Admission requirements

See Part 6 – “Information about the meeting” for details on admission requirements to attend the Annual Shareholders Meeting.

Proxy voting options

Your vote is important!

Whether or not you expect to attend in person, we urge you to vote your shares by phone, via the Internet, or by signing, dating, and returning the enclosed proxy card or voting instruction form at your earliest convenience. This will ensure the presence of a quorum at the meeting. Promptly voting your shares will save us the expense and extra work of additional solicitation. Submitting your proxy now will not prevent you from voting your stock at the meeting if you desire to do so, as your vote by proxy is revocable at your option.

Voting by the Internet or telephone is fast and convenient, your vote is immediately confirmed and tabulated, and helps Microsoft reduce postage and proxy tabulation costs.

If you prefer, you can vote by mail by returning the enclosed proxy card or voting instruction form in the addressed, prepaid envelope provided.

Please do not return the enclosed paper ballot if you are voting via the Internet or by telephone.

Vote by Internet

www.proxyvote.com

24 hours a day / 7 days a week

Instructions:

 

1.

Read the accompanying Proxy Statement.

 

2.

Go to the following website: www.proxyvote.com

 

3.

Have your proxy card or voting instruction form in hand and follow the instructions. You can also register to receive all future shareholder communications electronically, instead of in print. This means that the annual report, Proxy Statement, and other correspondence will be delivered to you via e-mail.

Vote by telephone

1.800.690.6903 via touch tone phone

toll-free 24 hours a day / 7 days a week

Instructions:

 

1.

Read the accompanying Proxy Statement.

 

2.

Call toll-free 1.800.690.6903.

 

3.

Have your proxy card or voting instruction form in hand and follow the instructions.

 

Proxy Summary			3
Part 1. Corporate governance at Microsoft
Corporate governance principles and practices			7
Investor outreach and our corporate governance cycle			7
Corporate governance framework			7
Independent Chairman of the Board			8
Board independence			8
Board committee independence and expertise			8
Shareholder authority			8
Risk oversight			8
Compensation			9
Director orientation and continuing education			9
Director self-evaluation			9
Citizenship			9
Political contributions			9
Shareholder communication with directors			10
Part 2. Board of Directors
Director nominations and qualifications			11
Our director nominees			14
Director independence			24
Meetings and meeting attendance			24
Board committees			25
Audit Committee			25
Compensation Committee			26
Governance and Nominating Committee			26
Regulatory and Public Policy Committee			27
Director compensation			27
Certain relationships and related transactions			29
Part 3. Named Executive Officer compensation
Compensation discussion and analysis			30
Section 1 – Chief executive officer transition			30
Section 2 – Fiscal year 2014 company overview			32
Section 3 – Fiscal year 2014 compensation decisions			34

Section 4 – Executive compensation overview			37
Section 5 – Compensation design process for fiscal year 2014			38
Section 6 – Other compensation policies and information			40
Compensation Committee report			43
Fiscal year 2014 compensation tables			43
Compensation Committee interlocks and insider participation			49
Stock Ownership Information			50
Principal Shareholders			51
Section 16(a) – Beneficial ownership reporting compliance			51
Part 4. Audit Committee matters
Audit Committee report			52
Fees billed by Deloitte & Touche			54
Audit fees			54
Audit-related fees			54
Tax fees			54
All other fees			54
Policy on Audit Committee pre-approval of audit and permissible non-audit services of independent auditor			55
Part 5. Proposals to be voted on at the meeting
Election of directors			56
Advisory vote on Named Executive Officer compensation			57
Statement in support			57
Ratification of independent auditor			58
Shareholder proposal			58
Proposals of shareholders for 2015 Annual Shareholders Meeting			60
Part 6. Information about the meeting
Internet availability of proxy materials			62
Proof of ownership required for attending meeting in person			62
Participation in electronic meeting			62

 

Solicitation of proxies			63
Householding			63
Election of directors			63
Voting procedures			63
Tabulation of votes			63
Majority vote standard for election of directors			63
Vote required; effect of abstentions and broker non-votes			64

Vote confidentiality			64
Where to find more proxy voting information			64
Where to find our corporate governance documents			65
Other business			65

Driving directions and parking
Downtown Bellevue			Back Cover

 

Annual Shareholders Meeting

 

Date		December 3, 2014
Time		8:00 a.m. Pacific Time
Place		Meydenbauer Center 11100 NE 6th Street Bellevue, Washington 98004
Record date		September 30, 2014
Voting		Shareholders as of the record date are entitled to vote. Each share of common stock is entitled to one vote for each director nominee and one vote for each of the proposals to be voted on.
Admission to meeting		Proof of share ownership will be required to enter the Microsoft Annual Meeting. See Part 6 – “Information about the meeting” for details. Please follow the directions to Meydenbauer Center on the last page of this Proxy Statement.

