Remuneration & Organizational Development Report

Remuneration & Organizational Development Rapport

We are pleased to present you the report of the Remuneration and Organizational Development Committee (‘the Committee’)

The Committee assists the Supervisory Board with establishing and reviewing the Company’s pay policy to ensure that members of the Board of Management are compensated consistently with that policy. Next to that, the Committee supervises and counsels the Company on Organizational & Management Development and reviews the succession plans for the members of the Board of
Management and other senior managers.

We are dedicated to fostering an action-oriented culture aimed at delivering results, and our pay programs therefore emphasize variable pay and long-term value creation. The target pay aims at 30–40% of pay in base salary, and 60–70% in variable pay in order to maintain a strong alignment with the Company’s annual financial performance goals and long-term value creation strategy.
In our judgment, this relationship and ratio between base salary and performance-related pay adequately reflects the balance between the Company’s objectives and its entrepreneurial spirit. Moreover, we are confident that in general the level and structure of the Board of Management pay is in line with management development goals and pay differentials within the Company.

For the remaining period of our current ‘Back to Growth’ strategy, the Committee decided that the fundamentals of the existing pay policy will remain unchanged. The existing pay policy was assessed in 2010, taking into account KPN’s risk profile, pay trends in The Netherlands and abroad as well as trends in Corporate Governance.

Subject to adoption by the Annual Meeting of Shareholders and based on the outcome of this assessment, adjustments to the pay policy will be proposed for the year 2011 onwards.

Besides assessing management performance and setting targets for the coming years, relevant topics discussed by the Committee included the balance between risk and reward and alignment with the Company’s strategic objectives, the Company’s efforts and achievements in the domain of talent management, the procedures to be followed in the event of a change of control and the CEO succession.

On behalf of the Supervisory Board, we are committed to preserving your confidence and trust by presenting an accountable and transparent implementation of our pay policy that further aligns the interests of our Board of Management with those of our shareholders and other stakeholders.

The Chairman and members of the Remuneration and Organizational Development Committee are appointed by the Supervisory Board.

The Committee currently consists of Mr Routs (Chairman), Mr Risseeuw, Mr Streppel and Ms Hooymans.

A. Executive pay at a glance

What are the objectives and principles of KPN’s pay policy?

How are executives rewarded?

The pay mix for executives consists of the following four elements:

What is the ratio between fixed and variable reward?

The ratio between fixed and variable pay is influenced by the extent to which targets are met. The left-hand pie chart represents the pay mix for the CEO in case of an on-target performance, whereas the right-hand chart represents the pay mix for the other Board members in case of an ontarget performance.

How do we establish the level of compensation?

KPN’s pay levels are benchmarked with other companies in order to ensure that KPN’s total level of compensation, based on the pay mix, is line with KPN’s pay policy and objectives, as described above. In order to benchmark pay levels, KPN uses peer groups with companies against which KPN competes for talent. The peer groups consist of the largest Dutch AEX-listed and European IT companies.

The advice of an independent external consultant (separate from the consultant used by the Company) is used by the Committee to ensure an objective benchmark for KPN’s levels of pay.

Are incentives aligned with strategy?

KPN’s ‘Back to Growth’ targets are reflected in the short-term targets (both financial and non-financial) and long-term targets (solely financial), which are used to compensate executives for their performance. The following diagram shows the alignment between Company strategy and executive pay.

Does the level of variable compensation pose a risk to KPN’s long-term strategy?

KPN aligns incentives with its long-term Company strategy, but it also needs to focus on short-term success in order to achieve further growth. The Company’s risk profile is embedded into the short-term and long-term incentive structure which is assured by KPN’s standards of internal control over financial reporting

What was rewarded to executives in 2010?

The bar chart below shows the actual components of pay and a total at the end of the bar. All figures are in thousands of euro.

1) Remuneration since appointment as CFO in November 2009.

B. Duties and activities of the Committee

Duties of the Committee

The Committee assists the Supervisory Board with:

• Establishing and reviewing the Company’s pay policy (amongst others based on national and international benchmark standards);
• Ensuring that members of the Board of Management are compensated consistently with that policy;
• Reviewing and, if appropriate, recommending changes to the pay of the Supervisory Board;
• Supervising and counselling the Company on Organizational and Management Development;
• Holding an annual review of senior managers; and
• Reviewing the succession plans for the members of the Board of Management and other senior managers.

