In accordance with section 3.10 of the German Corporate Governance Code, the Management Board – also acting on behalf of the Supervisory Board – reports on corporate governance at Villeroy & Boch in the following report. This report contains the declaration on corporate governance in accordance with section 289a (1) of the German Commercial Code (HGB) and the remuneration report pursuant to sections 4.2.5 and 5.4.6 of the German Corporate Governance Code on the remuneration paid to the Management Board and Supervisory Board.

Good corporate governance aimed at creating sustainable value through responsible corporate management is traditionally of fundamental importance for Villeroy & Boch. It serves as the foundation for promoting the trust of investors, customers, employees and the public. Accordingly, the recommendations and suggestions of the Government Commission of the German Corporate Governance Code constitute the basis for the actions of the Management Board and Supervisory Board of Villeroy & Boch AG.

Responsible management

Under the dual management system prescribed by law for a German public limited company, the Management Board of Villeroy & Boch AG is responsible, as the governing body, for managing the Company with the aim of creating short-term and long-term value. The workings of the Management Board are determined by corresponding Rules of Procedure. Resolutions are adopted at meetings of the Management Board, which take place at least twice a month. In filling management positions at the Company, the Management Board seeks to take regard of diversity and, in particular, to take appropriate account of women.

The Supervisory Board appoints, advises and monitors the Management Board. Its workings are established in corresponding Rules of Procedure. Ordinary meetings of the Supervisory Board are held at least four times a year. On the basis of continuous, rapid and transparent information – both written and verbal – provided by the Management Board, the Supervisory Board is directly involved in all decisions of material importance to the Company.

Composition of the Management Board

The Management Board of Villeroy & Boch AG currently consists of two members. The members of the Management Board are appointed by the Supervisory Board in accordance with the provisions of the German Codetermination Act. In appointing members to the Management Board, the Supervisory Board pays attention to the professional suitability, experience and management quality of the candidates. With respect to the overall composition of the Management Board, it seeks to ensure diversity and to have appropriate participation by women. When examining potential candidates to fill vacant positions on the Management Board, highly qualified women are included in the selection process and are taken into account to an appropriate extent. The precise composition of the Management Board is shown on page 14. Personnel changes in the year under review are presented in the Report of the Supervisory Board.

Composition of the Supervisory Board

The Supervisory Board of Villeroy & Boch AG is composed of twelve members, six of whom are elected by the General Meeting of Shareholders (shareholder representatives) and six of whom are elected by the Company’s employees in accordance with the provisions of the German Codetermination Act (employee representatives). The term of office of members of the Supervisory Board is normally five years. The Supervisory Board takes its role of monitoring a globally operating company seriously. It is of the opinion that its composition is an important factor in successfully performing its diverse tasks to the optimal benefit of the Company. In accordance with the recommendation set out in section 5.4.1 of the German Corporate Governance Code, it therefore defined the following targets for its composition at its meeting on 10 March 2011:

“The composition of the Supervisory Board of Villeroy & Boch AG should be such that the Management Board will be subject to informed monitoring by and receive expert advice from the Supervisory Board at all times. The candidates proposed for election to the Supervisory Board should be in a position, thanks to their knowledge, skills and professional experience, to perform the tasks of a Supervisory Board member in an internationally active company and to safeguard the reputation of the Villeroy & Boch Group with the public. In the process, attention should be paid to the personality, integrity, commitment, professionalism and independence of the persons proposed for election. The individual knowledge, skills and experience of the individual members of the Supervisory Board should complement each other in such a way that there is sufficient professional expertise available for the work of the Supervisory Board as such and for the business activities of each division at all times to guarantee that the Management Board is monitored professionally and efficiently and provided with advice on a continuous basis. In view of the Company’s international focus, attention should be paid to the fact that, as has been the case to date, there is an adequate number of members with many years of international experience. In proposing members for election, the Supervisory Board shall also seek to ensure appropriate participation by women. Highly qualified women should be included in the selection process when examining potential candidates as new members or filling vacant positions on the Supervisory Board and should be taken into account to an appropriate extent in the members proposed for election. The Supervisory Board will strive to have at least one female member in future. The Supervisory Board should have a sufficient number of independent members. Significant conflicts of interest that are not merely temporary should be avoided. The Supervisory Board members should also have sufficient time to perform their functions such that they can do so with the requisite regularity and diligence. The regulation on the age limit laid down by the Supervisory Board in the Rules of Procedure will be taken into account. No more than two former members of the Management Board of Villeroy & Boch AG should sit on the Supervisory Board.”

