Dunross is a long-term value investor in the global equity markets. We focus on finding the best countries to invest in, where we pick companies with a strong franchise, attractive valuation and healthy growth prospects. Given that our holdings are leaders in their respective industries, we of course also want them to excel when it comes to shareholder value creation and corporate governance. And this is where this brochure comes in.

Many ways to unlock shareholder value of a company

There are many ways to unlock the true value of a company, and one factor often overlooked is through good corporate governance. By applying some very simple measures, it is possible to significantly improve the market’s confidence in a company, reduce perceived risks and make the company best in class. In turn, this will lower the cost of capital, make the company more competitive and create value for all shareholders.

This is our guide to Shareholder Value Creation through Corporate Governance – the Dunross way.

The guiding and fundamental principles – all shareholders on the same side of the table

For us it is extremely important that the companies we invest in treat all shareholders equally. To demonstrate commitment to this principle is very important for all companies, especially those with a dominating shareholder, who might control not only the general meeting but also the board and management as well. The reason for this is that the company otherwise may run the risk of being perceived by minority shareholders as run only for the benefit of the majority shareholder, something that will increase the cost of capital.

In practice, we especially advocate for dominating shareholders to demonstrate their commitment to create value for all shareholders by taking a few simple but effective measures to align majority and minority shareholders (described in more detail in this booklet), such as: implement a well-defined and constructive dividend policy, give shareholders pre-emptive rights, and let minority shareholders decide on major related party transactions.

Focus on core business

Misunderstandings are the cause of many troubles, and to avoid these, we encourage companies to be transparent about everything that can be of interest to investors. Even if something is completely clear to the company internally, it might not be so for investors, so we advocate that companies always explain the background and rationale behind all decisions and suggestions to investors beforehand. This is especially important regarding significant changes such as a property acquisition, nomination of new directors, or a proposed mandate to issue new shares. A transparent company will command a lower risk premium and thus have a lower cost of equity and debt, creating a competitive advantage in the long-term. There are many ways to accomplish and communicate a company’s strategy and goals, for example through quarterly reports, annual reports, press releases, the website etc., but one very effective way from our experience, is to arrange regular capital markets days, inviting among others all substantial and interested shareholders, institutions, brokerage firms and banks.

Focus on Core Business

A company should solely focus on its core business, since a strict focus will be rewarded by the market and the company’s shareholders. If, however, an amendment to the business focus is justified, this should be subject to approval at a shareholders’ general meeting. Naturally, we also discourage all types of non-core investments and crossholdings that could be viewed as part of a “power strategy”.

Transparency is key

Misunderstandings are the cause of many troubles, and to avoid these, we encourage companies to be transparent about everything that can be of interest to investors. Even if something is completely clear to the company internally, it might not be so for external investors, so we advocate that companies always explain the background and rationale behind all decisions and suggestions to investors beforehand. This is especially important regarding significant changes such as acquisitions, nomination of new directors, or a proposed mandate to issue new shares. A transparent company will command a lower risk premium and thus have a lower cost of capital, creating a competitive advantage in the long-term.

There are many ways to accomplish and communicate a company’s stra­tegy and goals, for example through quarterly reports, annual reports, press releases, the website etc. One very effective way from our experience, is to arrange regular capital markets days, to which a broad set of people can be invited, such as shareholders, institutional investors and analysts.

Do not become a value trap

No company ever sets out to become a value trap, i.e. one which over time requires more capital from shareholders than what is returned as dividends and/or share buybacks. But some companies do end up as value traps anyway. Why? We believe this has to do with misaligned targets and incentives. For example, if the company has aggressive growth ambitions without adequate profit requirements, and management is incentivized based on such growth, the outcome will inevitably be that revenue and assets will increase but shareholder returns will suffer.

In order to avoid becoming a value trap, a company should have a strict adherence to profitable growth, because “growth for growth’s sake is the ideology of the cancer cell”. As such, we discourage all growth targets and endeavours to increase market share etc. if they are not combined with sustained or increased profitability. Exactly how a company balances growth vs. profitability also becomes a valuable tool in discerning whether the company is actually run with the sole intention of creating value for all shareholders, or for some other conflicting interests, e.g. as a power base for management, “ego-enhancer” or as an extension of the government.

