messrs. Gilmartin, Hastings, Marquardt, and Noski,

Ms. Dublon, and Drs. Panke and Klawe meet the standards of independence under our Corporate Governance Guidelines, director independence guidelines, and applicable NASDAQ listing standards, including that each member is free of any relationship that would interfere with his or her individual exercise of independent judgment. In making this determination, our 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 September 2010. Highlights of Microsoft’s corporate governance framework include:

Board Independence

Chief Executive Officer, Chairman, and Lead Independent Director

Board Committees

Shareholder Authority

Compensation

Stock Ownership

Hedging Policy

Director Orientation and Continuing Education

Political Contributions

Risk Oversight

MICROSOFT CORPORATE GOVERNANCE WEBSITE

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

We will provide any of the foregoing information without charge upon written request to MSC 123/9999, Corporate Secretary, 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 governance 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 our 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. Our Board annually conducts a self-evaluation to assess its adherence 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.

MEETINGS AND MEETING ATTENDANCE

Our Board of Directors holds regularly scheduled quarterly meetings. Typically, committee meetings occur the day before the Board meeting. During 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 our 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 seven times during fiscal year 2010.

All incumbent directors attended 75% or more of the aggregate of all Board of Directors 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. Six directors attended the 2009 Annual Meeting.

CHIEF EXECUTIVE OFFICER, CHAIRMAN, AND LEAD INDEPENDENT DIRECTOR

Since 2000, the roles of chairman and chief executive officer have been held separately. Mr. Gates serves as Chairman and Mr. Ballmer serves as Chief Executive Officer. The Board of Directors does not have a policy as to whether the chairman should be an independent director, an affiliated director, or a member of management. When the chairman is an affiliated director or a member of Company management, or when the independent directors determine that it is in the best interests of the Company, the independent directors will annually appoint from among themselves a Lead Independent Director. Mr. Gilmartin has served as Lead Independent Director since 2004. The Lead Independent Director coordinates the activities of the independent directors, coordinates with the Chief Executive Officer and corporate secretary to set the agenda for Board meetings, chairs executive sessions of the independent directors, and performs the other duties either specified in the Corporate Governance Guidelines or assigned from time to time by the Board. Our Board believes its current leadership structure is appropriate because it effectively allocates authority, responsibility, and oversight between management and the independent members of our Board. It does this by giving primary responsibility for the operational leadership and strategic direction of the Company to our chief executive officer, while enabling the Lead Independent Director to facilitate our Board’s independent oversight of management, promote communication between management and our Board, and support our Board’s consideration of key governance matters. The Board believes that its programs for overseeing risk, as described under Risk Oversight on page 10, would be effective under a variety of leadership frameworks and therefore do not materially affect its choice of structure. See Shareholder Communication with Directors on page 16 for information about how to communicate with the Lead Independent Director.

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 2010 meeting information for each of the Board committees. Committee memberships changed during the fiscal year. Dr. James I. Cash, Jr. retired from the Board as of the Company’s Annual Meeting on November 19, 2009. Following the election of directors at the Company’s Annual Meeting on November 19, 2009, Mr. Marquardt was appointed to the Governance and Nominating Committee, Dr. Klawe was appointed to the Antitrust Compliance Committee, and Dr. Panke was appointed to the Audit Committee and was appointed Chair of the Antitrust Compliance Committee. In May 2010, Mr. Noski stepped down from the Finance 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 our Board of Directors in its oversight of the quality and integrity of our accounting, auditing, and reporting practices. The 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 Committee relies on the expertise and knowledge of management, the internal 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 Committee member has sufficient knowledge in financial and auditing matters to serve on the Committee. In addition, the Board has determined that Ms. Dublon, Mr. Noski, and Dr. Panke are “audit committee financial experts” as defined by SEC rules.

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

The Compensation Committee periodically reviews the compensation paid to non-employee directors, and makes recommendations to our Board of Directors for any adjustments. The Committee may delegate to the senior human resources officer the authority to make equity compensation grants to employees who are not executive officers.