Members of the Supervisory Board regularly liaise with senior management below Board level.

In performing its duties, the Committee is assisted by an external remuneration consultancy firm (separate from the consultant used by the Company). The Committee is fully independent in the execution of its assigned responsibilities and ensures that the external remuneration consultancy firm acts on the instructions of the Committee and on a basis in which conflicts of interest are avoided.

Activities during 2010

The Committee met 10 times in 2010, with all members present at each meeting. Consistent with its charter, the Committee has been involved in several aspects, such as:

• Reviewing the existing pay policy and recommending adjustments subject to adoption by the Annual Meeting of Shareholders, taking into account KPN’s risk profile, pay trends in the Netherlands and abroad as well as trends in Corporate Governance;
• Proposing a pay package for the new CEO;
• Reviewing the need for adjustments in pay levels (where applicable, and in order to ensure a consistent pay structure for the individual members of the Board of Management);
• Reviewing procedures to be followed in the event of a change of control (the accelerated vesting of shares in the event of a change in control);
• Proposing targets and performance criteria and ensuring that the targets would be in line with the basic principles and objectives of pay policy;
• Monitoring the internal and external auditing of the results and procedures to verify the mathematical accuracy of the short and long term incentive plans;
• Reviewing whether performance of the Committee is in line with the Committee’s charter;
• Preparing the Remuneration and Organizational Development Report to be included in KPN’s Annual Report;
• Selection of an independent external remuneration consultancy firm; and
• Reviewing the Company’s efforts and achievements in the domain of talent management for senior management.

C. Executive pay policy – detailed overview

Over the last couple of years, no fundamental changes have been considered with regard to the principles and individual elements of the Company’s pay policy. The results of the Company indicate that the pay policy stimulates performance that generates long-term profitable growth and shareholder value.

Objectives of KPN’s pay policy

KPN is dedicated to fostering a strongly action-oriented culture aimed at delivering results. KPN’s pay programs therefore emphasize variable pay and long-term value creation. KPN’s plans are designed to achieve the following objectives:

• Attracting and retaining the necessary leadership talent in order to sustain and expand KPN’s unique competencies and capabilities;
• Driving performance that generates long-term profitable growth;
• Promoting behavior that reinforces the business strategy and desired culture;
• Encouraging teamwork across business units and functional areas;
• Strongly linking rewards to value creation for shareholders and other stakeholders
• Complying with best practice in corporate governance; and
• General acceptance by all stakeholders

Principles of KPN’s pay policy

KPN’s pay policy is guided by three broad principles:

• Paying competitively: this is achieved through benchmarking against a Dutch and an European employment-market peer group consisting of companies with whom KPN generally competes for talent;
• Pay-for-performance: target pay aims at 30–40% of pay in base salary, and 60–70% in variable pay in order to maintain a strong alignment with the Company’s annual financial performance goals and long-term value creation strategy; and
• Differentiating by experience and responsibility: this is achieved through alignment of the pay with the responsibilities, relevant experience, required competence and performance of individual jobholders. Consequently, there can be substantial differentials in pay levels, despite employees having similar job titles.

These principles apply to all levels of senior management. The Company’s pay policy is compliant with the relevant legal requirements and the principles of the Dutch Corporate Governance Code.

Composition of employment-market peer groups and market assessment

To ensure the overall competitiveness of KPN’s pay levels, these levels are benchmarked against two employment market peer groups. The Committee uses both a Dutch and an European employment peer group. The Dutch employment market peer group consists of AEX-listed companies, whereas the European peer group consists of sector-specific companies. The tables on the following page show the current composition of KPN’s employment peer groups:

The Committee regularly reviews both peer groups to ensure that their composition is still appropriate. The composition of the peer groups might be adjusted as a result of mergers or other corporate activities.

It should be noted that KPN ranks, on average, at the upper quartile level in terms of revenues and market capitalization. In terms of the number of employees, KPN ranks between the median and upper quartile levels. Based on these factors, the relative size of KPN is at or in line with the 70th percentile of the peer groups and the relative positioning is taken into account when determining
whether KPN ‘pays competitively’.