Growth that in the short run only creates a need for new equity must convincingly be demonstrated as a more profitable strategy in the long run than otherwise, or else it will be regarded by the market as a value trap, resulting in a higher cost of capital.

Have an efficient capital structure

One of the most fundamental corporate governance measures a company should implement is to decide on an appropriate capital structure to set the framework for the company’s total cost of capital, with the objective to minimize both cost of equity and cost of debt.

We don’t encourage companies to over-leverage, but rather to take on an optimal amount of debt depending on the business. For example, capital-intensive businesses with high earnings visibility such as infrastructure or real estate generating recurring income, should have a higher amount of debt, whereas highly cyclical companies or those with very lumpy revenue streams should carry less debt.

Examples of other factors that affect the suitable debt level are the interest rate level, the quality of the company’s franchise, poten­tially hidden or overstated values in the balance sheet, as well as political and regulatory risks. The figure below visualizes how a company can minimize the cost of capital (WACC – Weighted average cost of capital) by optimizing leverage. Note also how the cost of capital accelerates when gearing increases beyond the optimum, something that should be avoided.

From experience, we also know that it’s very important that companies set well-founded and sound targets for their capital structure (e.g. debt to equity, net debt to EBITDA, and/or interest coverage ratio), because this framework affects financing decisions, such as either retaining earnings or distributing dividends. Naturally, these targets also need to be communicated clearly to the market so everyone knows what to expect from the company.

Implement a policy for dividends and share buybacks

A well-defined policy of returning capital to shareholders is one of the most important ways through which a company can communicate financial strength and its commitment to shareholder value creation.

The shareholder remuneration policy should first of all state that all shareholders should be treated equal to the main shareholder. Second, annual dividends should ideally be based on a percentage range of earnings or cash flow, rather than a fixed amount, thereby making shareholders feel that they are part of the company’s successes or failures and not like a bond holder who receives a fixed coupon.

If capital is returned through dividends, dividend payments should be declared together with the record and ex-dividend dates in a timely manner, in order to allow investors to settle any transactions in connection with such payments and eliminate any ambiguity that otherwise may arise.

Share buybacks should be part of the dividend policy and are normally a more cost-effective way to return capital to shareholders compared to cash dividends, since dividend payments almost always are subject to taxes for shareholders, especially for international investors. Share buybacks are of course an extra suitable and profitable alternative to dividends if the company’s share price is undervalued by the market.
In order to increase visibility even further regarding buybacks, the company could for example have a policy saying that should its shares trade below a certain discount to its “intrinsic” value (defined in a transparent and credible way), then capital will be returned to shareholders through buybacks rather than dividends.

Don’t forget to cancel treasury shares

If and when a company decides to buy back shares it is of utmost importance that the acquired shares are cancelled. If the company chooses to keep them as treasury shares, investors will not subtract these shares in the denominator when calculating Earnings Per Share (EPS), resulting in an unchanged EPS and no increase in value.

Furthermore, a buy-back program without cancellation of treasury shares will be interpreted as if the company will sell the shares back into the market eventually, thereby creating an overhang that will negatively impact the cost of equity. Or even worse, the treasury shares could be interpreted as a power tool by the management or the controlling shareholder and create suspicions from investors regarding the company’s underlying intentions.
Should local regulations for some reason not allow cancellation of treasury shares, or make it practically impossible, the company should not buy back shares at all.

Let shareholders decide on major transactions

All major transactions by the company – be it asset disposals, share issues, acquisi­tions etc. – should be resolved at a general meeting, where all share­holders can vote (except of course when it comes to rela­ted party trans
actions, where only unconnected shareholders should be allowed to vote). As such, the board of ­directors should not be given any wide-ranging mandates, such as the right to do share issues or to conduct major transactions, because this will create mistrust from investors.

Pre-emptive rights

Shareholders should always be entitled to pre-emptive rights, i.e. the right of existing shareholders to have the first right of refusal to subscribe to any new shares issued by the company. To allow existing shareholders the possibility to take part of a share issue is not only fair, but more importantly, will lower investors’ perceived risk of being diluted by directed share issues to other parties.

Use existing shareholders for divestments

As with share issues, we also believe that the company should apply the same pre-emptive rights principles on disposals and spin-offs. If a company decides to divest a part of its business, the board should always consider the option to either sell the business to the parent company’s shareholders by using purchasing rights allocated on a pro rata basis, or to distribute the shares as a special dividend and list the divested business separately.