Our senior vice president, human resources and corporate vice president of compensation, benefits and HR operations support the Compensation Committee in its work. The Committee has retained Semler Brossy Consulting Group, LLC to advise the Committee on marketplace trends in executive compensation, management proposals for compensation programs, and executive officer compensation decisions. Semler Brossy also evaluates compensation for the next levels of senior management and equity compensation programs generally. It also has consulted with the Committee about its recommendations to the Board of Directors on director compensation. Semler Brossy assisted with the assessment of the risk arising from our compensation programs and policies described on page 24, which included a review of both executive officer and non-executive officer compensation programs. Semler Brossy’s fiscal year 2010 fees for all work outside providing advice or recommendations on the amount or form of executive or director compensation did not exceed $120,000. Semler Brossy is directly accountable to the Committee. To maintain the independence of the firm’s advice, Semler Brossy does not provide any services for Microsoft other than those described above. The Committee has adopted Compensation Consultant Independence Standards, which can be viewed at www.microsoft.com/investor/compensationconsultant. This policy requires that the Committee annually assess the independence of its compensation consultant. A consultant satisfying the following requirements will be considered independent. The consultant (including each individual employee of the consultant providing services):

In performing the annual assessment of the consultant’s independence, 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 Semler Brossy has been independent during its service for the Committee.

The Compensation Committee Charter describes the specific responsibilities and functions of the Compensation Committee. See the Compensation Discussion and Analysis beginning on page 19 for more information about the Committee’s work.

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

The Committee annually 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 Committee.

Finance Committee.    The Finance Committee is responsible for consulting with management and making recommendations to the Board of Directors about the financial affairs of the Company including areas of financial exposure and risk management. The principal topics the Finance Committee addresses include:

From time to time, the Board of Directors may delegate to the Finance Committee decisions with respect to specific transactions. 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 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 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. 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 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 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 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 Committee provides guidance to the compliance officer and to management and reports regularly to the Board of Directors.

DIRECTOR COMPENSATION

During fiscal year 2010, Mr. Ballmer received no compensation for serving as a director, except that he, like all directors, is eligible to be reimbursed for reasonable expenses incurred in attending Board and committee meetings. The directors, other than Mr. Ballmer, were entitled to receive the following compensation for serving on our Board of Directors and committees of our Board:

The annual Board retainer is paid quarterly in arrears. Quarterly 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 last day of the service period.

Under our Deferred Compensation Plan for Non-Employee Directors, 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. Amounts deferred by non-employee directors are maintained in bookkeeping accounts that are deemed invested in Microsoft common stock, and dividends paid on the deferred equity are deemed to be invested in our common stock. Accounts in the Plan are distributed in shares of Microsoft common stock, with payments either in installments beginning on separation from Board service or in a lump sum amount paid no later than the fifth anniversary after separation from Board service.

To align the interests of our directors and shareholders, our Board of Directors believes that directors should have a significant financial stake in Microsoft. Under the 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 becomes a Board member. Stock deferred under the Deferred Compensation Plan for Non-Employee Directors counts toward the minimum ownership requirement.

Mr. Ballmer, an employee director, is excluded from the following table because we fully describe his compensation in the Summary Compensation Table on page 32 and under Components of Compensation and Fiscal Year 2010 Awards on pages 27 and 28.

As of June 30, 2010, the non-employee directors had the following aggregate deferred director stock awards outstanding. Stock awards outstanding comprise (a) deferred stock awards, (b) cash compensation deferred into shares of common stock, and (c) dividend equivalents on deferred stock, which are paid in shares of our common stock.

Outstanding stock options held by Messrs. Gilmartin and Marquardt as of June 30, 2010 are described in the footnotes to the table regarding beneficial ownership on page 17.

In addition, to assist directors in developing an in-depth understanding of our businesses, products, and services, and to facilitate the efficient operation of the Board of Directors through the use of computing devices that feature Microsoft software, if requested, directors are provided a personal computer, printer, and associated peripherals for their use while they serve on our 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 up to $10,000 per director.

SHAREHOLDER COMMUNICATION WITH DIRECTORS

Shareholders may contact an individual director, the Lead Independent Director, our Board of Directors 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. Management 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 general information about Microsoft.