Meeting agenda

 

•

Election of 10 directors

 

•

Advisory vote on executive compensation

 

•

Ratification of Deloitte & Touche LLP (“Deloitte & Touche”) as our independent auditor for fiscal year 2015

 

•

Vote on one shareholder proposal

 

•

Transact other business that may properly come before the meeting

 

Business highlights

Fiscal year performance results included:

 

•

$86.8 billion in revenue, an increase of 12%

 

•

$27.8 billion in operating income, an increase of 4%

 

•

$2.63 diluted earnings per share, an increase of 2%

 

•

$25.2 billion in unearned revenue as of fiscal year-end, a record amount

 

•

116% growth in Commercial Cloud revenue

 

•

$15.7 billion returned to shareholders through dividends and stock buybacks, an increase of 27%

 

•

Total shareholder return of 24%

In addition to appointing a new chief executive officer (“CEO”), we made several significant strategic and Board leadership changes during fiscal year 2014, including:

 

•

In September 2013, we announced new reporting segments that resulted from a corporate restructuring we implemented for our 2014 fiscal year. The new segments provide investors with additional transparency through disclosing results by business model and customer segment rather than by product. We also began disclosing new key performance indicators to provide more insight for our shareholders into significant drivers of our business, including Commercial Cloud revenue, several views of Windows and Office 365 revenue growth, and Surface revenue.

 

•

In February 2014, John Thompson, previously our lead independent director, became independent Chairman of our Board. Mr. Thompson led the search process that resulted in Mr. Nadella’s appointment as our CEO.

 

•

In April 2014, we completed the acquisition of the Nokia Devices and Services business to both accelerate our phone market share and grow the opportunity for our entire set of offerings for the mobile-first and cloud-first world.

 

•

In July 2014, we announced a major restructuring plan to streamline and simplify our organization, eliminate duplicative efforts, and align our engineering and product teams for our overall long-term strategy.

Executive compensation advisory vote

Our Board of Directors recommends that shareholders vote to approve, on an advisory basis, the compensation paid to the Company’s named executive officers, as described in this Proxy Statement, for the following reasons.

Pay for performance

Over 70% of annual target compensation for our named executive officers is paid through equity, providing direct alignment with returns to shareholders and incentives to drive long-term business success. The compensation package for our CEO is designed to motivate him to successfully implement our business transformation and create sustainable long-term value for shareholders by providing the opportunity to build significant ownership and share in these gains if we perform well relative to the S&P 500 companies on total shareholder returns over performance periods spanning seven years. In addition, the Compensation Committee and management intend to develop and adopt performance metrics for executive officer incentive pay that align to the evolution of the Company’s business models and long-term goals to be implemented for the fiscal year 2016 senior executive compensation program.

Sound program design

We designed our executive officer compensation programs to attract, motivate, and retain the key executives who drive our success and industry leadership while considering individual and Company performance and alignment with the interests of long-term shareholders. We achieve our objectives through compensation that:

 

ü

provides a competitive total pay opportunity,

 

ü

consists primarily of stock-based compensation,

 

ü

enhances retention through multi-year vesting of stock awards, and

 

ü

does not encourage unnecessary and excessive risk taking.

Best practices in executive compensation

Some of our leading practices include:

 

ü

an executive compensation recovery policy,

 

ü

an executive stock ownership policy,

 

ü

a policy prohibiting pledging and hedging ownership of Microsoft stock,

 

×

no executive-only perquisites or benefits,

 

×

no employment contracts or change in control protections, and

 

×

no supplemental executive or similar retirement programs.

 

Shareholder proposals submitted for inclusion in our 2015 proxy statement pursuant to Securities and Exchange Commission (“SEC”) Rule 14a-8 must be received by us no later than June 18, 2015.

Notice of shareholder proposals to be raised from the floor of the 2015 Annual Shareholders Meeting outside of SEC Rule 14a-8 must be delivered to us no earlier than August 5, 2015 and no later than September 4, 2015.

 

This Proxy Statement includes estimates, projections and statements relating to our business plans, objectives and expected operating results that are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements may appear throughout this report, including this Proxy Summary and Part 3 – “Named Executive Officer compensation.” These forward-looking statements generally are identified by the words “believe,” “project,” “expect,” “anticipate,” “estimate,” “intend,” “strategy,”

“future,” “opportunity,” “plan,” “may,” “should,” “will,” “would,” “will be,” “will continue,” “will likely result,” and similar expressions. Forward-looking statements are based on current expectations and assumptions that are subject to risks and uncertainties that may cause actual results to differ materially. We describe risks and uncertainties that could cause actual results and events to differ materially in “Risk Factors” of our Forms 10-K and 10-Q. We undertake no obligation to update or revise publicly any forward-looking statements, whether because of new information, future events, or otherwise.

 

Corporate governance framework

Corporate governance at Microsoft is designed to promote the long-term interests of our shareholders, maintain internal checks and balances, strengthen management accountability, engender public trust, and foster responsible decision making and accountability.

The documents listed below establish our governance framework, which is intended to ensure our Board has the necessary authority and practices in place to review and evaluate our business operations and to make decisions independent of management. Our goal is to align the interests of directors, management, and shareholders, and

comply with or exceed the requirements of the NASDAQ Stock Market (“NASDAQ”) and applicable law. This framework establishes the practices our Board follows with respect to:

 

•

Board composition and member selection,

 

•

Board meetings and involvement of senior management,

 

•

chief executive officer performance evaluation,

 

•

management succession planning,

 

•

Board committees, and

 

•

director compensation.

 

Independent Chairman of the Board

The roles of chairman and chief executive officer have been separate since 2000. When the Board appointed Mr. Nadella as CEO, the independent members of the Board also designated John Thompson, previously lead independent director, as independent Chairman of the Board in February 2014.

In his role as lead independent director, Mr. Thompson coordinated the Board’s search for a new CEO following Mr. Ballmer’s announcement in August 2013 that he planned to retire as CEO upon the selection of a successor.