In this way, shareholders can decide for themselves if they want to be owners of the divested business or not, and it also creates the possibility for the company to use the shareholder base to get a wider distribution of the shares, thereby ensuring liquidity in the divested business’s shares. Remember that the shareholder base is a valuable asset.

Be very careful with related party transactions

To the largest extent possible, avoid related party transactions: disposals, acquisitions, loans, guarantees etc., involving shareholders, board members, management or companies related to any of these. If, however, related party transactions are being pursued anyway, there must be a transparent framework in place which clearly states who can decide on such transactions on the company’s behalf and how the terms should be negotiated. In this regard, we advocate that the board should always hire a truly independent expert to assess the fairness of any major related party transaction.

The connected shareholder should be restricted to vote on related party transactions, so that the decision on the transaction only rests with the minority shareholders.

Nominate truly independent directors

When nominating independent ­directors, we urge companies to think long and hard about which candidates to propose, because they will be the voice of the minority shareholders on the board. As such, it is not enough for candidates to be classified as independent on paper. For this reason, the board should consider whether they can be viewed as ­credible and truly independent, because in our view a de facto independent board member will bring more value to the board’s work than someone who might fit the bill but in the end just thinks and votes like all the other board members.

Nomination of independent direc­tors should ideally be approved by the minority shareholders of the company. Alternatively, the minority shareholders should be represented in the nomination committee appoin­ting the independent direc­tors.

Set incentives that give the right results

Directors and management should be satisfactorily rewarded if they do a good job, but not if they don’t ­deliver. To understand what is expected of mana­gement, their pay should be tied to the company’s finan­cial targets (which of course also need to be clearly communicated), and all remuneration policies must be made available for shareholders. We also advocate that shareholders should vote on remuneration policies at the general meeting with regular intervals.

The financial targets and bonus criteria must be relatively bold and aggressive, thus making it clear that bonus should only be paid out if the goals are reached, thereby avoiding excessive pay for sub-par performance. By being transparent on pay and setting remuneration – whether being cash, options or shares – at a long-term performance-based and morally justifiable level, investors will feel increased confidence in the management and the company.

Management and directors should also be encouraged to acquire shares in the company at market price, making their long-term interests more aligned with that of shareholders.

Disclose how insiders trade

Even if it’s not required by stock market regulations, we advocate for companies to keep investors informed about all transactions in a company’s share conducted by major shareholders and members of the board and management. Exactly how this should be done (if not regulated) is up to the company, but the important thing is that investors receive transparent and frequent updates on how insiders act.

Use a transparent voting system at general meetings

We encourage companies to use a ballot system at general meetings of shareholders – either in paper or digital – and not conduct voting by show of hands or any other outdated method. By properly counting the number of votes present and the number of votes cast for each agenda item, the company doesn’t only ensure a fair decision-making process for shareholders, but also safeguards a very important feedback loop: if the board of a company doesn’t know what exact percentage of share­holders support or disapprove of a certain measure, it may continue proposing matters that in fact are quite unpopular but can be misinterpreted as having broad-based support in a show-of-hands situation.

The Dunross Guide to shareholder value creation through Corporate Governance

• Open, informative and constructive dialogue with all shareholders.
• Focus on the core business.
• Avoid becoming a value trap by focusing on profitability over growth.
• Set appropriate targets for the capital structure.
• Implement and communicate a well-defined dividend policy.
• Don’t forget to cancel treasury shares.
• Ensure that major transactions are resolved by shareholders and not by the board.
• Safeguard pre-emptive rights in share issues.
• Use existing shareholder base for disposals and spin-offs.
• Minority shareholders should have deciding power on related party transactions.
• Allow minority shareholders to nominate independent directors.
• Introduce transparent and justifiable remuneration policies.
• Disclose all insider shareholdings and transactions.
• Use a transparent voting system at general meetings.

…and last but not least, you’re always most welcome to use Dunross as a discussion partner on how to create shareholder value.