The Supervisory Board is of the opinion that, on the whole, its current members have the necessary knowledge, professional experience and skills to perform their tasks properly. In the year under review, there were no elections to the Supervisory Board and no future proposals for election were discussed. The precise composition of the Supervisory Board is shown in the list on page 15.

Trust-based cooperation between the Management Board and the Supervisory Board

The cooperation between the Management Board and Supervisory Board was again characterised by open, trust-based communication to the benefit of the Company in 2011. This was seen in the meetings of the Supervisory Board and in the discussions between members of the Management Board and the Chairman of the Supervisory Board and the Chairman of the Audit Committee. In the past financial year, the reports by the Management Board to the Supervisory Board focused specifically on the direction and implementation of corporate strategy, the Company’s business development, the Group’s position, and questions relating to the risk situation, risk management, the internal control system and compliance.

The Supervisory Board’s right to withhold approval in certain cases is laid down in the Rules of Procedure for the Supervisory Board and the Management Board. This applies to significant transactions or measures affecting the net assets, financial position and results of operation of Villeroy & Boch AG.

Supervisory Board committees

To allow it to perform its tasks efficiently and deal with complex issues more intensively, the Supervisory Board has formed three expert committees, each consisting of three members, in addition to the Conciliation Committee prescribed by section 27 (3) of the German Codetermination Act. The activities of the committees are governed by the Rules of Procedure for the Supervisory Board and the respective committees.

By law, the Conciliation Committee prescribed by section 27 (3) of the German Codetermination Act must be established in order to perform the task set out in section 31 (3) sentence 1 of the German Codetermination Act. It submits proposals for the appointment or the revocation of the appointment of Management Board members to the Supervisory Board if the requisite majority of two-thirds of the votes of Supervisory Board members is not reached in the first ballot. It consists of the Chairman and First Vice Chairman of the Supervisory Board, one shareholder representative and one employee representative. The current members are Wendelin von Boch-Galhau (Chairman), Ralf Runge (First Vice Chairman), Peter Prinz Wittgenstein and Ralf Sikorski.

The Human Resources Committee primarily deals with the conclusion as well as the amendment and termination of the employment contracts of Management Board members and long-term succession planning. It prepares the appointment and dismissal of members of the Management Board, the remuneration system for the Management Board and the total remuneration for the individual members of the Management Board, including contractual bonus provisions, pension provisions and other contractual benefits, for resolution by the full Supervisory Board. It is chaired by the Chairman of the Supervisory Board and also includes one employee representative and one shareholder representative. The current members are Wendelin von Boch-Galhau (Chairman), Ralf Sikorski and Dr. Jürgen Friedrich Kammer.

The tasks of the Investment Committee include advising on corporate and investment planning in advance and preparing investment decisions. The Investment Committee is chaired by the Chairman of the Supervisory Board and also includes one employee representative and one shareholder representative. The current members are Wendelin von Boch-Galhau (Chairman), Dietmar Langenfeld and Peter Prinz Wittgenstein (Vice Chairman).

The Audit Committee discusses the topics of accounting, risk management, the internal control and audit system, compliance, and issues relating to the audit of the annual financial statements. It is composed of two shareholder representatives and one employee representative. The current members are Charles Krombach (Chairman), Peter Prinz Wittgenstein and Werner Jäger (Vice Chairman). The Chairman of the Audit Committee is independent and has extensive expertise in the areas of accounting and auditing as a result of his long-standing position as managing partner of Landewyck Group S.à r.l. and Heintz van Landewyck S.à r.l.

No separate Nomination Committee has been formed to propose suitable candidates for election to the Supervisory Board. Proposals for election have been and will continue to be prepared at shareholder representatives’ meetings.

