Explanatory report by the Directors and proposals of resolution

Report of the Board of Directors issued in accordance with Article 72, first paragraph, of Consob Regulation No. 11971 of May 14, 1999, as amended.

Dear Shareholders,

  1. You have been convened also to attend this extraordinary meeting to discuss our proposal regarding (i) some amendments to the Company's By-Laws, (ii) the voluntary reduction of the share capital by the amount of € 32,498,345.12 pursuant to article 2445 of the Italian civil code, to be allocated to stockholders' equity; consequent amendments to article 5 of the By-Laws.

As regards the first proposal:

Amendment to articles 5 (Share Capital), 7 and 8 (Shareholders' Meeting), 10 and 11 (Management), 16 (Board of Statutory Auditors) of the By-Laws. Inherent and consequent resolutions.


1. The reasons for the proposed amendments to the By-Laws

Firstly, we wish to recall that on January 27, 2010, Legislative Decree No. 27 (the "Decree") was approved. The Decree, implementing "Directive 2007/36/EC on the exercise of certain rights of shareholders in listed companies", has introduced some changes into the Italian Civil Code and into Legislative Decree No. 58 of February 24, 1998 ("TUF") with the aim of promoting the participation of shareholders in general meetings and of facilitating the exercise (including cross-border ambit) of the right to vote. It should be recalled that the shareholders' meeting (resolution of April 21, 2010) has already incorporated in the Company's By-Laws the right - reintroduced into the Italian system by the said Decree - to call the meeting to approve the Financial Statements within 180 days after the end of the company's financial year (in lieu of the previous term of 120 days).

Furthermore, by virtue of the powers granted thereto (Article 2365, second paragraph, of the Italian Civil Code, art. 11.2 of the By-Laws), the Board of Directors of the Company (meeting of November 3, 2010) has approved some amendments to the By-Laws. In particular:

  • following the entry into force of Legislative Decree No. 39 of January 27, 2010 (the so-called "Consolidating Act on Legal Revision"), the term "accounting audit" has been changed into "statutory audit";
  • pursuant to the so-called "record date" mechanism, introduced for the first time into the Italian system by the said Decree, the term "shareholder" has been replaced with that of "holder of the right to vote". In fact, under the amended Article 2370 Italian Civil Code and the new art. 83-sexies TUF, the subject who is entitled to participate in the general meeting and exercise his voting rights is no longer (only) that who, on the date of the meeting, is a shareholder of the company but that who holds the right to vote and intervene on the so-called "record date" (i.e. "at the end of the accounting day of the seventh trading day preceding the date of the meeting to be held on first [or single] call");
  • since the new art. 135-novies, paragraph 6, TUF, has introduced the possibility of «appointing a proxy holder by electronic means» (according to rules to be prepared by the Minister of Justice) establishing that «the companies indicate in their By-Laws at least one effective method of notification by electronic means of the proxy that shareholders are entitled to use», Article 7.3 of the new By-Laws allows for the proxy itself to be notified via: (i) a dedicated section of the Company website or (ii) certified electronic mail;
  • Article 7.5 of the By-Laws has been suited to Article 126-bis TUF regarding (i) procedures and time limits that members must comply with to put new items on the agenda, and (ii) the report on the new items which the applying members propose to discuss;
  • the time limits (from 15 days to 25 days before the meeting) for the submission of slates for the appointment of the Board of Directors (Article 10) and of the Board of Statutory Auditors (Article 16) have been changed.

At its meeting on March 8, 2011, the Board of Directors of the Company deemed it appropriate to make further amendments and additions to the By-Laws which, therefore, it now proposes to adopt. In particular, these proposals are intended to give effect to certain rights granted to companies as under the Decree. In order to fully understand the proposed amendments and the reasons thereof, please find below a description of the non-mandatory provisions contained in the aforementioned Decree.

a) Provisions contained in the Decree which we propose to adopt:

(i) meetings held on single call

The amended Article 2369 Italian Civil Code allows companies to "exclude second or subsequent calls, establishing that the majorities indicated in the third and fourth paragraph [of art. 2369] as well as in the first paragraph, second sentence, of art. 2368, apply to single-call ordinary meetings, while the majorities laid down in the seventh paragraph [of art. 2369] apply to single-call extraordinary meetings. In other words, companies can provide for a single call which the quorums reported below will apply to.