As Chairman, Mr. Thompson leads the activities of the Board, including calling meetings of the Board and independent directors, as necessary, setting the agenda for Board meetings in consultation with the CEO and corporate secretary, chairing executive sessions of the independent directors, engaging with shareholders as appropriate, acting as an advisor to Mr. Nadella on strategic aspects of the CEO role with regular consultations on major developments and decisions likely to interest the Board. He also performs the other duties specified in the Corporate Governance Guidelines or assigned from time to time by the Board. The independent directors annually appoint a Chairman of the Board.

Our Board believes its current leadership structure effectively allocates authority, responsibility, and oversight between management and the independent members of our Board. It gives primary responsibility for the operational leadership and strategic direction of the Company to our CEO, while the Chairman facilitates our Board’s independent oversight of management, promotes communication between management and our Board, engages with shareholders and leads our Board’s consideration of key governance matters. The Board believes its programs for overseeing risk would be effective under a variety of leadership frameworks and therefore do not materially affect how it structures its leadership.

Board independence

 

•

Substantial majority of independent directors – Ten of our 12 directors are independent of the Company and

management. We are committed to maintaining a substantial majority of independent directors.

 

•

Executive sessions of independent directors – At each quarterly Board meeting, time is set aside for the independent directors to meet in executive session without Company management present. Additional executive sessions are held as needed.

 

•

Independent compensation consultant – The compensation consultant retained by the Compensation Committee is independent of the Company and management as described in our Compensation Consultant Independence Standards.

Board committee independence and expertise

 

•

Committee independence – Only independent directors are members of the Board’s committees.

 

•

Financial sophistication and expertise – All members of the Audit Committee meet the NASDAQ listing standard of financial sophistication, and Mmes. Dublon and List-Stoll, Mr. Noski and Dr.  Panke are “audit committee financial experts” under SEC rules.

Shareholder authority

 

•

Majority voting – We have a majority vote standard for director elections. In an uncontested election, directors will be elected by the majority of votes cast.

 

•

Annual elections – All directors are elected annually. Microsoft does not have a classified board.

 

•

Confidential voting – We have a confidential voting policy to protect the voting privacy of our individual shareholders.

 

•

Special meetings – Shareholders representing 25% or more of outstanding shares can call a special shareholders meeting.

Risk oversight

 

•

Board – The Board oversees risk management at the Company. The Board exercises direct oversight of strategic risks to the Company and other risk areas not delegated to one of its committees.

 

•

Committees – The Audit Committee reviews and assesses the Company’s processes to manage financial reporting risk and to manage investment, tax, and other financial risks. It also reviews the Company’s policies for risk assessment and steps management has taken to control significant risks, except those delegated by the Board to other committees. The Compensation Committee oversees compensation programs and policies and their effect on risk taking by management. The Regulatory and Public Policy Committee oversees business risks related to privacy and cybersecurity, public policy, corporate citizenship, and competition law.

In each case, management periodically reports to the Board or relevant committee, which provides guidance on risk assessment and mitigation. Each committee charged with risk oversight reports up to the Board on those matters.

Compensation

 

•

Compensation clawback – We have a strong executive compensation recovery policy that applies to executive officers and our principal accounting officer.

 

•

Stock ownership – We have stock ownership policies for directors, executive officers, and other senior executives. The policies were established to promote a long-term perspective in managing the enterprise and to help align the interests of our shareholders, executives, and directors.

 

•

Anti-hedging and pledging policy – We prohibit our directors and executive officers from hedging their ownership of Microsoft stock, including trading in options, puts, calls, or other derivative instruments related to Company stock or debt. Directors and executive officers are prohibited from purchasing Microsoft stock on margin, borrowing against Microsoft stock held in a margin account, or pledging Microsoft stock as collateral for a loan.

Director orientation and continuing education

 

•

Board orientation – Our orientation programs familiarize new directors with Microsoft’s businesses, strategies, and policies, and assist new directors in developing the skills and knowledge required for their service on the Board of Directors.

 

•

Continuing education – Continuing education programs assist directors in maintaining skills and knowledge necessary or appropriate for the performance of their responsibilities. These programs may include internally developed materials and presentations, programs presented by third parties, and financial and administrative support for attendance at qualifying academic or other independent programs.

Director self-evaluation

Each year, our Board and committees conduct self-evaluations to assess their effectiveness and adherence to the Corporate Governance Guidelines and committee charters, and to identify opportunities to improve Board and committee performance.

Citizenship

Microsoft’s citizenship mission is to serve the needs of communities globally and fulfill our responsibilities to the public. Our customers and society expect us to maximize the value of technology while also preserving values that are timeless. Microsoft’s commitments to corporate citizenship help us meet these expectations and they contribute long-term value to our business, our shareholders, and communities around the world. In recognition of the importance of citizenship to Microsoft’s long-term business success, the duties of the Regulatory and Public Policy Committee of our Board of Directors include reviewing and providing guidance to the Board and management about the Company’s policies and programs that relate to corporate citizenship, including human rights, environmental sustainability, corporate social responsibility, supply chain management, charitable giving, and political activities and expenditures.

For an in-depth review of Microsoft’s approach to corporate citizenship and performance in fiscal year 2014, please visit our 2014 Microsoft Citizenship Report at www.microsoft.com/citizenshipreport. The report details the progress we are making serving communities through efforts such as Microsoft YouthSpark, our company-wide initiative to create opportunities for 300 million youth through technology, training and experiences. It also covers our commitments to ethical business conduct and governance, our people, human rights, responsible sourcing, and environmental sustainability.

