How Microsoft evaluates execs

Microsoft's board of directors is holding top management to a higher standard, and in key areas such as Internet search share and customer satisfaction, the company's performance last year fell short of expectations.

As a result, four executives got no more than half as much stock as they would have if the company had met or exceeded all of its goals, according to a regulatory filing Friday.

The Microsoft proxy filing provided a detailed look at how the board evaluates company leaders and motivates them with company stock.

Financial analysts were glad to see that top executives did not get the full award they could have for the past fiscal year.

"I would be more concerned if they were paying out 100 percent," said Charlie Di Bona, an analyst with Sanford C. Bernstein, noting that while the company posted strong sales and profits in fiscal year 2007, there were problems of varying magnitude across the company.

"This is not putting-bread-on-the-table money, this is gravy money, and so you want the gravy to be something that you have to earn," he said.

Microsoft began its Shared Performance Stock Awards program in the 2004 fiscal year as part of a shift away from stock options. The program is designed to be the biggest component of compensation for about 950 top-tier Microsoft employees — typically starting with the "partner" or general-manager level — and to tie that compensation to company performance.

The amount of the award is based on an individual's role and responsibilities, and an aggregate score measuring the company's performance against a set of goals.

Achieving the goals nets an executive 100 percent of his or her target payout. Awards can be smaller or larger, up to 150 percent of the target payout, depending how much goals are missed or exceeded.

In making its first set of awards under the program last year, the board evaluated company performance during a three-year period ended June 30, 2006.

For that period, the board looked at four areas: customer satisfaction, unit volumes of Windows products, usage of Microsoft's developer tools and desktop application deployment.

Microsoft "exceeded the target in one metric, reached the target in two others, and performed below the target in the fourth," according to an earlier filing. Microsoft did not disclose specifics on which areas missed, met or exceeded expectations.

The net result was a 101 percent payout, indicating the company, as a whole, exceeded its goals for the three-year period, but just barely. That translated to stock awards of 37 million shares, which vest over three years, divvied out among the 900 executives participating at the time.

The board came to a dramatically different conclusion this year.

While Microsoft did not report a companywide payout figure for 2007, it did break down the awards given to executives named in the proxy filing: Chief Financial Officer Chris Liddell; Kevin Johnson, president of the Platforms and Services Division; Business Division President Jeff Raikes; and Chief Operating Officer Kevin Turner. (Microsoft Chairman Bill Gates and CEO Steve Ballmer do not participate in the program.)

Taken as a group, these four executives received 41 percent of what they were eligible for under the stock-award program.

This substantial underperformance relative to the board's goals still resulted in stock awards to the four worth more than $10.6 million, in addition to their base salaries and bonuses. Had they received 100 percent of their potential award, the figure would have been $25.9 million. The shares vest in equal, annual increments between Aug. 31 and 2010.

The board noted that it set a high bar, "with the intention of requiring meaningful improvements" over the previous year.

It's unclear from the filings whether the payout to the four reflects what the rest of the 950 executives in the program received. Even among the four, award percentages varied considerably from Johnson, who made 22.5 percent of his target, to Raikes and Turner, who each were at 51.3 percent.

Still, the general trend, especially compared with last year's 101 percent payout, is evident.

"It's probably fair to assume that people lower down the chain may not have gotten their target stock awards as well," said Sid Parakh, a technology analyst with McAdams Wright Ragen.

The board also disclosed a broader and more detailed set of metrics for the award program than it did last year.

They apply to different employees differently. For example, 25 percent of Raikes' award is based on the net revenue and profit margin of his division; 30 percent is based on overall customer satisfaction and 45 percent comes from product acceptance.

Here are the metrics and what the board said:

• Customer satisfaction, as measured by customer experiences, "while steady ... fell short of our challenging goals."

• Share of Internet searches using MSN-Microsoft Web sites, "while growing" also "fell short" of the board's goals.

• The board was "satisfied" with product acceptance, including the percentage of developers using Microsoft's latest tools, the amount of activity and advertisements generated through its Web sites, sales of Windows licenses and Office units, and new Windows Server licenses.

• The board was also "satisfied" with net revenue and contribution margins in both the Business Division and the Sales Marketing and Services Group.

• The board was "not satisfied" with the financial performance of the Entertainment and Devices Division, which has been a source of losses and took a $749 million charge against profits for problems related to the Xbox 360.

Benjamin J. Romano: 206-464-2149 or bromano@seattletimes.com