As for the ordinary meeting held on single call, this (i) will be duly constituted regardless of the capital represented at the meeting, and (ii) will decide by absolute majority, unless the By-Laws require a higher majority (the quorums for ordinary meetings held on second call will thus apply).

As for the extraordinary meeting held on single call, this will be duly constituted in the presence of members representing at least 1/5 of the share capital, unless the By-Laws require a higher capital share, and will decide with the favourable vote of at least 2/3 of the share capital represented at the meeting (the quorums for extraordinary meetings held on third and subsequent calls will thus apply). The possibility of having a single-call meeting, with the application of the above mentioned quorums, is an opportunity to simplify the organizational activities of general meetings with potential cost savings benefits, and it facilitates the members' participation in general meetings because of the certainty as to the actual date thereof.

For this reason, we propose to incorporate this option in the By-Laws, subject to the possibility for the Board of Directors to call the general meeting more than once in case of circumstances where subsequent calls to the first one are appropriate.

(ii) S hareholders' representative designated by the company

The new art. 135-undecies TUF introduces into the Italian system the so-called "designated representative". In particular, unless otherwise provided in the By-Laws, "listed companies designate for each general meeting a person who may be appointed as a proxy holder by the members by the end of the second trading day preceding the date of the meeting held on first or single call, with voting instructions for all or some of the items on the agenda".

Although the decision as to the appointment of the "designated representative" for each general meeting may be completely excluded or referred to the Board of Directors, we propose to include an express provision in the By-Laws according to which, for each general meeting, one or more persons be (necessarily) designated who may be appointed as proxy holders by those entitled to participate in the general meeting, leaving it to the notice of call to set solely the method and time limits for the issue of such proxy.

To include this statutory provision in the By- Laws underlines the importance given by the Company to this option to intervene in the general meeting, on the one hand, and allows the shareholder to become aware of this option by merely reading the By-Laws, on the other.

(iii) "record date" and other amendments connected to the decree

As said above, the Decree has introduced for the first time into the Italian system the so-called "record date" mechanism, so that the person who is entitled to participate in the general meeting and exercise his voting rights is no longer (and necessarily) the person who, on the date of the meeting, is a shareholder of the Company; rather, the person who holds the right to vote and intervene in the meeting "at the end of the accounting day of the seventh trading day preceding the date of the meeting to be held on first call".

Given this innovative provision that substantially changes the mechanism of entitlement to attend general meetings, we propose to underline in the By-Laws the essential elements that characterize the so-called record date in order to make it easier for shareholders to understand its content.
For the same reason, we propose to underline in the By- Laws the main points regarding convocation of general meetings and the option of putting new items on the agenda.

b) Further proposals to amend the By-Laws which we propose to adopt

We also propose (i) to introduce an amendment related to the Company's adoption of the so-called "Procedure for Related Party Transactions" (see explanation below) and (ii) further amendments to refine the By-Laws and make them clearer, more systematic and complete, including minor changes of a purely terminological and/or formal nature.

 

For the sake of completeness, please find below the other provisions contained in the Decree which the Board of Directors has decided not to propose to adopt for the time being.

(i) voting by electronic means

Under the new art. 2370, fourth paragraph, of the Italian Civil Code, the By-Laws may provide that votes may be cast by electronic means, as is already the case of postal voting.

Given the limited success of this option in the Italian experience and given, more importantly, the lack of a regulatory framework that fully and clearly regulates this issue, the Company has decided to postpone to a later stage its assessment as to the incorporation of this right in the By-Laws.