Political contributions

Microsoft recognizes the increasing interest of U.S. public company shareholders in establishing greater transparency about corporate political contributions. We disclose our political contributions to support candidates and ballot measures and how certain of our trade association membership dues are used for political activities. As part of our commitment to transparency, we developed our Principles and Policies Guiding Microsoft Participation in Public Policy Process in the United States, which focus on ensuring compliance with applicable federal and state laws and are designed to go beyond compliance to implement what we consider leading practices in corporate accountability, transparency, integrity, and responsibility. The policy is available at www.microsoft.com/politicalengagement.

 

Shareholders are invited to contact the Board about corporate governance or the Board of Directors. Inquiries meeting these criteria will be received and processed by management before being forwarded to the Board, a committee of the Board, or a director as designated in your message. Communications relating to other topics, including those that are primarily commercial in nature, will not be forwarded.

 

Email:		AskBoard@microsoft.com
Mail:		MSC 123/9999
		Office of the Corporate Secretary
		Microsoft Corporation
		One Microsoft Way
		Redmond, WA 98052-6399

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

 

Selection of Board members – The Company’s shareholders elect Board members annually. The Governance and Nominating Committee recommends to the Board director candidates for nomination and election at the Annual Shareholders Meeting or for appointment to fill vacancies. The Governance and Nominating Committee annually reviews with the Board 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 the qualifications of individual director candidates in light of the board membership criteria described below. The Governance and Nominating Committee retains any search firms and approves payment of their fees.

Board membership criteria – 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 considers 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 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.

The Governance and Nominating Committee assesses its efforts to maintain an effective and diverse Board of Directors in the course of its regular responsibilities, which include annually

 

•

reporting to our Board on the performance and effectiveness of the Board,

 

•

presenting to our Board individuals recommended for election to the Board at the annual shareholders meeting, and

 

•

obtaining or performing an assessment of the Governance and Nominating Committee’s own performance.

 

Current Board – Shareholders previously elected Drs. Klawe and Panke and Messrs. Gates, Noski, and Thompson. As described above, during the past year we added five directors to our Board. In addition to the annual review of the Board composition, the Governance and Nominating Committee works with the full Board to regularly evaluate the composition of the Board to assess whether one or more directors should be added in view of director departures, the number of directors needed to fulfill the Board’s responsibilities under the Corporate Governance Guidelines and committee charters, and the skills and capabilities that are relevant to the Board’s work and the Company’s strategy. In recruiting the directors who joined the Board in 2014, the Governance and Nominating Committee retained the search firm of Spencer Stuart to help identify director prospects, perform candidate outreach, assist in reference and background checks, and provide other related services. The recruiting process typically involves either the search firm or a member of the Governance and Nominating Committee contacting a prospect to gauge his or her interest and availability. A candidate will then meet with several

members of the Board including Mr. Nadella, and then meet with members of management as appropriate. At the same time, the Governance and Nominating Committee and the search firm will contact references for the prospect. A background check is completed before a final recommendation is made to the Board to appoint a candidate to the Board.

Mr. Nadella was appointed to the Board in February 2014 concurrent with his appointment as CEO. Mr. Morfit was appointed to the Board in March 2014 in connection with the Cooperation Agreement between ValueAct Capital (Mr. Morfit’s employer) and Microsoft. Mr. Stanton was appointed to the Board in July 2014. Management recommended Mr. Stanton as a candidate for consideration by the Governance and Nominating Committee. Ms. List-Stoll and Mr. Scharf were appointed to the Board in October 2014 following Ms. Dublon’s and Mr. Marquardt’s announcement that they would not be standing for re-election. The director search firm identified Ms. List-Stoll and Mr. Scharf as candidates.

 

The Governance and Nominating Committee considers shareholder recommendations for candidates for the Board of Directors using the same criteria described above. 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 must be sent to the attention of MSC 123/9999, Office of the Corporate Secretary, Microsoft Corporation, One Microsoft Way, Redmond, WA 98052-6399. A shareholder who wishes to nominate a candidate must follow the procedures described in Article 1 of our Bylaws.

 

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 website at www.microsoft.com/investor/independenceguidelines. The guidelines either meet or exceed the independence requirements of NASDAQ. 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 his or her responsibilities as a director. 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 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. Marquardt, Morfit, Noski, Scharf, Stanton, and Thompson, Mses. Dublon and List-Stoll, and Drs. Klawe and Panke meet the standards of independence under our Corporate Governance Guidelines, the 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 and that the Company may at times invest in businesses in which such funds have invested. The Board also considered the Company’s purchase of and payment for software licenses, hardware devices, and support services for technology from Virtual Instruments, Inc., of which Mr. Thompson is Chief Executive Officer, to enhance the performance and reliability of the Company’s storage area network resources. Payments to Virtual Instruments of $2.1 million in fiscal year 2014 constituted less than 5% of its last fiscal year revenues.

 

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 the evening and following day can be devoted to the Board’s annual retreat, which includes presentations and discussions with senior management about Microsoft’s long-term strategy. Besides 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 twelve times during fiscal year 2014.

All of our 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 expected to attend the Annual Shareholders Meeting. All of our directors attended the 2013 Annual Meeting.

 

Our Board has four standing committees: an Audit Committee, a Compensation Committee, a Governance and Nominating Committee, and a Regulatory and Public

Policy Committee. Each committee has a written charter. The table below provides current membership for each Board committee.