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 is 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 3, 2010, information about the beneficial ownership of our common stock by all directors, our chief executive officer, our current and former chief financial officer, and the three other highest paid executive officers for fiscal year 2010 (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 3, 2010 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

This Compensation Discussion and Analysis provides information about the fiscal year 2010 compensation program for our fiscal year 2010 named executive officers, who are:

Executive Summary

Fiscal Year 2010 Corporate Performance

Fiscal year 2010 was a year of many accomplishments as well as important challenges. We reported record revenue and earnings per share, driven by new product launches and sales momentum across all our businesses. We maintained a disciplined approach to controlling costs. We also sharpened our focus on smart investments in technology innovation, with an eye on ongoing changes in the marketplace and the need to bring forward-looking, high-quality products to market in the months and years ahead.

Our revenue reached a record $62.5 billion, an increase of 7% over 2009. Operating income grew 18% to $24.1 billion. Diluted earnings per share increased 30% to $2.10 and we returned almost $16 billion to shareholders through stock buybacks and dividends. In addition, operating income grew more quickly than overall revenue during each quarter of fiscal year 2010, demonstrating our ability to maintain a tight focus on controlling expenses.

Fiscal year 2010 was also one of the strongest years in our history for the range and quality of the product advances that we delivered. Windows 7 sold over 150 million copies during the year, making it the fastest-selling operating system in history. Late in the year, we released Office 2010 with Office Web Apps. Even before its official launch, Office 2010 had been downloaded by more than 9 million beta customers. In our Server & Tools Business, we had product advances in Windows Server, SQL Server and Visual Studio. In our Online Services Division, we delivered innovative advances in Bing throughout the year. Bing gained over four points of share during the year and feedback from customers and industry analysts has been positive. Along with these product releases, in fiscal year 2010 we laid the groundwork for several products that will continue to deliver innovation over the next year, including Kinect for Xbox 360, Windows Phone 7, and Internet Explorer 9.

Governance and Say-on-Pay

In September 2009, our Board of Directors strengthened its commitment to strong corporate governance by adopting a Say-on-Pay policy that enables our shareholders to provide direct feedback to us on our executive compensation policies and practices. Shareholders have the opportunity to cast a non-binding, advisory vote every three years on the compensation programs for our executive officers. The first vote took place at our November 2009 annual shareholders’ meeting where nearly 99% of the votes cast supported our executive compensation practices.

The decision to adopt a triennial vote grew out of an open and constructive dialogue with our shareholders. Our Board of Directors determined that a three-year cycle was appropriate for Say-on-Pay votes at Microsoft after receiving input from several of our largest institutional shareholders, governance advocates, and other companies. With the enactment of a mandatory advisory vote on executive compensation as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act, we expect to ask our shareholders to approve the frequency for our Say-on-Pay votes at our 2011 annual meeting of shareholders.

Incentive Compensation Program

In fiscal year 2010, we continued to provide incentive compensation to our executive officers under our Executive Officer Incentive Plan (“Incentive Plan”). 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 not derived from 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 26 and 27. The table below sets forth the Incentive Plan award for each named executive officer’s performance in fiscal year 2010. As in previous years, Mr. Ballmer’s incentive compensation for fiscal year 2010 was limited to a cash payment of up to 200% of his fiscal year 2010 base salary, consistent with his request that we not award him equity compensation. The fiscal year 2010 Incentive Plan awards for other executive officers were payable:

Total Direct Compensation Awarded Named Executive Officers for Fiscal Year 2010

The following table is intended to provide insight into the compensation that our named executive officers were awarded for their performance in fiscal year 2010. The table sets forth the base salaries and the cash and stock-based incentive compensation they were awarded for fiscal years 2008—2010, providing simple year-over-year comparisons. Except for Mr. Klein, who received a base salary increase for his promotion to chief financial officer in November 2009, we did not increase the base salaries of our executive officers in fiscal year 2010. The slight increase in base salary shown for fiscal year 2010 reflects a full year of pay at the fiscal year 2009 rate, whereas the fiscal year 2009 increase was effective on September 1, 2008 and, therefore, applied for only 10 months.

This table is intended to supplement, not replace, the Summary Compensation Table on page 32, which presents the fiscal year 2010 compensation of our named executive officers in the format required by SEC rules. Because the Summary Compensation Table shows the value of stock-based compensation at target for fiscal year 2010, not the value of the stock-based compensation actually awarded for fiscal year 2010 performance, we believe this alternative table should help investors understand our fiscal year 2010 compensation actions.