(ii) dividend bonus

Pursuant to the new art. 127-quater TUF, the By-Laws may provide for the possibility of awarding to "each share held by the same shareholder for an uninterrupted period […] of not less than one year" the "right to a bonus of up to 10 per cent of the dividend awarded to the other shares". This benefit is limited to those who (directly or indirectly) have a shareholding that does not exceed 0.5% of the company's capital (or the lower percentage indicated in the By-Laws).

The bonus cannot be attributed to (i) the shares held by those who during the said period have exercised, even temporarily or together with other members through a shareholders' agreement, a dominant influence or significant influence over the company, (ii) the shares that have been transferred, even temporarily, to a shareholders' agreement concerning a total shareholding of more than 0.5% (or the lower percentage indicated in the By-Laws).

The uncertainty that currently arises from the relevant regulatory framework and the difficulties encountered in applying in practice the dividend bonus mechanism (not least, the difficulty of identifying the persons entitled to the bonus), have induced the Board to postpone its evaluation to a later stage.

(iii) identification of shareholders

Under the new art. 83-duodecies TUF "where provided by the By-Laws, Italian [listed] companies may ask intermediaries, at any time and at the former's own cost and through a central management company, for the identification data of shareholders who have not expressly prohibited disclosure thereof, together with the number of shares registered in their accounts". Where the By-Laws provide for this option, "the company must make this request upon the demand of members representing half the minimum shareholding set by Consob" for the submission of slates for the appointment of the management, and "costs are shared between the company and the requesting members according to criteria established by Consob".

In this latter regard, please note that the so-called Issuers' Regulations establish that "if the right [to identify shareholders] is exercised by members within six months of year-end and in any case before the annual ordinary meeting and no request for identification is made in the same period […], the company shall bear the full cost of disclosure of the shareholder's identification data and of the number of shares registered in their accounts".

Given (i) the absence of rules establishing, in a clear and comprehensive way, the concrete method which intermediaries must follow to determine the disclosure costs borne by issuers and (ii) the current shareholding structure of the Company that is "nominally" public for more than 50% of the share capital, the Board has decided to postpone its decision on the implementation of this right to a later stage.

Given that the general meeting that is called to approve the Financial Statements at December 31, 2010 is also required to decide on the renewal of the Board of Directors which has lost office due to expiry of its term, it is essential to give the following information.

According to Article 10, fifth paragraph, of the By-Laws, slates may be submitted only by members who, either alone or together with other members, hold shares representing at least 2% of the share capital with voting rights in the ordinary shareholders' meeting, or the minor percentage required by the regulations issued by Consob which, for the year 2011, was 1. 5% of the share capital (cfr. Consob Resolution No. 17633 of 26/01/2011).

The Board has deemed it appropriate not to propose to reduce the percentage established by the By-Laws in order to align it with that established by Consob since, on the one hand, the current formulation is already designed to facilitate the submission of slates by minorities for the renewal of Management bodies (establishing in any case a "cap" to the percentage required for the presentation of minority slates which, in any case, may be reduced according to an assessment of the parameters set by Consob, among which market capitalization) and, on the other hand, this allows for the By-Laws provision to be adequately flexible.

The following paragraphs describe in detail the amendments indicated above with reference to the single articles of the By-Laws.

article 5 (share capital)

The current Article 5, fourth paragraph, gives evidence (i) of the resolution adopted by the extraordinary shareholders' meeting of May 7, 2003 by which Directors were authorized to issue, on one or more occasions, up to a maximum of 100,000,000 ordinary shares to be allocated to executive managers and cadres of the company and its subsidiaries, and (ii) of the resolution adopted by the Board of Directors, in partial implementation of the authorization granted to it, to increase the share capital by issuing new ordinary shares to be reserved for subscription to executive managers and cadres of the company and its subsidiaries.
Having expired the authorization granted by the shareholders' meeting on May 7, 2003 and being terminated the stock option plans by which, as resolved by the Board of Directors, the share capital increase has been inplemented as under point (ii), we propose to fully amend the said paragraph 4 and thereby re-number the current paragraph 5.