 

Below is a description of each standing committee. 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 overseeing the quality and integrity of our accounting, auditing, and reporting practices. The Audit Committee’s role includes:

 

•

overseeing the work of our accounting function and internal control over financial reporting,

 

•

overseeing internal auditing processes,

 

•

inquiring about significant risks, reviewing our policies for enterprise risk assessment and risk management, and assessing the steps management has taken to control these risks,

 

•

overseeing business continuity programs,

 

•

reviewing with management policies, practices, compliance, and risks relating to our investment portfolio,

•

overseeing, with the Regulatory and Public Policy Committee, cybersecurity and other risks relevant to our information technology environment, and

 

•

reviewing compliance with significant applicable legal, ethical, and regulatory requirements, including those relating to regulatory matters that may have a material impact on our financial statements or internal control over financial reporting.

The Audit Committee is responsible for the appointment, compensation, retention, and oversight of the independent auditor engaged to 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 auditor, and the independent auditor in carrying out its oversight responsibilities. The Audit Committee Responsibilities Calendar accompanying the Audit Committee Charter describes the Audit 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 Audit Committee. In

 

addition, the Board has determined that Mmes. Dublon and List-Stoll, 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:

 

•

assist our Board of Directors in establishing the annual goals and objectives of the chief executive officer,

 

•

recommend to the independent members of our Board the compensation of the chief executive officer,

 

•

oversee an evaluation of the performance of the Company’s other executive officers and approve their compensation,

 

•

oversee and advise our Board on the adoption of policies that govern executive officer compensation programs and other compensation-related polices,

 

•

assist the Board in overseeing plans for executive officer development and succession, and

 

•

oversee administration of our equity-based compensation and other benefit plans.

Our senior executives for human resources and compensation and benefits support the Compensation Committee in its work. The Compensation Committee delegates to senior management the authority to make equity compensation grants to employees who are not executive officers. The Compensation Committee periodically reviews the compensation paid to non-employee directors, and makes recommendations to our Board of Directors for any adjustments.

Compensation consultant

The Compensation Committee retains Semler Brossy Consulting Group, LLC (“Semler Brossy”) 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. The firm also consults with the Compensation Committee about its recommendations to the Board of Directors on chief executive officer and director compensation.

Consultant independence

Semler Brossy is directly accountable to the Compensation 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 Compensation Committee has adopted Compensation Consultant Independence Standards, which can be viewed at www.microsoft.com/investor/compconsultant. This policy requires that the Compensation 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):

 

•

is retained and terminated by, has its compensation fixed by, and reports solely to the Compensation Committee,

 

•

is independent of the Company,

 

•

will not perform any work for Company management except at the request of the Compensation Committee chair and in the capacity of the Committee’s agent, and

 

•

does not provide any unrelated services or products to the Company, its affiliates, or management, except for surveys purchased from the consultant firm.

In assessing the consultant’s independence, the Compensation 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 fees paid for those services in relation to the firm’s total revenues. The consultant annually prepares for the Compensation Committee an independence letter providing assurances and confirmation of the consultant’s independent status under the policy. The Compensation Committee believes that Semler Brossy has been independent during its service for the Committee.

Governance and Nominating Committee

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

 

•

annually establish the process for reviewing the chief executive officer’s performance,

 

•

determine and recommend the slate of director nominees for election to our Board of Directors,

 

•

identify, recruit, and recommend candidates to fill director vacancies occurring between annual shareholder meetings,

 

•

review and make recommendations to the Board about the composition of Board committees,

 

•

annually evaluate the performance and effectiveness of the Board, and

 

•

monitor adherence to, review, and recommend changes to our corporate governance framework.

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

 

Regulatory and Public Policy Committee

The principal responsibilities of the Regulatory and Public Policy Committee are to:

 

•

review and advise the Board of Directors and management about legal, regulatory, and compliance matters concerning competition and antitrust, privacy, security, employment, and immigration laws,

•

oversee, with the Audit Committee, risks relevant to our information system architecture and controls and cybersecurity, and

 

•

review our policies and programs that relate to matters of corporate citizenship, including human rights, corporate social responsibility, environmental sustainability, supply chain management, and political activities and expenditures.

 

The Compensation Committee periodically reviews compensation paid to non-employee directors and makes recommendations for adjustments, as appropriate, to the full Board of Directors. Our objective for compensation to non-employee directors is to pay at or near the median of the Dow 30, to award the majority of compensation in

equity, and to make meaningful adjustments every few years, rather than smaller adjustments that are more frequent. Except for the addition of an annual chairman retainer in conjunction with Mr. Thompson’s appointment as independent Chairman, there were no changes to director compensation for fiscal year 2014.

 

The Company pays for reimbursement of reasonable expenses incurred in connection with Board-related activities.

Director retainers are paid quarterly in arrears. Quarterly periods are measured beginning with the annual shareholders meeting. At the end of each quarterly period, we pay 25% of the total annual retainer to each director. Retainers are pro-rated for directors who join or leave the Board or have a change in Board role during a quarterly period.

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 the Deferred Compensation Plan for Non-Employee Directors. Amounts deferred 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. We calculate the number of shares credited by dividing each quarterly amount deferred by the closing market price of our common stock on the originally scheduled payment

date. 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.