The chairmen of the committees report to the full Supervisory Board on the work of the committees. Information on the key contents of the committee meetings in the past financial year can be found in the Report of the Supervisory Board.

Prevention of conflicts of interest

The members of the Management Board and the Supervisory Board have a duty to uphold the interests of the Company and not to pursue any personal interests that could clash with those of the Company in fulfilling their duties. All members of the Management Board and the Supervisory Board are obliged to disclose any potential conflicts of interest to the Supervisory Board. Roles in other statutory supervisory boards and comparable domestic and foreign controlling bodies of commercial enterprises held by members of the Management Board and the Supervisory Board can be found on pages 14 and 15. Links with related parties are shown in the notes to the consolidated financial statements on page 118.

Efficiency review

The Supervisory Board of Villeroy & Boch AG performs a regular efficiency review. This is a self-assessment of the workings of the Board and is carried out by its members. The efficient work of the Supervisory Board is driven in particular by the work of the committees, which meet as re-quired and prepare the resolutions to be passed by the full Supervisory Board.

Directors’ dealings

In accordance with section 15a of the German Securities Trading Act (WpHG), disclosures on transactions in shares of Villeroy & Boch AG requiring notification are published immediately on the Company’s website; this was the case for transactions by members of the Management Board in the 2011 financial year. At the end of the year under review, the members of the Supervisory Board held directly and indirectly (within the meaning of sections 15a and 22 WpHG) 7.36% of all the ordinary and preference shares issued by the Company (2,066,230 shares). Of this figure, 4.36% (1,223,530 shares) were attributable to Wendelin von Boch-Galhau and 2.77% (778,980 shares) were attributable to Alexander von Boch-Galhau. The members of the Management Board held 0.10% of the shares in circulation (28,750 shares).

Comprehensive information creates transparency and trust

Villeroy & Boch AG seeks to inform all target groups of the Company’s position equally and in good time and to ensure optimal transparency with regard to its management and controlling mechanisms by way of comprehensive reporting. This includes the annual publication of the consolidated financial statements and quarterly reports, which are prepared in accordance with the International Financial Reporting Standards (IFRS). The 90-day period for the publication of the consolidated financial statements set out in section 7.1.2 of the German Corporate Governance Code was again observed this year. The single-entity financial statements of Villeroy & Boch AG are prepared in accordance with the German Commercial Code (HGB).

The website www.villeroy-boch.com also contains the latest news in the form of press releases, ad hoc disclosures and other publications. Annual and interim reports by Villeroy & Boch AG are also available to download in German and English from the Investor Relations section. The publications comply with the transparency requirements set out in the German Securities Trading Act. The annual document in accordance with section 10 of the German Securities Prospectus Act compiles all of the publications relating to Villeroy & Boch AG in the 2011 financial year.

To allow us to maintain a dialogue with analysts and shareholders, the financial and analysts’ press conference and the General Meeting of Shareholders are held once a year.

Publication dates and recurring events are published in the financial calendar on our website, in this annual report and in our interim reports.

Ernst & Young confirmed as auditors

The Supervisory Board again commissioned Ernst & Young GmbH Wirtschaftsprüfungsgesellschaft to audit the single-entity and consolidated financial statements for the 2011 financial year as the auditor appointed by the General Meeting of Shareholders. The Audit Committee and the Supervisory Board had previously satisfied themselves as to the independence of the auditor.

In accordance with the recommendations of the German Corporate Governance Code, the Supervisory Board agreed with the auditor that the Chairman of the Audit Committee would be informed immediately of any potential grounds for disqualification or partiality and any facts and events of importance for the proper performance of the tasks of the Supervisory Board arising during the performance of the audit. If the audit gives rise to facts that show a misstatement in the declaration of conformity issued by the Management Board and the Supervisory Board in accordance with section 161 of the German Stock Corporation Act (AktG), the auditor must inform the Supervisory Board or make a corresponding note in the audit report.