Introduction

The Dunross & Co Group1 (“Dunross” or “the Group”) is a long-term value investor in the global equity markets. This document is intended to provide guidance on our position on corporate governance and shareholder matters, and should be read in conjunction with our brochure “Shareholder Value Creation through Corporate Governance – The Dunross way”. Said brochure provides fundamental principles and overall guidelines, while this policy further specifies how we are likely to act in a number of given situations. The policy is only applicable to listed holdings.

We are active in numerous countries around the world, and although the intention for this policy is to be applicable everywhere, we know that it’s impossible to find a “one size fits all” solution for each possible scenario in every single market. Therefore, we might deviate from this policy from time to time.

Framework

Dunross expects the companies we invest in to follow applicable laws and regulations. National corporate governance codes also serve as useful guidelines, and should generally be encouraged to comply with. We also encourage our portfolio companies to seek guidance in our Shareholder Value Creation brochure on how to approach corporate governance matters in order to lower the cost of capital, and thereby enhance their competitive advantage. In return, companies can expect a trusting, listening and constructive partner for the long term.

The Group approaches stewardship in three ways:
– Proactive
– Reactive
– Ad hoc

Proactive stewardship comprises the continuous dialogue we have with the companies in our portfolio in person or by other means of communication. To better shape a company’s expectations, clarify our views on specific governance matters and how we are likely to vote on these, while also demonstrate how the company compares to other companies, we have developed the Dunross Annual Letter. The letter is based on a yearly internal corporate governance ranking of the companies in our portfolio and will be sent to all of the Group’s significant holdings in due course before the annual general meeting, to allow for companies to provide feedback and potentially address issues and concerns.
We also encourage proactivity from companies, especially when it comes to major proposals being contemplated at an upcoming general meeting, such as changes to the articles of association, share capital increases, share issue mandates or new remuneration policies. If companies reach out early to the major shareholders and discuss proposals with them, transparency will increase and there will be fewer surprises at general meetings.

Reactive stewardship refers to voting on general meetings or engagements initiated by Dunross in response to new events. It is our goal to minimize the amount of purely reactive stewardship to provide for a transparent relationship between the Group and the portfolio companies.

Ad hoc stewardship can involve colla­borative efforts with fellow shareholders, if we believe this to be a better way to gain influence compared to acting alone. Dunross does not view ourselves as an activist investor, but we intend to keep a close and constructive dialogue with all our portfolio companies, and will put forward proposals to the general assembly if we believe them to be in the interest of all shareholders. We generally don’t seek board representation, but we are open to be represented on the nomination committee in companies where this is made up of the largest shareholders.

Voting at general meetings

It is our intention to vote at every general meeting held by our most important portfolio companies. Voting can be conducted either by Dunross representatives present at the general meeting or by proxy, but since we want to build long-lasting relationships with our portfolio companies, the ambition is to be present physically.

Outlined below are our guidelines for voting on the most common general meeting matters.

Meeting notices and information

In order for international shareholders to be able to prepare voting instructions before general meetings, we encourage companies to issue notice of meetings no later than four weeks before the meeting. Such notice should be made by way of press release distributed via e-mail to ensure that all investors receive the information. And in order for shareholders to make an informed decision on how to vote, supporting information and related explanations about the agenda items should be made available in English on the company’s website at the same time that the meeting notice is issued.

Voting procedures

We encourage companies to use a ballot system – either in paper or digital – and not conduct voting by show of hands or any other outdated method. By properly counting the number of votes present and the number of votes cast for each agenda item, the company doesn’t only ensure a fair decision-making process for all shareholders, but also safeguards a very important feedback loop: if the board of a company doesn’t know what exact percentage of shareholders support or disapprove of a certain measure, it may continue proposing matters that in fact are quite unpopular, but can be misinterpreted as having broad-based support in a show-of-hands situation.

Auditors

We generally support the company’s proposal of auditor, unless there is any indication of compromised inde­pendence, malprac­tice or other serious issues. We monitor the audit fees paid by all our portfolio companies and encourage companies to regularly review their audit firms in terms of pricing and quality. To the largest extent possible, we urge companies to use the same audit firm for the parent company as well as for all significant subsidiaries. In situations where the audit firm consistently earns significant revenue from non-audit services aside from the audit fee, we will consider voting against the auditors, since such circumstances risk jeopardizing the auditor’s independence and judgment.