Base salary

The Committee determines appropriate base salary levels based on KPN’s relative positioning in the peer groups. In line with KPN’s pay-for-performance principle, base salary is targeted at the low end of the market-competitive range. Each year the Supervisory Board considers whether circumstances justify an adjustment in base salary within the market-competitive target range for individual members of the Board of Management.

Short-term incentives (STI)

General
At the beginning of each year, the Supervisory Board sets financial and operational (non-financial) target ranges for the Board of Management. These ranges are based on the Company’s business plan. At the end of the year, the Supervisory Board reviews the Company’s performance against the target ranges. The Company’s external auditor has been engaged to perform procedures to verify a
consistent application of the approved calculation method, the mathematical accuracy of the STI calculations and a reconciliation of the source data used in the financial statements. Members of the Board of Management are eligible for an annual cash incentive depending on Company performance at or above the predetermined ranges.

Objectives
The objective of this short-term incentive scheme is to ensure that the Board of Management is well incentivized to achieve Company performance targets in the shorter term. Specific details on targets cannot be disclosed for all performance measures, as this would require providing commercially sensitive information.

Performance incentive zone
The target ranges for financial and operational performance comprise:

• A ‘threshold’ below which no incentive is paid;
• An ‘on target’ performance level at which an ‘on target’ incentive is paid; and
• A ‘maximum’ at which the maximum incentive is paid.

The STI is designed to strike a balance between the Company’s risk profile and the incentive to achieve ambitious targets.

The Supervisory Board’s ability to apply a modifier ranges between 0.5 (i.e. cutting half of the cash incentive) and 1.5 (i.e. increasing the cash incentive by 50%) based on the achievement of individual objectives. The individual Board Member objectives are agreed upon at the beginning of
the year and tend to reflect longer-term goals such as customer satisfaction, diversity, compliance, Net Promotor Score, Corporate Social Responsibility, market shares and strategic progress. The ability to apply a modifier does not increase average achievement levels. It does, however, allow the Supervisory Board some discretion in differentiating on the basis of individual contributions to Company performance.

The Supervisory Board has the discretionary authority to reward extraordinary management achievement that outperforms the regular business plan(s) and has created substantial additional value for the Company and its shareholders. Other than that, discretion both up and down can be applied if the outcome on the STI incentive scheme would be grossly unfair or if the outcome would
not be considered to reflect the basic objectives and principles of pay as outlined in this section.

Actual pay-out levels
In recent years maximum incentive levels have only been paid out on a few occasions. This is despite the fact that the Company has delivered competitive performance ahead of market expectations and has consistently achieved guidance given to the financial community.

For 2010, on average, the Revenues were below target, EBITDA was above target and Profit before Tax was above maximum. In determination of the 2010 incentive, the Supervisory Board, decided on payment of the incentive for the Members of the Board of Management, using its discretionary authority for the incentive for Mr Blok, taking into account excellent results achieved in respect of Mobile International.

Long-term incentives (LTI)

General
In addition to the base salary and the short-term annual cash incentive described above, a long-term incentive based on performance shares is used to ensure that the interests of management are aligned with those of its long-term (or prospective) shareholders and to provide
an incentive for members of the Board of Management to continue their employment relationship with the Company.

The number of shares granted under this plan is derived by applying a percentage to base salary and dividing this amount by the value of each granted share, as shown in the following table.

The number of shares that actually vest is conditional on the extent to which the returns to KPN shareholders outperform the returns to shareholders of a peer group of Western European telecommunications companies. It is felt that comparing KPN with a wider group of companies
(either geographically or with other industries) is not meaningful. Variations in returns would most likely be attributed largely to macroeconomic events and/or sector shifts rather than to variations in management actions. Therefore, benchmarking achievements relative to other, similar companies emphasizes rewarding for specific KPN performance.

Vesting is also subject to the condition that the member of the Board of Management has not resigned within three years of the date of the initial grant.

Similar to prior years, the value used to determine the number of granted shares is typically materially substantially below the then prevailing share price. The share price is decreased to account for the characteristics of the plan. This system is chosen to include the odds of non-vesting, holding restrictions after the vesting date, conditionally of the grant on continued employment and the shares not paying any dividends prior to the vesting date.