Declaration of conformity in accordance with section 161 AktG

The Management Board and the Supervisory Board are obliged to issue a Declaration of Conformity regarding the adoption of the recommendations of the German Corporate Governance Code once a year in accordance with section 161 AktG. Following intensive discussions at the meeting of the Supervisory Board in December, the Management Board and the Supervisory Board issued the following declaration of conformity, which stated that the Company had complied with and continued to comply with all of the recommendations of the Government Commission of the German Corporate Governance Code with two exceptions.

“The Management Board and the Supervisory Board examined the Company’s compliance with the German Corporate Governance Code on 14 December 2011. In accordance with section 161 AktG, the Management Board and the Supervisory Board of Villeroy & Boch AG hereby declare that, since the publication of the last declaration of conformity on 10 March 2011, the Company has complied with and continues to comply with the recommendations of the Government Commission of the German Corporate Governance Code (the “Code”) in the version dated 26 May 2010 with the exception of the small number of recommendations listed below:

Section 3.8 (2) of the Code:

The existing D&O (directors’ and officers’ liability insurance) policy does not prescribe a deductible for the members of the Supervisory Board. Villeroy & Boch AG is of the opinion that a deductible is not a suitable means of influencing the level of motivation and responsibility with which the members of the Supervisory Board perform their activities.

Section 5.3.3 of the Code:

The Supervisory Board has not formed a separate Nomination Committee to propose suitable candidates for election to the Supervisory Board. Proposals for election have been and will continue to be prepared at shareholder representatives’ meetings. As the Supervisory Board has only six shareholder representatives and the current practice of preparing proposals for election at shareholder meetings has proven to be efficient, the Supervisory Board does not see the need to institutionalise this practice by forming an additional Nomination Committee.”

In the 2011 financial year, Villeroy & Boch focused on the further intensification of the compliance organisation within the Group:

The establishment of an effective compliance organisation is a vital element of good corporate governance with a view to ensuring compliance with statutory provisions, internal guidelines and our corporate values. In the 2008 financial year, a compliance organisation going above and beyond the existing measures was created as part of the risk management system.

Restructuring of the Compliance organisation

In the year under review, Villeroy & Boch restructured its existing compliance organisation in line with the principle of permanent and sustainable self-improvement. The objective was to ensure that operating business is incorporated within the compliance organisation to an even greater extent, starting from the level of the Management Board:

• Technical responsibility for compliance issues is divided between the Legal department, which is responsible for ensuring that the statutory provisions relating to competition and anti-trust law are upheld, and the Compliance department, which is responsible for all other issues.
• As in the previous years, our compliance organisation begins directly with the Management Board of Villeroy & Boch AG. Compliance falls within the responsibility of the Chief Financial and Human Resources Officer with the exception of issues falling within the responsibility of the Legal department, which reports to the Chief Executive Officer.
• The Chief Compliance Officer, who is responsible for Group-wide compliance at Villeroy & Boch with the exception of competition and anti-trust law, reports directly to the Chief Financial and Human Resources Officer.
• To ensure that compliance is present within all departments, the Compliance Officer is supported by the Compliance Advisory Board (CAB). The members of the Compliance Advisory Board are the heads of Treasury, Human Resources, Controlling, Internal Audit and Information Technology, the senior environment and occupational health and safety manager, and the senior controllers of the Bathroom and Wellness and Tableware divisions.
• To ensure that compliance is represented in the Group’s operating business to an even greater extent, a Compliance Advisory Group has been introduced for each division in addition to the central Compliance Advisory Board. The Compliance Advisory Groups for the Bathroom and Wellness and Tableware divisions are managed by the respective divisions. Their members are the respective heads of Supply Chain Management, Divisional Controlling, Sales, Marketing and Logistics and the head of the Legal department. These Compliance Advisory Groups also support the Chief Compliance Officer.
• Villeroy & Boch has also restructured its compliance organisation at the level of its subsidiaries: As previously, each subsidiary has a local Compliance officer with responsibility for compliance at the respective company. The local Compliance Officers are assigned directly to, and report to, the Chief Compliance Officer. This serves to ensure that compliance is realised throughout the Group and that feedback is provided to the Management Board by the subsidiaries via the Chief Compliance Officer.
• The Legal department at Villeroy & Boch retains sole Group-wide responsibility for compliance in the area of competition and anti-trust law. It performs the central monitoring of all of the Company’s business processes with respect to the provisions of competition and anti-trust law. In this function, the head of the Legal department continues to report directly to the Management Board, including on legal issues. To provide support for this process, a separate function for advising on and monitoring the Company and its subsidiaries from an anti-trust law perspective has been established and an appointment has been made to this position.