More information about our fiscal year 2010 Incentive Plan awards can be found beginning on page 27.

Contents of Compensation Discussion and Analysis

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

Section 2   explains how we make decisions about the design and operation of our compensation program for our 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 2010 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 design the compensation program for our executive officers to attract, motivate, and retain the key executives who drive our success and industry leadership. We achieve these objectives through a compensation package that:

Section 2. Decision Making

Compensation Program Actions and Governance

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

The following table depicts the roles of management, the Compensation Committee, and our Board of Directors in recommending or approving actions relating to the compensation of our executive officers.

Compensation 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 relative to technology and broad industry peers (described in detail below). If the review shows our executive compensation is not competitive, we recommend changes to the Compensation Committee. We may also recommend changes to the executive compensation program based on changes in our strategic goals or the business environment in which we operate.

The Compensation Committee periodically reviews the overall goals of our executive compensation program and the elements of the program, including the mix of cash and stock-based compensation 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 Committee may make modifications or revisions to existing compensation plans and adopt new plans. In reviewing our executive compensation program, the Committee retains and is advised by an independent compensation consultant, as described on page 13.

Peer Groups

To assist the Compensation Committee in assessing the competitive position of our executive compensation program and making decisions about individual compensation elements, we conduct and provide the Committee with the results of our review of third-party surveys and publicly available executive compensation data for two specific groups of peer companies.

Technology peer group.    These are information technology companies that focus on producing software or hardware or providing online services, employ work forces with skill sets and professional backgrounds similar to those of our work force, have a significant global presence, and are generally comparable in terms of annual revenue and market capitalization.

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 sector.

The following table identifies the companies in these two peer groups when we conducted our fiscal year 2010 compensation analysis planning in spring 2009.

Positioning of Pay

The Compensation Committee determines target total direct compensation (base salary and target Incentive Plan awards) for our executive officers (other than Mr. Ballmer) after considering a variety of third-party surveys that pro-

vide information on compensation for similar positions, publicly available peer group information and internal comparisons of the executive officer’s total compensation to the total compensation of our other executive officers. We do not apply a formula that ties our target compensation levels to specific market percentiles. Excluding Mr. Ballmer, the target compensation levels for the named executive officers generally 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. A significant portion of the named executive officers’ total compensation (other than Mr. Ballmer’s) is delivered through stock awards under the Incentive Plan with a multi-year vesting schedule to align the interests of our named executive officers to the long-term interests of Microsoft and our shareholders and to encourage the named executive officers to act as owners.

The following chart provides information about the fiscal year 2010 target mix of pay for our named executive officers (excluding Mr. Ballmer) compared to the named executive officers of our peer group companies.

Assessment of Risk

In fiscal year 2010, we performed a comprehensive assessment for the Compensation and Audit Committees of our Board of Directors to determine whether the risks arising from any of our compensation policies or practices are reasonably likely to have a material adverse effect on the Company. Our assessment covered each material element of executive and non-executive employee compensation. We concluded that these policies and practices do not create risk that is reasonably likely to have a material adverse effect on the Company.

In addition, the structure of our compensation program for executive officers does not incentivize unnecessary or excessive risk taking. The 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, whether their base salaries should be increased, and whether they should be promoted.

Chief Executive Officer

Following the end of each fiscal year, the independent members of our Board of Directors, led by the Chair of the Governance and Nominating Committee, evaluate Mr. Ballmer’s performance using a multi-year view of quantitative and qualitative factors to consider his success in achieving his performance commitments, which typically include financial, operational, strategic, and Company culture/leadership objectives. To aid in this review, the independent members of our Board are provided the following information:

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

Other Named Executive Officers

The Compensation Committee discusses executive officer performance several times during the fiscal year. 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 establishes the amount of each executive officer’s Incentive Plan award for the fiscal year 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:

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. For our peer group companies with continuing chief executive officers, excluding those with founder chief executive officers, the average annual base salary for their chief executive officers was $1.4 million, average cash bonus compensation was $4.1 million, and average total compensation was $14.4 million (based on public compensation information available through August 21, 2010). For fiscal year 2010, Mr. Ballmer’s maximum compensation opportunity was $2,010,000, consisting of base salary and a potential Incentive Plan award of up to 200% of his base salary for the fiscal year.