The performance period of the long-term incentive plan is set at three years. The Committee uses scenario analysis to estimate the possible outcomes of the value of the shares vesting in coming years and decides whether a correct risk incentive is set for the Management Board members with
respect to the overall level of pay and pay differentials within the Company.

In addition to the information provided in the Remuneration Report, please refer to Note 3 of the
Financial Statements for a further description and valuation of the option and share plans.

Performance-measuring and peer group performance

Vesting of the shares is conditional on KPN’s relative shareholder return. The table below provides an overview of KPN’s performance peer group.

Please note that the peer group used for relative TSR reflects the relevant competitive market in which KPN competes for investor preference. As such, it is different from the employment-market peer groups, which are used to determine pay levels for the CEO and members of the Board of Management. The peer group may be adjusted if an individual company no longer qualifies as a relevant peer company.

Performance incentive zone
Since 2008, the design of KPN’s long-term incentive plan ensures that shares are rewarded for ‘above average’ returns while no shares are rewarded for ‘below average’ returns. Once vested, the shares will have to be held for a minimum period of two years. This does not hold for shares
that would have to be sold to cover income tax obligations in relation to the vested shares (typically the value taxed as income equals the amount of shares vested multiplied by the share price at the time of vesting). The table below provides an overview of the vesting schedule applied.

The external remuneration consultant calculates the endof- year TSR peer group position and the number of shares vested and makes certain that calculations are performed objectively and independently.

The Supervisory Board has the discretionary authority to reward extraordinary management achievement that outperforms the regular business plan(s) and has created substantial additional value for the Company and its shareholders. Other than that, discretion both up and down can be applied if the outcome on the LTI incentive scheme would be grossly unfair or if the outcome would
not be considered to reflect the basic objectives and principles of pay as outlined in this section.

It is KPN’s policy to remunerate management in the event of a change of control in a manner which encourages management to take into account the interests of all stakeholders of the enterprise as is required under Dutch law. An amendment to the remuneration of the Members of the Board of Management in case of a change in control was adopted by the AGM in April, 2010.

Actual pay-out levels
KPN’s performance over the period 2008–2010 resulted in the 5th position in the TSR performance peer group with respect to the 2008 share award, which leads to a vesting percentage of 150% of the shares that will vest in April 2011. This TSR performance justifies the conclusion that KPN’s excellent short-term performance does not have to come at the expense of KPN’s longer-term performance and vice versa.

Special arrangement for the CEO
The performance period of the shares granted to the CEO in 2010 is one year, and any shares vested cannot be sold before July 2011. At the end of 2010, KPN held the 11th position with respect to the 2010 share grant, which does not lead to vesting of the shares in April 2011 for the CEO.
This TSR position is no indication of KPN’s final ranking after the three-year performance period that applies to the other members of the Board of Management.

Special LTI

As presented in the 2009 AGM, the Supervisory Board agreed to an uplift of the LTI entitlements for 2009 and 2010 in order to reflect the extremely high ambitions of the ‘Back to Growth’ strategy. This will result in a LTI value determination of 200% (instead of 150%) of base salary for the CEO and 125% (instead of 75%) of base salary for the other members of the Board of Management. The uplift in LTI will be rewarded if the challenging financial targets in 2009 and 2010 are met and KPN will reach a number 1, 2 or 3 position in the TSR peer group ranking. The Committee reviewed the extent to which the stretched targets have been achieved and decided that, taking into account the vesting conditions, the Special LTI will not be rewarded to the CEO. For the other members of the Board of Management this decision will be made based on KPN’s final ranking after the three-year performance period.

Change in composition and responsibilities of the Board of Management

KPN and Mr Miller agreed upon his resignation as director and CEO of Mobile International. KPN and Mr Miller agreed that his employment contract terminated on February 1, 2010.

A severance arrangement amounting to EUR 2.25 million was contractually agreed upon, consisting of two years’ base salary (taking into account the contractually agreed gross-up) and additional items such as pension and healthcare contributions. Mr Miller’s 2007 LTI and 2009 STI were paid pursuant to his contract of employment.