article 7 (shareholders' meetings)

For the reasons outlined above, we propose to revise paragraph 2 of Article 7 of the By-Laws establishing that the Board of Directors may provide for the meeting to be held on single call or on more calls.
In the same article, we also propose to revise:

  1. in part and to supplement paragraph 3 of Article 7 in order to incorporate art. 135-undecies, paragraph 1 TUF, on the designation of the representative who may be appointed as a proxy holder with voting instructions by those entitled to vote;
  2. paragraph 5 and to add the "new" paragraphs 6, 7, 8 and 9, which reaffirm the essential elements of the reformed regulations on the convocation of the general meeting and on the right to put new items on the agenda. As a result of these amendments, we propose to re-number paragraph 6 as paragraph 10.

article 8 (shareholders' meetings)

As stated above, the proposed amendments consist of introducing paragraphs 3, 4, 5 and 6, which state again the provisions of Art. 83-sexies TUF regarding the entitlement to attend the general meeting and the exercise of voting rights (the so-called "record date").

Article 10 (Administration of the company)

The proposed amendments to Article 10 are (i) designed to foster greater explanatory clarity, and/or of a purely formal nature or (ii) due to other changes proposed in this report (in particular, the inclusion in paragraph 3 of the reference to the general meeting held on single call).

Article 11 (Administration of the company)

On November 3, 2010, the Board of Directors approved a new "Procedure for Related-Party Transactions", published on the Company website in compliance with the prescriptions on this issue contained in the "Regulation of related-party transactions", adopted by Consob Resolution No. 17221 of March 12, 2010, as amended by Consob Resolution No. 17389 of June 23, 2010, taking into account the guidelines and clarifications provided by Consob in its Communication No. DEM/10078683 of September 24, 2010.

This Procedure includes the possibility (under article 13, sixth paragraph, of the said Regulation issued by Consob), in case of urgent matters, to enter into transactions with related parties of greater or lesser importance (as defined in the Procedure) by derogating from the respective authorization processes required therefor, provided this is allowed by the By-Laws and in cases where the transaction does not pertain to the Shareholders' meeting and needs not be approved thereby, subject to the obligations in terms of "information to the public about related-party transactions". Therefore, we propose to introduce a new paragraph 3 which allows for the enforcement of this option. Hence, we also propose to re-number the subsequent paragraphs of Article 11.

Article 16 (Board of Statutory Auditors)

The proposed amendments concern the re-wording of paragraph 7, taking into account the provisions of art. 144-sexies of the Issuers' Regulations and art. 147-ter TUF) about disclosure of the slates presented by the shareholders to appoint the Statutory Auditors candidates. Further amendments proposed in relation to Article 16 are (i) designed to foster greater explanatory clarity, and/ or of a purely formal nature or (ii) due to other changes proposed in this report (in particular, also in this case, the inclusion in paragraph 7 of the reference to the general meeting held on single call).

2. Compared illustration of the articles of the By-Laws which we propose to amend

The comparison between the current articles of the By-Laws which we propose to amend and those which we submit for your approval is contained in the following resolution proposal.

3. Evaluation by the Board of Directors as to the potential enforceability of the right of withdrawal

The Board of Directors believes that the amendments to the By-Laws described above do not give rise to the right of withdrawal as under Article 2437 Italian Civil Code.

4. Resolution proposal

Based on the foregoing, the Board of Directors submits the following resolution proposals for your approval: "The extraordinary shareholders' meeting of Pirelli & C. S.p.A.,

  • having examined the Directors' Report explaining the proposed amendments to Articles 5 (Share capital), 7 and 8 (Shareholders' meetings), 10 and 11 (Administration of the company), 16 (Board of Statutory Auditors) of the By-Laws;