Non-executive Chairman compensation. On February 4, 2014, the Board appointed John Thompson as independent non-executive Chairman of the Board. In establishing the retainer for the non-executive Chairman, the Compensation Committee considered the scope of Mr. Thompson’s responsibilities and time commitment and the compensation paid at similar companies with chairs having similar roles. Mr. Thompson’s pay reflects the estimated additional time commitment for this role compared to other non-employee directors, which includes: (i) managing meetings of the Board of Directors, leading the work to set the agenda for Board meetings, leading the Board’s annual chief executive officer performance review, and representing the Board at the annual shareholders meeting, (ii) meeting with the Company’s investors, (iii) acting as an advisor to Mr. Nadella on strategic aspects of the chief executive

 

officer role with regular consultations on major developments and decisions that are likely to be of interest to the Board, and (iv) at the request of Mr. Nadella, interacting with external audiences. To compensate Mr. Thompson for the greater responsibilities of the non-executive Chairman role, he will receive the annual chairman retainer in lieu of the regular Board retainers.

Director stock ownership policy. 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. Each director must retain 50 percent of all net shares (post tax) from the retainer until the minimum share ownership requirement is achieved. Stock deferred under the Deferred Compensation Plan for Non-Employee Directors counts toward the minimum ownership requirement. Each of our directors complied with our stock ownership policy at the end of fiscal year 2014.

 

We are a global company with extensive operations in the United States and many foreign countries. Every year we spend tens of billions of dollars for goods and services from third parties. The authority of our employees to purchase goods and services is widely dispersed. Because of these far-reaching activities, there may be transactions and business arrangements with businesses and other organizations in which one of our directors, executive officers, or nominees for director, or their immediate families, or a greater than 5% owner of our stock, may also be a director, executive officer, or investor, or have some other direct or indirect material interest. We will refer to these relationships generally as related-party transactions.

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

 

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the goods or services provided by or to the related party,

 

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the nature of the transaction and the costs to be incurred by Microsoft or payments to Microsoft,

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the benefits associated with the transaction and whether comparable or alternative goods or services are available to Microsoft from unrelated parties,

 

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the business advantage Microsoft would gain by engaging in the transaction,

 

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the significance of the transaction to Microsoft and to the related party, and

 

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management’s determination that the transaction is in the best interests of the Company.

To receive Audit Committee approval, a related-party transaction must have a Microsoft business purpose and be on terms that are fair and reasonable to Microsoft, and as favorable to the Company as would be available from non-related entities in comparable transactions. The Audit Committee also requires that the transaction meet the same Company standards that apply to comparable transactions with unaffiliated entities.

 

This compensation discussion and analysis provides information about our fiscal year 2014 compensation program for our fiscal year 2014 named executive officers (the “Named Executives”).

Fiscal year 2014 was a significant year for Microsoft’s business and leadership. In the case of our business, we made bold and difficult decisions that will help us achieve our ambition to be the productivity and platform company for the mobile-first and cloud-first world. Through these changes we are refining our ability to create high-value productivity experiences for work and life, built on a single platform and available on any device at work and at home. As we reinvent our business, we are also reinforcing a leadership team equipped to execute our strategy and strengthening our corporate governance structure. These changes include the appointment of a new chief executive officer with a performance-oriented compensation package that ties compensation tightly to shareholder returns.

The contents of this compensation discussion and analysis are organized into six sections.

Section 1 – Chief executive officer transition

Section 2 – Fiscal year 2014 company overview

Section 3 – Fiscal year 2014 compensation decisions

Section 4 – Executive compensation overview

Section 5 – Compensation design process for fiscal year 2014

Section 6 – Other compensation policies and information

Section 1 – Chief executive officer transition

Following Steve Ballmer’s announcement of his decision to retire as CEO, the Board of Directors conducted an extensive, in-depth search of internal and external candidates that culminated in the February 2014 appointment of Satya Nadella – only the third chief executive officer in our history. These leadership

developments resulted in several significant executive compensation actions during the fiscal year.

Compensation decisions related to Mr. Nadella’s appointment as Chief Executive Officer

On February 4, 2014, our Board of Directors appointed Mr. Nadella as our Chief Executive Officer. For its first 39 years, Microsoft was led by Bill Gates and then Steve Ballmer, both of whom were among our largest shareholders. As a result, until the appointment of Mr. Nadella, the compensation structure for our CEO differed significantly from those of almost every major global company. Neither Mr. Gates nor Mr. Ballmer received any equity incentive compensation given the intrinsic alignment with shareholders and the wealth-building opportunity their existing Microsoft shares afforded. Historically, this compensation structure produced actual total compensation for our CEO that was significantly lower than that of the chief executive officers of our peers.

In hiring a successor without a pre-existing major equity stake in Microsoft, our Board conducted a comprehensive review of pay structures for chief executive officers at comparable companies. Our Board concluded it was important to establish a compensation framework for our next CEO that would provide a target total compensation opportunity that was competitive with those of leaders at other major global companies, that included long-term company performance as an important ingredient in determining a meaningful portion of pay, and that provided the opportunity to build significant ownership when the CEO creates sustained long-term value for shareholders.

To further these objectives, the Compensation Committee (with the assistance of its executive compensation consultant) developed, and the independent members of the Board approved, a compensation structure comprised of two principal components:

 

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A long-term performance-based stock award (the “LTPSA”) designed to motivate the CEO to successfully implement our business transformation and create

 

sustainable long-term value for shareholders by providing the opportunity to share in these gains when Microsoft performs well relative to the S&P 500 companies over a seven year term; and

 

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An annual total compensation opportunity comparable to the competitive market.