The departure of Mr Miller has led to a change in responsibilities within the KPN Board of Management. Mr Blok assumed responsibility for KPN’s International operations and Mr Coopmans assumed responsibility for KPN’s Dutch Telco activities. Mr Blok and Mr Coopmans received a revised remuneration within the framework of KPN’s remuneration policy.

The Supervisory Board has announced its intention to appoint Mr Blok as the next Chairman of its Board of Management. The appointment will, as planned, come into effect as of KPN’s AGM on April 6, 2011, on which date current CEO Mr Scheepbouwer will step down from his position.

Claw-back clause

The Supervisory Board has committed itself to the clawback clause since 2009. This clause provides for the ability to recover pay based on incorrect financial or other data.

Benefits

Pensions

• Members of the Board of Management are eligible for a defined contribution pension plan with a contribution based on the fiscal defined contribution table that corresponds to a retirement age of 65 and an annual accrual rate of 2.25%.
• Those members that were part of the Board of Management prior to January 1, 2006 will continue to participate in the previous pension plans.

Additional arrangements
The additional arrangements, such as expense allowances, use of cellphones and Company car provisions needed for the execution of their roles, are broadly in line with other companies of similar size and complexity, as well as with market standards.

Loans
Company policy does not allow loans to be granted to members of the Board of Management.

Terms of employment

Severance arrangements
Severance payments for the CEO and members of the Board of Management are aligned with the Dutch Corporate Governance Code (one year base salary), with the exception of Mr Blok. In his current employment contract, a severance arrangement of one year base salary plus 100% short-term incentive was contractually agreed with Mr Blok. As part of the appointment of Mr Blok as
Chairman of the Board of Management, the severance clause will be contractually adjusted to one year base salary.

Main differences in pay compared to last year (Special LTI)

Although the fundamentals of our pay policy have remained unchanged, as presented in the 2009 AGM, the Supervisory Board agreed to an uplift of the LTI entitlements for 2009 and 2010 in order to reflect the extremely high ambitions of the current ‘Back to Growth’ strategy, in particular in this economic climate. This will result in a LTI value determination of 200% (instead of 150%) of base salary for the CEO and 125% (instead of 75%) of base salary for the other members of the Board of Management. The uplift in LTI will be rewarded if the challenging financial targets in 2009 and 2010 are met and KPN will reach a number 1, 2 or 3 position in the TSR peer-group ranking. In 2011, the Committee will review the extent to which the stretched targets have been achieved.

Outlook for 2011

A review and discussion of the existing pay policy was assessed in 2010, taking into account KPN’s risk profile, pay trends in the Netherlands and abroad as well as trends in Corporate Governance.

The adjustments to the pay policy will be proposed for adoption by the AGM on April 6, 2011, including but not limited to:

With the proposed changes, the Supervisory Board wishes to shift the emphasis of the incentives towards the longer term, to simplify the LTI grant policy and to add non‑financial elements to the LTI.

Due to an increase in workload, complexity and level of responsibility, a market competitive adjustment to the fee structure for the Supervisory Board will be proposed for adoption by the AGM on April 6, 2011.

D. Details of actual pay-out in 2010

The pay of the current members of the Board of Management is set out below.

1) The fair value of the 2010 grant was EUR 8.94 for Board members and EUR 6.06 for the CEO, to whom slightly different arrangements applied. This value deviates from the value attributed to the individual awards at the date of grant, due to differences in the calculation method. Please refer to the ‘Long-term incentives’ section of this report for a further explanation.

2) The pension costs relate to the premiums paid for new members of the Board of Management as of 2006 and the service cost in the corresponding years for the other members. Interest charges and investment yields are not allocated on an individual basis. Since 2006, Board of Management members are eligible for a defined contribution pension plan with a contribution based on the fiscal defined contribution table that corresponds to a retirement age of 65 and an annual accrual rate of 2.25%. The CEO receives a defined benefit pension based on a final pay structure with a retirement age of 65 and an attainable pension equal to 70% of his last fixed salary. The defined benefit pension of the CEO was fully funded at the start of his employment in 2001. No service charges to the pension provision are allocated because the fixed salary remains unchanged.

3) Actual bonus that relates to performance in the current year but paid out in the following financial year. On average, revenues were
below target, EBITDA was above target and Profit before Tax was above maximum.

