By OSCAR MACKERETH
Portfolios managed by Cerno Capital are run in accordance with the UN principles of Responsible Investment, to which we have been signatories since 2020. These principles help guide our actions in the discipline of long-term investment, which according to our philosophy, entails two structural modalities. First, is the absorption of information with respect to a company’s historical path and current conditions. Second is the forecasting exercise of developing theses as to the possible future paths to growth and the challenges of these paths. These two are distinct, yet intrinsically interconnected as company and industry forecasts cannot be reasonably made without timely access and analysis of accurate information, obtained both through observation and directly from the portfolio companies in question.
The Global Leaders portfolio is first and foremost managed with the aim of generating sustainable long-term returns for investors. We consider this to be a combination of capital appreciation and the security of that appreciation, relative to wider economic scenarios. Our investment horizon and the time frame which we are most concerned with is those which extend beyond five years. As stewards of assets over long timeframes, we are empowered to make decisions on behalf of our investments which potentially have impacts beyond the scope of financial outcomes. This requires us to understand and respond to the short- and long-duration consequences of corporate actions within your portfolio.
Due to our long-term investment horizon, we expect to encounter issues that are dissonant with our preferred outcomes over our holding period. Selling those assets into the secondary market is always a possibility and often offers a sense of resolution. However, we are cognisant of the idea that upon sale, those issues which objectionable to us will persist and continue to be harmful. Therefore, our preferred cause of action is to engage on such issues and work to promote superior outcomes in both financial and non-financial matters.
As such, to our mind, we have three courses of action which, in order of preference, are as follows:
- Retain the asset and engage on the issue, stating our reservations and assessing the responses we receive.
- Retain the asset and engage with other stewards of capital and policymakers to form a joint or combined approach.
- Sell the asset and communicate the reasons for sale to relevant persons of responsibility.
In the calendar year 2023, our engagement has primarily centred around issues of corporate governance. Our approach to governance looks to assess the ability of an appropriately experienced Board to act independently in the interests of long-term shareholders. We look for clearly documented procedures and a prudent approach with regards to management of financial matters and for governance to promote openness and a culture that commits the long-term success of both businesses and industries. Our comfort in the ability, and tendency, of management to act in the best interests of all stakeholders helps to navigate around investments which may ultimately destroy value.
This approach is evidenced through the following case studies, where we highlight votes of significant in the exceptional or annual general meetings of Global Leaders portfolio companies:
LVMH
Enhancing responsibility and disclosure: Advocating for transparency and accountability in family-owned and majority-controlled public companies
Our concerns primarily revolved around the lack of transparency regarding ‘Agache’ related party transactions, which involve Bernard Arnault’s family holding company. Such opacity raises questions about the alignment of interests and potential conflicts of interest within the company.
Furthermore, the lack of independence on the board, particularly in the context of a family-controlled public company, is a matter of concern. We firmly believe that an independent and diverse board is crucial for effective governance and safeguarding the interests of all shareholders.
In addition, we find the sub-par disclosure on the compensation and remuneration policies for Bernard Arnault and Antonio Belloni to be unsatisfactory. As shareholders, we expect best-in-class disclosure, enabling us to make informed decisions and assess the alignment of executive compensation with long-term shareholder value creation.
We understand that such non-normative business structures are not uncommon in family-controlled and operated public businesses, often arising due to the coexistence of family-oriented management approaches and public shareholder ownership. However, these structures should not facilitate the obfuscation of operational ongoings, nor be unnecessarily opaque, as transparency is vital for fostering trust and ensuring the integrity of corporate governance.
We expressed our discontent via proxy voting at the recent AGM votes, in which we voted against several measures:
- Item 4a: We voted against the approval of the auditor’s special report on related-party transactions, as the company failed to provide sufficient information with respect to Agache, thus making us unable to ascertain that the continuation of this agreement is in alignment with shareholder interests.
- Items 5-7: We voted against the re-election of several non-independent nominees, given the lack of independence on the board.
- Items 14, 15, 17 & 18: we voted against the approval of CEO and Vice CEO compensation, given the lack of disclosure on short and long term incentive conditions that vested during FY23, with criteria appearing insufficiently challenging and not truly met.
- Items 28: We voted against the authorisation of up to 1% of issued capital for use in stock options for employees and corporate officers, on the basis of insufficient disclosure.
Assa Abloy
Promoting Shareholder Rights: Advocating for transparent information dissemination and facilitating granular voting rights on critical matters.
Our concerns regarding Assa Abloy revolve around several key issues. Firstly, we expressed dissatisfaction with the bundling of directors in the election vote, which restricts our ability to express satisfaction or dissent against individual board members. This lack of granularity in the voting process prevents us from directly addressing our concerns and holding specific members accountable for their performance or suitability.