Long-term performance-based stock award

To focus Mr. Nadella on improving returns for shareholders over the long term, while at the same time providing him the opportunity to build significant ownership and share in those returns when he achieves strong, sustainable performance, the independent members of our Board granted him the LTPSA with these key features.

 

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The payout term is seven years. Payout opportunities only occur on the 5th, 6th, and 7th anniversaries of the grant date, reinforcing the importance of value creation over the long term. There are no payout opportunities before the 5th anniversary of the grant date. Unless Mr. Nadella’s employment is terminated without cause, he must continue to be employed by the Company through the fifth anniversary of his promotion to CEO to receive any of the shares under the LTPSA.

 

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Relative total shareholder return determines the payout level. More than 80% of the reward opportunity is performance-based measured by our total shareholder return (“TSR”) relative to the S&P 500 over each of three overlapping, five-year performance periods ending in February 2019, 2020, and 2021.

 

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Target payout requires above-market performance. Above-market performance (60th percentile of S&P companies over each performance period) is required to earn the target number of shares.

 

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Above target payouts require even greater performance. The maximum number of shares are earned only if Microsoft’s TSR is at or above the 80th percentile of the S&P 500 companies over each five-year performance period.

The annualized value of the LTPSA over its seven-year term, using the grant date fair value at target, is $8.45 million. The Board chose the S&P 500 as the compare group for relative TSR because it is a broad and stable index group that represents investors’ alternative capital investment opportunities. To minimize the risk of gains from short-term stock price volatility, TSR is measured over 90-day periods from the end of each five-year period. Similarly, three performance periods are used to limit the impact of short-term price fluctuations on the final outcome. The following graphs depict the payout curve for each tranche of the LTPSA and timing of the long-term payouts. Importantly, the Board considers the seven-year LTPSA a non-recurring award that is separate from Mr. Nadella’s ongoing annual compensation package. Moreover, the Board does not intend to grant any other special awards to Mr. Nadella during the next several years.

Annual total compensation opportunity

In approving the initial annual total compensation opportunity for Mr. Nadella, our Board was mindful of both the fierce competition for talented executives in the technology sector and the demands on and responsibilities of the leader of a global organization with the scope and stature of Microsoft. Accordingly, the independent members of our Board approved the following annual compensation arrangements for Mr. Nadella in connection with his appointment as Chief Executive Officer:

 

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An annual base salary of $1,200,000.

 

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A target annual cash incentive award opportunity under the Microsoft Executive Officer Incentive Plan (the “Incentive Plan”) equal to 300% of his annual base salary (which, for purposes of fiscal year 2014, would apply only to the portion of his annual salary earned after his promotion). His actual annual cash incentive award could range from 0% – 300% of the target and will be based on his actual performance as evaluated by our Board.

 

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Beginning in fiscal year 2015, an annual equity award for shares of Microsoft common stock under the Incentive Plan with a value equal to $13,200,000 (representing approximately 70% of his target annual total

 

compensation opportunity for the fiscal year. Like the stock awards granted to the other Named Executives under the Incentive Plan, this award will vest in four equal annual installments.

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The Company’s practice is to increase the size of an employee’s equity award when the employee is promoted to a new pay level. However, Mr. Nadella did not receive a promotion stock award because of the one-time retention stock award described below.

 

One-time special retention stock awards

There is intense competition for talent in technology businesses. Talented leaders and employees are the lifeblood of our business. The Compensation Committee determined it was critical to ensure we retained key members of our senior executive team during the transition to a new CEO and to ensure the successful execution of our Company’s ongoing business transformation. Recognizing that we do not maintain employment agreements with our executive officers and aware that these individuals are actively recruited for senior leadership positions at other organizations, during fiscal year 2014 one-time special retention stock awards were made to a small group of executives (including the Named Executives) to ensure the continuity of our senior executive team, some of whom were potential internal candidates for CEO. For example, Mr. Nadella received this award in his prior role as Executive Vice President, Cloud and Enterprise. In addition, Ms. Hood received a similar

award due to her exceptional performance, and to bring her total compensation in line with her peers at other companies. Because the awards were designed to ensure continued service beyond the CEO transition, the awards vest based on service ranging from three to five years. All recipients of the one-time retention grants remain with the Company.

The Compensation Committee structured these awards so that the full number of shares of Microsoft common stock subject to each award will only be earned if the Named Executive provides services to us through the full vesting period. Unlike our annual stock awards, these one-time special retention stock awards are not eligible for vesting upon retirement or pro-rated vesting under the Microsoft Senior Executive Severance Benefit Plan. Mr. Shum also received a one-time bonus of $1,000,000 in addition to his retention stock award.

 

Section 2 – Fiscal year 2014 company overview

Corporate transformation

In addition to appointing a new CEO, we made several other significant strategic and Board leadership changes during the past year, including:

 

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In September 2013, we announced new reporting segments that resulted from a corporate reorganization we implemented for our 2014 fiscal year. The new segments provide investors with additional information by disclosing results by business model and customer segment rather than by product. We also began disclosing new key performance indicators to provide

insight for our shareholders into significant drivers of our business, including Commercial Cloud revenue, several views of Windows and Office 365 revenue growth, and Surface revenue.

 

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In February 2014, John Thompson, previously our lead independent director, became independent Chairman of our Board. Mr. Thompson led the search process that resulted in Mr. Nadella’s appointment as our CEO.

