Late Monday afternoon, a

Bloomberg

article appeared quoting an unnamed source suggesting that

Microsoft

(MSFT) - Get Report

would look to tap the debt markets and use the money to fund a higher dividend and do more stock buybacks. The stock ended up more than 5% in the last hour of trading. For Microsoft, that's a monster move.

The company has come under increased shareholder pressure to disgorge its ample cash to shareholders. Last month, I filed a shareholder resolution to be voted on this November at the shareholders' meeting

calling on Microsoft to dramatically increase its payout ratio on its regular dividend, as well as considering stock buybacks.

Last week, Microsoft CFO Peter Klein spoke at the

Citi

(C) - Get Report

Tech conference and got an earful from investors in the Q&A about the dividend and cap structure. Klein and Microsoft Investor Relations GM Bill Koefoed also spoke last week to many Microsoft holders, including me, about their views on these questions.

Although I can't disclose what they said during our meeting, here is a summary of my argument to them:

Microsoft is greatly under-appreciated by investors today at current levels. Yet, the company can take its greatest weakness (the perception that it has all this excess cash because it is not growing as quickly as its younger, nimbler rivals) and turn it into its greatest strength (by using its cash to payout a dividend that gets yield-hungry investors to sit up and realize that holding Microsoft is safer than U.S. Treasuries).

There is constant reference in the media these days for "the hunt for yield" by investors, but Microsoft is never mentioned even though it is best positioned to take advantage of this secular trend.

Every pension fund in America today has promised its pensioners it will deliver 8% annual returns forever. They are having trouble in the last three years meeting that commitment. They -- and other large and small investors -- would beat a path to Microsoft's door if there was a substantial increase in the regular dividend.

The status quo for Microsoft of stock buybacks and marginal annual increases to the regular dividend (which returned $16 billion in cash to shareholders last year) isn't working given the stock price. Microsoft needs to be bold.

There are 3 levers that Microsoft can and should pull to get investors' attention in the coming weeks:

1. Most important, in my view, is to substantially increase the regular dividend. I believe it should be nothing less than a doubling of the dividend. Investors would be happy to sit and wait for the market to better see the value in the stock if they were getting a whopping payout. A large increase in the payout would also assuage investor fears that Microsoft might do a large, ill-advised acquisition (like

Yahoo!

(YHOO)

or

Research in Motion

(RIMM)

) which would waste shareholders' money on declining assets.

Although some in the media have raised the question about how wise it is to increase the dividend with the uncertainty of the dividend tax rate, I asserted that I thought this issue was irrelevant. Even assuming the rate goes up, that argues even more for why a drastic increase in the payout is necessary just to tread water.

2. Tapping the debt markets.

Johnson & Johnson

(JNJ) - Get Report

recently raised $1.1 billion in the debt markets selling 10- and 30-year notes at record low rates. JNJ paid 2.95% on their 10-year notes. In May 2009, Microsoft made its first foray into the debt markets, selling $3.75 billion. Back then, Microsoft paid 4.2% on their 10-year notes.

Why not raise the cash at these levels, especially when Microsoft is seen as more creditworthy than the U.S. government and is one of only a handful of AAA corporate issuers. I reminded Klein that I'd written an article prior to their first debt offering where I pointed out that

Microsoft could issue $60 billion in debt and only match

IBM

's

(IBM) - Get Report

current debt-to-cash ratio.

3. Do more stock buybacks. Finally, I told them that I was not a fan of buybacks, as Microsoft has been doing them for some time now and they have had no appreciable effect on the stock price in my view. However, I admitted that there are some Microsoft shareholders who do seem intent on asking for them. If Microsoft is trying to make moves to satisfy the greatest number of shareholders, it's a reality that they will do more. I told them that, despite my misgivings about buybacks, they beat letting the cash sit on the balance sheet.

The bottom line is that Microsoft has conservatively dipped its toe in the water of dividends and raising debt over the last several years. They've been so conservative that they've actually trained the market to expect such behavior.

A substantial increase in the dividend and tapping of the debt markets would smash investors' complacency and cause them to take another look at what an attractive opportunity Microsoft is at these levels -- relative to other investments.

I strongly believe the market would immediately and positively react to such bold moves by Microsoft.

Based on the large move we saw in Microsoft's stock on Monday following the

Bloomberg

article, I stand by that last statement. According to the article, a decision on the issue of the dividend, debt raise, and buybacks will be made at the September Microsoft board meeting which will likely be held next week. The article suggests an announcement could come immediately after that meeting.

Investors should hope the board likes the market's response to Monday's trial balloon and that they will err on the side of allocating more cash to Microsoft shareholders than less.

At the time of publication, Jackson held long positions in MSFT and C and a short position in RIMM.

Eric Jackson is founder and Managing Member of Ironfire Capital and the general partner and investment manager of Ironfire Capital US Fund LP and Ironfire Capital International Fund, Ltd. In January 2007, Jackson started the world's first Internet-based campaign to increase shareholder value at Yahoo!, leading to a change in CEOs in 2007. He also spoke out in favor of Yahoo!'s accepting Microsoft's buyout offer in 2008. Global Proxy Watch named Jackson as one of its 10 "Stars" who positively influenced international corporate governance and shareowner value in 2007.

Prior to founding Ironfire Capital, Jackson was President and CEO of Jackson Leadership Systems, Inc., a leadership, strategy, and governance consulting firm. He completed his Ph.D. in the Management Department at the Columbia University Graduate School of Business in New York, with a specialization in Strategic Management and Corporate Governance, and holds a B.A. from McGill University.

He was previously Vice President of Strategy and Business Development at VoiceGenie Technologies, a software firm now owned by Alcatel-Lucent. In 2004, Jackson founded the Young Patrons' Circle at the Royal Ontario Museum in Toronto, which is now the second-largest social and philanthropic group of its kind in North America, raising $500,000 annually for the museum. You can follow Jackson on Twitter at www.twitter.com/ericjackson or @ericjackson.

You can contact Eric by emailing him at eric.jackson@thestreet.com.