Furthermore, we find the independence level of the audit committee to be insufficient. It is crucial for the audit committee to consist of independent directors who can provide objective oversight of financial reporting and internal control processes, free from any conflicts of interest. A robust and independent audit committee is essential for maintaining transparency and safeguarding the interests of shareholders. Additionally, we have reservations about candidate Johan Hjertonsson’s potential over-boarding, given his commitments at four other institutions. Over-boarding can compromise a director’s ability to dedicate sufficient time and attention to each position, potentially affecting their effectiveness and ability to fulfil their responsibilities.
If we had the opportunity, we would have voted against these structures in a more direct manner. However, the current voting structure limits our ability to voice our concerns and hold specific committees or directors accountable. We believe that shareholders should have the ability to vote on individual directors and committees, as this empowers them to exercise their rights to express opinions on a granular level and encourage proper corporate governance. While Assa Abloy’s governance structures are generally coherent and disclosure levels are acceptable, we stress the need for voting procedure to prioritise active shareholder participation.
Moreover, the poor disclosure of long-term incentive rewards awarded to directors in 2022 is another area of concern. The referenced performance period is insufficiently short at less than three consecutive years, and the performance targets for long term incentives were not disclosed. We emphasise the importance of comprehensive disclosure to enable shareholders to assess the alignment of executive compensation with long-term performance and shareholder value creation.
To express our discontent with the referenced issues, we voted in the following manner:
- Item 12: we voted against the election and re-election of all standing directors, as a reflection of our dissatisfaction with the limitations on imposed on our ability to vote on specific committees and directors.
- Item 17: we voted against the approval of the performance share matching plan for long term incentives in 2023.
Koninklijke Philips
Fostering accountability and responsive governance: holding management accountable and advocating for responsible decision-making.
Our concerns primarily revolved around the remuneration structure and the actions of the former CEO. While we typically align with standard voting practices, we decided to deviate from the norm in this case. We voted against the discharge of management but in support of all forward-looking voting items. This was done in order to expressing our dissatisfaction with the ex-CEO’s performance and refusal to act in line with companywide remedial actions for shareholder failures, whilst supporting the responsiveness of ongoing management.
A key concern was the remuneration report presented in the 2022 Annual report. Last year, Cerno Capital, as part of a cohort of 80% of all shareholders, voted against the report due to apprehensions regarding the adjustment of Short-Term Incentive (STI) and Long-Term Incentive (LTI) outcomes, in light of the product recall. We believed that the justification provided for the adjustment was insufficient, especially considering the company’s poor operational performance during the ongoing product recall procedures since 2021.
Management’s response to the dissenting vote was encouraging. They acknowledged the need for transparency and clarity and made commitments to enhance the understanding of potential adjustments and rewards for performance. New targets have been set and disclosed, based solely on adjusted EBITDA metrics. Moreover, a well-defined set of adjustment mechanisms were established, for use in future scenarios. These steps demonstrated their willingness to address our concerns and improve shareholder engagement.
In consideration of the company’s performance amid supply chain challenges and the product recall, and in acknowledgement of shareholder grievances, the supervisory board and the board of management made additional commitments to waive any 2022 payouts and vesting of 2020 long-term incentive grants, aligning incentives with shareholders’ best interests. We supported the new performance-based management incentive payouts and appreciate management’s acknowledgement and responsiveness to sub-par shareholder experiences over the past two years.
However, the departure of former CEO Frans van Houten raised concerns. It appeared that he was unwilling to sacrifice his STIs in line with other members of management. While a majority of his STIs remained unpaid, a portion was payable based on undisclosed non-financial metrics, in addition to a termination benefit, resulting in a total payout of EUR 3,276,264. We deemed this payout inappropriate, considering the company’s recent financial performance and ongoing operational challenges.
In response, Cerno Capital voted in dissent against the discharge of the management board via voting item 2.e. This vote indicated our dissatisfaction and lack of confidence in their performance during the preceding year. Simultaneously, we supported all other voting items, recognising the forward-looking nature of these decisions and ongoing management’s receptiveness to shareholder experiences. Our approach aimed to express our concerns while acknowledging management’s commitment to shareholder engagement.
Taiwan Semiconductor Manufacturing Company
Advocating for superior public divulgence in strategic initiative risk management: Emphasising the importance of facilitating informed shareholder action via detailed public disclosures.
TSMC proposed an increase in the upper limit for guarantee provisions, allowing endorsement/guarantee provided by TSMC and/or its subsidiaries to reach 40% of the consolidated company’s net worth. Some guidance was provided regarding limitations on individual guarantees, such as capping the total amount provided to any individual entity at 10% of the lower of the company or entity’s net worth. However, these limitations were discretionary in nature and subject to board approval and could be lifted in their entirety for wholly owned subsidiaries.