Commitment of the Management Board and senior managers

To ensure that the Management Board is also committed to compliance, the head of the Legal department and the Chief Compliance Officer are the direct points of contact for the Management Board when it comes to compliance-related matters. They are also involved in central decisions by the Management Board and the two divisions.

Employee involvement

Villeroy & Boch has also taken the intensification of its compliance organisation seriously with respect to its employees:

In 2010, an internal whistleblower platform allowing all employees to report breaches of compliance regulations anonymously if desired was installed at the level of Villeroy & Boch AG. In the year under review, Villeroy & Boch continued and intensified the Group-wide training of its employees as initiated in previous years with a particular focus on competition and anti-trust law and the topics of ethical behaviour, combating corruption and money laundering, and occupational health and safety. These classroom-based training sessions are individually adjusted to reflect the needs of the respective target groups – managers, members of the Works Council, administration and, in particular, employees in purchasing, sales and marketing functions. Participation in these training sessions is mandatory for all employees.

At the same time, Villeroy & Boch has created e-learning systems together with external advisors, which it is continuing to develop on an ongoing basis. These e-learning systems are also individually tailored to the Company and the employees being trained and can be used throughout the Group. The systems, which end with a final examination and a certificate of participation, will provide our employees with further training on the topics of ethical behaviour, anti-trust law, combating corruption, IT security and occupational health and safety.

Involvement of business partners

Villeroy & Boch has also continued to implement the topic of compliance with respect to its business partners. For example, it has rolled out a Code of Conduct for suppliers, made preparations for customer commitment to its Code of Conduct, and introduced a Letter of Compliance obliging employees to actively implement and demand compliance in their dealings with business partners. The Chief Compliance Officer, the local Compliance Officers and the Legal department are the day-to-day contacts for employees and business partners. The Code of Conduct for suppliers can also be viewed in the Investor Relations/Corporate Governance section of our website at www.villeroy-boch.com

Permanent improvement

The basis for these improvements to the compliance organisation is provided by Villeroy & Boch’s compliance strategy for the period from 2011 to 2016: This involves the regular adjustment and coordination of guidelines and interfaces, the internal authorisation concept and the analysis and further development of compliance and the internal control system.

The compliance organisation at Villeroy & Boch is based on ethical principles, a general Code of Conduct and supplementary guidelines. These principles and guidelines apply directly to all employees throughout the world. General guidelines and guidelines on the various areas of activity are also in place; these describe the Group’s general Code of Conduct in greater detail and provide employees with specific instructions on how to behave in individual cases. These guidelines are binding for all employees within their respective area of application. All of the principles and guidelines can be viewed by all employees on the Intranet.

The ethical principles and the general Code of Conduct can also be viewed in the Investor Relations/Corporate Governance section of our website at www.villeroy-boch.com

Outlook

The next measures will be to intensify our compliance organisation further, particularly at our subsidiaries, to offer our employees more detailed training based on an existing training cascade, to constantly analyse and improve our general compliance, and to establish a certification process for our anti-trust compliance.

Details of the controlling and risk management system can be found in the Risk Report contained in the Management Report.

Principles of the remuneration system

The Supervisory Board examined the remuneration system for the Management Board in light of the extension to the contract of the Chief Executive Officer and the appointment of a new Management Board member in the year under review. In particular, it examined the remuneration system with respect to the changes in statutory requirements resulting from the German Act on the Appropriateness of Management Board remuneration, which came into force on 31 July 2009, and the recommendations of the German Corporate Governance Code and made adjustments where it considered this to be necessary or otherwise appropriate.

As in the case of the reassessment of Management Board remuneration, the Supervisory Board obtained advice in this matter from an independent remuneration consultant.