Board members

In our view, board members should be nominated by a committee comprised of the largest share­holders as well as representatives for ­minority share­holders, and not by a committee made up of board members.
Having shareholders nominate board members for approval at the general meeting creates a direct link between ownership and stewardship, which risks getting lost if a board gets to choose among themselves whom to include or not. Regarding board composition, we encourage companies to create a good mix of skills and age. We generally support company proposals regarding board nominations, but would consider voting against board members who display any of the following characteristics:

• If the board member has attended less than 75% of meetings in the previous year
• If the board members is considered independent on paper but where circumstances point to the opposite
• If the board member has a significant number of other similar board positions. What exactly can be considered “significant” must be viewed in context of the company in question, but in order to put in the time necessary for meaningful board contribution, holding a directorship in more than five listed companies should be avoided
• If the board member is employed by the company in a managerial position (with the exception of the chief executive officer)

The above should be interpreted in context of the whole board, meaning that if only one person displays any or more of the above characteristics, we are less likely to vote against this one person than if more than one board member does.
We would also like to point out that many years of service on the board is not a disqualification in itself, but could rather be seen as a merit. In our view, many corporate governance codes – although well-intended – risk creating a short-term mindset when specifying term limits for independent directors that don’t extend beyond the peaks and troughs of a normal business cycle.

In order to keep the board efficient, we advocate that companies limit the board size to no more than eight members. For companies whose board exceeds this number, we could be inclined to vote against the whole board.
We encourage companies to conduct an annual assessment of the board’s composition and effectiveness – especially in relation to the factors mentioned above – and to publicly disclose the findings.

If CEO = Chairman

In situations where the Chief Executive Officer (or similar) is also the Chairman of the board, we would be inclined to vote against this person unless there are other safeguards in place to protect minority shareholders from the concentration of power that such a setup creates.

Management and board remuneration

We would generally vote against all management remuneration proposals that don’t have a clear link to company performance and to a reasonable extent can be verified using publicly available information. The same applies for proposals that we consider unsound in any way.

Remuneration to board members should be a fixed annual fee and not be based on the number of board meetings conducted. For companies who do not apply a fixed fee system, we could be inclined to vote against the whole board.

Dividends

We generally support dividend proposals that fall within the limits of the company’s dividend policy, unless such dividend would jeopardize the financial health of the company.

Share buybacks

We generally support buyback proposals, provided that the scope is reasonable and there is a stated intention to subsequently cancel the shares unless they are to be used for share based remuneration. We would be inclined to vote against a buyback proposal if the company at the time of the proposal has outstanding treasury shares and there is no stated intent to cancel these or use them for share based remuneration.

Share capital changes

We will vote against increases in the authorized share capital unless the proposal increase is explicitly tied to either a defined share issue or a defined share issue mandate. Regarding decreases in the authorized share capital, we generally support such proposals if they are intended to facilitate share cancellations due to buybacks.

Share issue mandates

We will vote against directed share issue mandate proposals, unless the company’s financial condition has deteriorated to the point where a directed share issue is the only viable way to save the company. We could also be inclined to vote against pre-emptive rights issue mandates that lack a stated and demonstrably profitable purpose and don’t have a specific link to the company’s strategy, capital structure policy and other related frameworks.

Related party transactions

If sufficient information on proposed related party transactions has not been issued in accordance with what is outlined under “Meeting notices and information” above, we will vote against all such proposals.

Other transactions and corporate changes

If sufficient information on proposed other transactions or corporate changes – such as introduction of stock option plans or amendments to the articles of association – has not been issued in accordance with what is outlined under “Meeting notices and information” above, we will vote against all such proposals.

Other matters

We will generally vote against agenda items labelled “Other matters” or similar, if it has not been specified in the meeting notice what exactly will be discussed and resolved under said item.

Dunross & Co, January 2020

If enough people maintain an assertion for long enough, eventually it becomes the truth. But how good is it really to run in the same direction as everyone else?

When you go with the flow and invest in sectors and companies in which everyone else is investing, you normally invest at higher multiples. The higher valuation limits any increases and profits. If the mainstream opinion fails, the high valuation results in a large drop in value and a major loss.

One of our values is to think in contrarian views. We search for companies with great underlying values. The low valuation by the market limits the potential loss. If the company develops, the low valuation and the sudden insight by mainstream, releases major potential and profit. If we fail, our losses are hopefully less than the knowledge gained.