Cerno Capital voted against the provision due to the lack of sufficient justification. Although the additional endorsements and guarantees were intended to support the funding needs of TSMC’s international manufacturing footprint expansion, the level of disclosure regarding the specific purpose of the additional funding and the entities benefiting from it was insufficient. Additionally, there was no guarantee that the recipient companies would be under TSMC’s overarching control, raising concerns about potential risks associated with such a provision.
Our opposition to the proposal stems from the inadequate disclosure and the unanswered questions regarding the potential risks involved. However, we remain open to reconsidering our position in the future if TSMC publishes more detailed disclosure, allowing us to assess the potential benefits of such a transaction and evaluate the adequacy of the risk mitigation measures in place. Transparency and clear communication are essential in enabling us to make informed voting decisions that align with the best interests of the company and its shareholders.
Linde
Protecting minority shareholder rights: preventing potential management entrenchment and advocating for an inclusive corporate governance framework.
Cerno Capital supported a shareholder resolution in 2022 calling for the adoption of a simple majority vote requirement at Linde, replacing the existing supermajority vote requirement. Our rationale for supporting this resolution was based on the belief that supermajority requirements often serve to block proposals that are supported by the majority of shareholders but opposed by a status quo management and a few major shareholders.
We view such mechanisms as detrimental to shareholder rights within company decisions. The previous requirement for 75% of all shares in float to vote in dissent in order to prevent management proposals is illogical, especially considering that typically only 80% of total shareholders vote at each meeting.
Last year, this resolution was passed as a shareholder proposal via a simple majority approval (52%), leading the board to propose a reduction of the supermajority vote requirement where permissible under Irish company law. The proposed changes would alter the vote requirement in several scenarios, such as amending the rights of any specific class of shares, issuing shares of capital stock with unpaid amounts, converting issued shares of capital stock to redeemable shares, treating reduction of share capital as a realised profit, and engaging in a merger or similar transaction with a party that acquired 10 percent or more of shares with potentially hostile intentions.
Cerno Capital maintains the view that a simple majority vote is sufficient protection from outside influence, considering the size of the company and the absence of controlling shareholders. The Vanguard Group holds 9.5% of shares. As a result, there are no beneficial shareholders who could automatically pass simple majority votes.
Nevertheless, the top 5 shareholders collectively hold 21.9% of the free float. Under the previous supermajority voting system, only an additional 3.1% of abstain or refusal votes would be required to veto an amendment. This highlights the potential for management entrenchment and the blocking of amendments that could be in the best interest of shareholder rights.
Cerno Capital’s support for a reduction in the supermajority vote requirement aimed to protect the rights of smaller shareholders and promote a more equitable decision-making process within Linde.
Microsoft
Prioritising ethical governance and accountability: encouraging responsible decision making to ensure the long-term interest of shareholder and uphold Microsoft’s corporate values.
Our commitment to responsible investment and our duty of care to our shareholders led us to address two items during the FY23 Annual General Meeting (AGM).
One of our concerns revolves around the re-election of Mr. Reid G. Hoffman to Microsoft’s board of directors. Reports have raised questions about Mr. Hoffman’s historical association with Mr. Jeffrey Epstein, including alleged visits to Epstein’s properties. We find it disconcerting that a director’s position appears contradictory to Microsoft’s commitment to corporate governance and social responsibility.
Another concern pertains to a shareholder proposal addressing the risks of operating in countries with significant human rights concerns. In response to significant consumer demand, Microsoft announced a plan in 2021 to build out 100 new data centres each year. Saudi Arabia, which scores poorly on numerous human rights and economic freedom indices, is a targeted area for construction. In this AGM, the Human Rights Watch called on the company to delay the buildout of new cloud data centres in Saudi Arabia, until it could sufficiently demonstrate it’s ability to mitigate the risk of facilitating and benefiting from human rights violations. The proposal, whilst co-signed by 12 other human rights groups did not pass and was met with a response by management. Management drew attention to the well-defined human rights practices, which are disclosed in the annual human rights report. However, we believe the language used to address this issue lacks specificity and robustness, potentially leaving the company exposed to risks such as forced labour deployment and reputational damage. We urge Microsoft to provide greater clarity on the specific steps taken to mitigate these risks in high-risk areas.
Although we voted against these items in the AGM, they did not receive sufficient shareholder support to pass. As such, we have escalated our response and initiated an engagement process with Microsoft’s management directory, posing questions regarding Mr. Hoffman’s association and the company’s approach to human rights risks. Our aim is to ensure transparency, accountability, and the long-term comfort as shareholders. By actively participating in the governance processes, we seek to protect shareholder value, foster corporate responsibility, and contribute to the sustainable growth of our investments. We will continue to address these concerns and actively engage with Microsoft’s management to ensure alignment with our long-term objectives as the company continues to grow.