The pay of the former members of the Board of Management is provided below.

1) The income of Mr Miller is partly subject to Belgian tax law, pursuant to his Belgian employment contract. It was agreed that a Dutch employment contract would not have a negative impact on his net income. In 2010, the amount payable to Mr Miller therefore includes compensation for loss of net income of EUR 654,500 (EUR 119,500 for base salary and EUR 535,000 for the exit payment). In 2009 this compensation for loss of net income was EUR 261,920 (EUR 160.000 for base salary, EUR 101,920 for the STI). Further, Mr Miller received reimbursements for tuition costs of children and for private international medical plan expenses. Mr Miller’s pension entitlement was insured in Belgium based on a retirement age of 60 and a defined contribution scheme. In 2010, salary and social security is predominantly related to the notice period.

2) Excluding the payment of EUR 890,961 related to the 2007 share grant of Mr Smits and excluding the payment of EUR 588,856 related to the 2007 share grant of Mr Miller (see paragraph ‘Change in composition of the Board of Management’).

The following table summarizes the shares/share-based awards granted to current and former members of the Board of Management, granted (un)conditional shares/share-based awards held by them during 2010, granted shares sold during 2010, and granted (un) conditional shares/share-based awards held by them as of December 31, 2010.

1) The shares granted to the Board members represent 17% of the total number of shares and share-based awards granted in 2010 to all employees. On the grant date (April 15, 2010) the KPN share price quoted EUR 11.46 (closing price) while the fair value of each granted share was EUR 8.94 for Members of the Board of Management.

2) The value of each granted share for the CEO (to whom slightly different arrangements apply) as EUR 6.06.

3) Value is calculated by multiplying number of share awards by the fair value.

4) Former member.

5) Not granted in capacity as Board Member.

6) The 2007, cash-settled, share-based award had a vesting percentage of 183%, the 2009 share award for the CEO had a vesting percentage of 150%.

See Note [3] of the Consolidated Financial Statements for a description of the share plan.

The following table summarizes the options granted to current and former members of the Board of Management under previous policies, granted options exercised by them during 2010, and unexercised options held by them as of December 31, 2010. Options issued carry an entitlement to one KPN share.

1) Options not granted in capacity as Board Member.
2) The pre-tax market value of 2005 options at the end of holding period is EUR 1,556,959. The pre-tax market value of 2007 options at the end of vesting period is EUR 0.

The exercise price of the options equals the market value of KPN’s share on the grant date. These options are performance related. As contractually agreed at the time of appointment, the stock options for the CEO are not linked to performance. See Note [3] of the Consolidated Financial Statements for a description of the option plans.

Stock ownership Board of Management

The tables on the left show the shares held by members of the Board of Management (excluding vested shares in lock-up period).

1) Former members. Number of shares at the date of step down from the Board of Management.

Share ownership relates to normal shares. In 2006, Mr Coopmans privately purchased 200 options on 100 shares on the stock market.

E. Supervisory Board pay

The Committee is responsible for reviewing and, if appropriate, recommending changes to the pay of the Supervisory Board. Any recommended changes to Supervisory Board pay must be submitted to the AGM for approval.

The current annual pay for the Chairman of the Supervisory Board is EUR 80,000. Annual pay for Supervisory Board members is EUR 55,000. Committee fees are determined on an annual basis. Please refer to the table for further details. Members receive an additional fee if a meeting is held in a country other than the member’s country of residence.

Shareholdings in the Company held by Supervisory Board members serve as a long-term investment in the Company and help to align their interest with those of KPN’s other shareholders. No Supervisory Board member is granted stock options or shares as a form of pay. No member of the Supervisory Board held any stock options in the Company. As a policy, the Company does not provide loans to its Supervisory Board members.

The table below shows the pay-out to current and former Supervisory Board members in 2010 and fixed Committee fees on an annual basis.

The table below shows the actual fee received by each member of the Supervisory Board.

The pay of the former Supervisory Board members is provided below.

Stock ownership Supervisory Board

The table below shows the shares held by members of the Supervisory Board.

The shares of the former Supervisory Board members are provided below.

Share ownership relates to normal shares or ADRs, constituting one vote in the AGM per share.