Section 3. Components of Compensation and Fiscal Year 2010 Awards

For fiscal year 2010, 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. During fiscal year 2010, no executive officer received any base salary increase in connection with our annual review process.

Incentive Plan

We use our Incentive Plan to provide both cash and equity incentive compensation for our executive officers. Awards under our 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 flexible framework for determining awards that:

The Incentive Plan is designed to deliver a significant portion of total direct compensation to our named executive officers (other than 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’ interests with the long-term interests of Microsoft and our shareholders.

For fiscal year 2010, the Incentive Plan awards for our named executive officers (other than 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 members (or, for Mr. Ballmer, the independent members of our Board) use their business judgment to determine an appropriate award after considering the information discussed on pages 25 and 26, which includes the executive officer’s performance across a wide range of quantitative and qualitative financial, operational, and strategic measures. These measures vary based on individual responsibilities and the business function, division, or group that an executive officer manages. Among the most important factors that were used in fiscal year 2010 and prior years to evaluate performance were:

Mr. Ballmer’s Incentive Plan Award

Mr. Ballmer’s potential award under the Incentive Plan for fiscal year 2010 was limited to an amount from 0% to 200% of his fiscal year 2010 base salary, payable in cash, consistent with our past practice and his request that we not award him equity compensation. His maximum award was the lesser of 200% of his fiscal year 2010 base salary or the maximum pool percentage assigned to him; his target award was 100% of his base salary; and the award was payable following the end of the fiscal year.

For fiscal year 2010, Mr. Ballmer’s Incentive Plan award was $670,000, which was 100% of his target award. The incentive plan award was recommended by the Compensation Committee and approved by the independent members of our Board of Directors based on his performance appraisal by the independent members of our Board and other information deemed relevant, including: Mr. Ballmer’s performance against his individual commitments; the strong financial year in which Microsoft reported a record $62.5 billion in revenue and $24.1 billion in operating income; the operating income performance of the Company relative to 25 large technology companies; his leadership in continuing the prior year’s disciplined expense management; a series of successful product launches including Windows 7, Office 2010, Bing, Windows Server, and SQL Server; progress pursing new innovations that will position the Company to lead the transformation to the cloud (Azure and Office Web Apps) in active gaming (Kinect), and in other product areas in which work is well underway; the unsuccessful launch of the Kin phone; loss of market share in the company’s mobile phone business; and the need for the Company to pursue innovations to take advantage of new form factors.

Other Named Executive Officer Incentive Plan Awards

After considering Mr. Ballmer’s performance assessment of each of the other named executive officers for fiscal year 2010 and factors including those listed on page 27, the Compensation Committee approved the fiscal year 2010 Incentive Plan awards set forth below. Our named executive officers were each reviewed on their performance on a wide range of measures, which included for the business division leaders the financial performance of the business or organization they led. While the performance results described below were relatively more important than other factors that were considered in determining the fiscal year 2010 Incentive Plan Awards for the other named executive officers, no specific weight was assigned to any single measure of performance.

Mr. Bach.    During fiscal year 2010, Mr. Bach was President of the Entertainment and Devices (“EDD”) Division, the division 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, EDD revenue was $8.1 billion and operating income was a record $679 million, substantially exceeding the fiscal year 2010 financial goals for EDD. Non-gaming revenue also increased during fiscal year 2010 and EDD experienced strong performance in the Xbox platform year-over-year from the fourth quarter of 2009, with console sales up 26% and Xbox Live subscribers increasing more than 20% to over 25 million. The Xbox team continued to deliver innovation through the development of Kinect for Xbox 360. The strong financial performance was offset by disappointing performance in the Windows Mobile portion of the business, where the Company lost share and continued to have operating losses yet made strategic progress toward the fall 2010 launch of the Windows Phone 7. Based on his fiscal year 2010 performance, Mr. Bach received an Incentive Plan award of $7,000,000, which was 100% of his target award. Mr. Bach’s aggregate base salary and Incentive Plan award increased 22% from fiscal year 2009, driven by the fact that his 2009 Incentive Plan award was 80% of his target award. Due to Mr. Bach’s resignation effective December 31, 2010, he will only receive 25% of the fiscal year 2010 Incentive Plan award payable in stock.