The remuneration system for current members of the Management Board is performance-oriented, with the fixed remuneration of the Management Board members being supplemented by a performance-based variable component. The amount of the variable remuneration is dependent on the extent to which the targets set out in the annual objectives are met. If all of the targets are met, it constitutes more than half of the total remuneration paid. In contrast to the previous remuneration system, however, there are changes to the composition and weighting of the variable remuneration. The variable remuneration is now broken down into a short-term annual component (annual bonus) and a long-term component with a measurement period of three years. This long-term remuneration has a higher weighting than the short-term component. In terms of content, both variable remuneration components are oriented towards the Company’s financial targets (return on assets, EBIT, also EBT in some cases) and individual targets. The target parameters for the variable remuneration component are preliminarily agreed upon by the Human Resources Committee of the Supervisory Board together with the members of the Management Board before being approved by the full Supervisory Board; this was also the case in the 2011 financial year. Performance targets and remuneration parameters cannot be amended subsequently. In addition, a company car, also for private use, is offered to members of the Management Board. The existing contracts of the current members of the Management Board provide for defined benefit or defined contribution pension commitments. In the opinion of the Supervisory Board, total remuneration and the individual remuneration components maintain an appropriate relationship to the responsibilities and achievements of the respective Management Board members and the Company’s financial situation and do not exceed typical remuneration either in a vertical comparison or in a horizontal comparison with reference companies.

Supervisory Board remuneration is also composed of a fixed and a variable component. The variable performance-related component is measured on the basis of the dividend distributed by Villeroy & Boch AG.

Supervisory Board remuneration

In accordance with the Articles of Association of Villeroy & Boch AG, the members of the Super-visory Board are entitled to claim reimbursement for the expenses incurred as a result of their work. They also receive fixed basic remuneration and a variable remuneration component.

The fixed annual basic remuneration is Euro 20,000. The Chairman receives an additional Euro 45,000, while the Deputy Chairman receives an additional Euro 13,500. Members of the Supervisory Board receive a meeting fee of Euro 1,250 for each meeting of the full Supervisory Board. The Chairman of the Investment Committee, the Human Resources Committee and the Audit Committee each receive Euro 4,000 p.a. in addition to their basic remuneration, while the members of the respective committees each receive an additional Euro 2,500 p.a.

The variable remuneration amounts to Euro 195.00 per member of the Supervisory Board for each cent by which the dividend payable to shareholders exceeds 10.5 cents per share (calculated as the average of the dividends paid for one preference share and one ordinary share).

The aforementioned remuneration is paid together with any value added tax incurred. Members are entitled to receive remuneration only on a pro rata basis for their term of office.

The members of the Supervisory Board of Villeroy & Boch AG received the following remuneration for performing their duties in the financial year:

A total expense of Euro 506 thousand was reported in the Group result for the 2011 financial year (previous year: Euro 459 thousand). In addition to the fixed remuneration paid and the meeting fees for 2011, this figure includes Euro 83 thousand for the provision for variable remuneration as well as other reimbursements of expenses.

Management Board remuneration

An expense of Euro 1,935 thousand (previous year: Euro 1,968 thousand) was reported in the income statement for the 2011 financial year. This figure is composed of fixed salary components amounting to Euro 1,139 thousand (previous year: Euro 1,144 thousand) and variable salary components amounting to Euro 796 thousand (previous year: Euro 824 thousand). In the past financial year, the Villeroy & Boch Group paid insurance premiums for Management Board members in the amount of Euro 2 thousand (previous year: Euro 2 thousand). The members of the Management Board received remuneration in kind totalling Euro 35 thousand (previous year: Euro 43 thousand). The aforementioned payments also include remuneration paid to a member who has left the Management Board. Provisions for pensions for former members of the Management Board amounted to Euro 15,199 thousand (previous year: Euro 13,174 thousand). In the past financial year, former members of the Management Board received pension benefits totalling Euro 1,371 thousand (previous year: Euro 1,135 thousand).

The provisions of section 314 (2) sentence 2 in conjunction with section 286 (5) HGB apply with respect to the disclosure of the individual remuneration paid to members of the Management Board up to and including the 2011 financial year.