 

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In April 2014, we completed the acquisition of the Nokia Devices and Services business to grow the opportunity for our entire set of offerings for the mobile-first and cloud-first world.

 

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In July 2014, we announced a major restructuring plan to streamline and simplify our organization, eliminate duplicative efforts, and align our engineering and product teams with our overall long-term strategy.

Strong financial performance amid significant change

Strong financial results provide the foundation for Mr. Nadella’s plans for Microsoft as a productivity and platform company for the mobile-first and cloud-first world. Over the last five years, our revenue has grown over 48% to $86.8 billion and net income has grown over 51% to $22 billion in fiscal year 2014. Our sales to the enterprise are stronger than ever and consumer offerings are gaining momentum. Our emphasis on long-term growth is unchanged as we undertake to transform our business in a mobile-first and cloud-first world.

Even as we navigated the challenges of business and leadership changes, in fiscal year 2014 we remained disciplined and continued to deliver solid business performance. Reflecting effective cost discipline and growing momentum in our cloud businesses, key fiscal year 2014 results were:

 

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$86.8 billion in revenue, an increase of 12%

 

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$27.8 billion in operating income, an increase of 4%

 

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$2.63 diluted earnings per share, an increase of 2%

 

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$25.2 billion in unearned revenue as of fiscal year-end, a record amount

 

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Over $49 billion of combined unearned revenue and contracted-not-billed revenue

 

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116% growth in Commercial Cloud revenue

 

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$15.7 billion returned to shareholders through dividends and stock buybacks, an increase of 27%

 

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Total shareholder return of 24%

Over the last three years we have consistently grown total shareholder return, cash returned to shareholders, annual revenue and diluted earnings per share (“EPS”).

 

 

 

 

 

 

 

Section 3 – Fiscal year 2014 compensation decisions

Consistent with our performance and compensation philosophy, the Board of Directors and the Compensation Committee took the following compensation actions for fiscal year 2014.

Performance review process for the CEO

For the purpose of determining incentive awards and compensation changes, our Board of Directors annually assesses our CEO’s performance. This evaluation considers:

 

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a summary of Microsoft’s performance for the fiscal year using a wide range of quantitative and qualitative financial, operational, and strategic assessments

 

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Mr. Nadella’s evaluation of the Company’s and his performance over the past fiscal year, and

 

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the factors listed below under “Performance review process for other Named Executives.”

Based on this assessment, the Compensation Committee recommends the CEO’s Incentive Plan award for the most-recently completed fiscal year and any base salary adjustment. The Compensation Committee does not apply a formula to determine these amounts. Instead, the Compensation Committee exercises its business judgment in making its recommendations, taking into consideration the evaluation of the CEO’s performance, our performance relative to other technology companies, the performance relative to target for the other executive officers over the same period, and the advice of the Compensation Committee’s compensation consultant.

Fiscal year 2014 Incentive Plan award decision for Mr. Nadella

For fiscal year 2014, the Compensation Committee recommended, and the independent members of our Board of Directors approved, an Incentive Plan cash award of $3,600,000 for Mr. Nadella, which was 141% of his target award. In reaching this decision the independent members of our Board considered Mr. Nadella’s performance against his core priorities, the financial and operational performance of the Company, and the financial performance of the Company relative to a group of large technology companies.

Prior to his appointment as CEO, Mr. Nadella successfully led the Cloud and Enterprise business where he drove the transformation to the cloud infrastructure and services business. In fiscal year 2014, the Commercial Cloud annual revenue run rate more than doubled and now exceeds $4.4 billion. He helped drive high renewal rates in our hybrid cloud offerings as well as continued investment in premium versions of our on-premise server products. In addition, as the leader of the Cloud and Enterprise business, Mr. Nadella was responsible for developing a

deep technical organization with a strong leadership team from which his successor was selected.

Since becoming CEO in February, Mr. Nadella led the development of our mobile-first and cloud-first strategy, guiding the Company through significant organizational changes, restructuring and evolution of the Company’s culture.

Performance review process for other Named Executives

The Compensation Committee reviewed each executive officer’s performance following the end of the fiscal year. Mr. Nadella and Lisa Brummel, Executive Vice President, Human Resources, also participated in these discussions.

The Compensation Committee placed significant weight on Mr. Nadella’s recommendations for the compensation of executive officers and his evaluation of each executive officer’s performance for the fiscal year because of his first-hand knowledge of each individual’s contributions. Mr. Nadella used information about performance against a wide range of quantitative and qualitative financial, operational, and strategic assessments.

The Compensation Committee also reviewed company-wide and business performance against quantitative and qualitative financial, operational, and strategic measures. These factors vary based on individual responsibilities and the function, division, or group that an executive officer leads, and may include (in alphabetical order):

 

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Compliance and integrity

 

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Contribution margin

 

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Corporate citizenship

 

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Customer acceptance

 

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Customer satisfaction

 

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Developer community satisfaction

 

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Efficiency and productivity

 

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Innovation

 

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Operational excellence

 

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Organizational culture and leadership

 

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Organizational diversity

 

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Product development and implementation

 

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Quality

 

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Revenue

 

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Sales and licensing volume

 

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Strategic progress

The Compensation Committee also considers any other information that it deems relevant. After completing this review process, the Compensation Committee, applying its independent judgment, determines each executive officer’s Incentive Plan cash award for the just-completed fiscal year.