Mr. Elop.    Mr. Elop was President of the Microsoft Business Division (“MBD”) during fiscal year 2010. This division is responsible for the Microsoft Office system of programs, servers and software-based services, Microsoft Dynamics business applications for small and midsize businesses, large organizations and divisions of global enterprises, and Microsoft’s Unified Communications products which provide software-based communications tools to business.

For fiscal year 2010, MBD had revenue of $18.6 billion and operating income of $11.8 billion, which exceeded fiscal year 2010 goals for MBD. Under Mr. Elop’s direction, the division launched a new suite of Office products with strong customer satisfaction results. MBD also made progress in developing cloud services launching Office Web Apps and exceeding goals for licensed seats in Business Productivity Online Suite (“BPOS”). Based on his fiscal year 2010 performance, Mr. Elop received an Incentive Plan award of $6,720,000 which was 96% of his target award. Due to his resignation, he was not eligible to receive the 80% portion of this award payable in stock, and the remaining $1,344,000 of his award payable in cash was reduced by $667,000 due to the repayment of a portion of his July 2008 signing bonus.

Mr. Klein.    Mr. Klein became Chief Financial Officer effective November 24, 2009. Mr. Klein is responsible for leading Microsoft’s worldwide finance organization. He successfully transitioned into the chief financial officer role, was instrumental in maintaining focus on operating expenses, and provided strong balance sheet management which resulted in returning $16 billion to investors through dividends and share buy-backs. Prior to his appointment as chief financial officer, he oversaw successful initiatives as chief financial officer of MBD that will contribute to MBD’s future success, including driving the strategic planning process that resulted in a new long range plan and developing new reporting and financial models for cloud services economics. Based on his fiscal year 2010 performance, Mr. Klein received an Incentive Plan award of $2,775,000, which was 111% of his target award.

Mr. Turner.    As Chief Operating Officer, Mr. Turner is responsible for the strategic and operational leadership of Microsoft’s worldwide sales, marketing, and services organization. In addition, Mr. Turner manages the online advertising sales organization and corporate support organizations, including product and customer support services, branding, advertising, public relations, marketing research, relationship marketing, corporate operations, and internal information technology.

Mr. Turner led his organization to superb sales results while achieving effective cost management, contributing to the Company’s substantial 18% increase in operating income. Mr. Turner also led his team to achieving record levels of customer and partner satisfaction, where 15 of 17 audiences tracked were at all-time highs. The sales organization achieved market share gains in HyperV-Server, Windows Server, and revenue growth in SQL Server that outpaced competitors. Under Mr. Turner’s leadership the sales organization made strong progress in the sale of cloud based services. Based on his fiscal year 2010 performance, Mr. Turner received an Incentive Plan award of $9,800,000, which was 140% of his target award. Mr. Turner’s aggregate base salary and Incentive Plan award increased 93% from fiscal year 2009, which is driven by the fact that his 2009 Incentive Plan award was 68% of his target award.

Mr. Liddell.    Until November 24, 2009, Mr. Liddell served as our Chief Financial Officer, and he continued as a Microsoft employee through December 31, 2009. He received a cash payment of $1,900,000 as compensation for his substantial services during the first half of the fiscal year and in consideration for entering into a resignation agreement with the Company. He did not receive an Incentive Plan award for his services in fiscal year 2010.

Fiscal Year 2011 Incentive Plan

For fiscal year 2011, the Compensation Committee determined it would make awards to our executive officers as of July 1, 2011 from an incentive pool with maximum funding of 0.25% of Microsoft’s fiscal year 2011 corporate operating income. As with the fiscal year 2010 Incentive Plan awards, each executive officer’s Incentive Plan award from this pool will be limited to a fixed percentage of the pool. The Committee intends that each executive officer (other than Mr. Ballmer) will receive between 0% and 150% of his or her established target award, subject to the availability of pool funding.

Section 4. Other Compensation Topics