Corporate governance – also known in financial circles as corporate governance – is the cornerstone of our sustainability work. Without good principles for governance, it is difficult to see the company acting sustainably in other respects. Principles are nothing if they are not embodied in the work of the board and management. Governance is the "G" in ESG and is the alpha and omega in sustainability work. Perhaps the acronym should revert to its original: GES. Ideally, there is a good culture of order and discipline in the company, where it is obvious to everyone whose interests are being served. How to balance different stakeholders and strive for an optimal result over time.

Cui bono? – who benefits from it? – is the devilishly apt Roman question that cuts through the most complicated structure. In modern times, we talk about incentives, agency problems, and skin in the game. For us as managers, this means, among other things, that we need to take a stance on the long-term incentive programs that companies develop. This applies both in our continuous dialogue with the companies and more formally in the nomination committees we work in.

Our basic attitude towards incentive programs is pragmatic and aims to align the interests of management and shareholders in the short and long term. What does it mean to be pragmatic? One example is that we have realized that the same rules cannot apply to all listed companies. What applies to Atlas Copco and other large, well-established companies does not necessarily apply to very small companies. We cannot oversimplify and use cookie cutters.

We often talk about how fortunate we are to invest in the Nordics. Our region is not only one of the absolute best in the world, but has been so for very long periods. When comparing systems for incentive programs, the Nordics also appear as a bit of an oasis of moderation, especially when compared to the situation in many American companies. As the business world becomes increasingly international, not least through Nordic companies acquiring operations in other regions, the construction of incentive programs becomes more complex. This forces us again towards pragmatism – cookie-cutter approaches of the one size fits all type become even less useful.

How do we bind management and shareholders together over time? Our preferred base model is for companies to introduce a three-year incentive program annually, with reasonable demands on stock development for it to be profitable for the individuals involved. The scope of the program must take into account the situation after three years, by which time two additional programs have been introduced according to the same principle. Specifically regarding the scope of the program – the "option pool" – its size should be tailored to the company's size and stage of development.

By starting a program every year, the relevant individuals always have something to strive for. Stock prices vary more with market sentiment than with the underlying development of the companies. By spreading the programs over time, some of the randomness is removed. Some years, the employees participating in the option program will have to live with a difficult starting point (high valuation of the stock) and some years, the starting point will be significantly more favorable (low valuation).

Compare this with starting a large program over five years. The potential dilution is too great to allow for additional programs along the way. If the company and its stock price develop very well in a short time, management may feel they can relax and not need to exert themselves. Similarly (but the opposite), a stock market crash in year four could make it impossible for the program to succeed, which demotivates management.

Schematic overview of annual three-year option programs

When it comes to the technical design of incentive programs – stock options, warrants, restricted stock units (RSUs), or other alternatives – we are, once again, pragmatic. Different solutions may be appropriate for different companies. Often, key personnel in other countries and cultures are a key factor. If there is a good standard and established practice in other markets, one cannot crusade with a Swedish model but should create something that leads to everyone in the company working in a direction that is beneficial for all shareholders.

One aspect of incentive programs where there are differing opinions, and actually some friction right now, is whether individuals offered incentive programs must meet certain operational goals or KPIs; that is, fulfill so-called performance requirements. A basic example: to be able to buy options in the program, the turnover must have grown by 10 percent and the operating margin must have been over 10 percent the year before the allocation. At first glance, this seems reasonable. Participating in the incentive program is reserved for a few people in management and should be advantageous. Requiring a counterpart performance is only fair – shareholders should not give away anything for free. Natural. Almost tautological.

Now, let's dig a little deeper into the details, for that is where all the devils live. Under what conditions do the CEO and other leaders participate in the program? Do they buy the options with their own, heavily taxed money? Do they take risks like all of us other shareholders? Isn't this in itself a highly reasonable counterpart performance? Even in a more international context where options are awarded for free, as part of total compensation: are additional performance requirements reasonable, and how should they be designed to work in a changing world?

To illustrate the issue, let's highlight a current example. Cint meets the criteria to present a case that contains many spicy details. The company went public with a clear growth agenda, which has been embarrassed, partly driven by macroeconomics, partly by internal shortcomings, and actions by previous major owners. For the shareholders who joined the company's IPO, it has been a challenging journey, and many owners have given up. The shareholder list has been completely reshaped, and few Swedish institutions remain.

There has been a high turnover in the company's leadership. The company's board, and especially its chairman, Patrick Comer, former founder and CEO of Lucid, which Cint acquired in 2021, have taken their responsibility seriously. A new CEO, Giles Palmer, came in April. We met him recently and gained a better understanding of how performance requirements can backfire. These lessons are worth describing and hopefully something we can take with us to more future situations.

Palmer's first priority, under the motto "consolidate, standardize, innovate," is to complete the integration between Cint and Lucid and migrate the operations to new platforms that have already been planned and prepared for. The process starts with the operations they manage on behalf of clients – managed services – and continues through the entirety of 2024. By 2025, they will be able to start enjoying the fruits of the savings this brings – the real synergies from the acquisition of Lucid. These measures will short-term hinder the company's margin development but are the right thing to do in the long term. At the same time, it will be impossible for the staff to receive an allocation under the company's LTIP ("long-term incentive plan") as the company, for good, forward-looking reasons, will not meet the set margin requirements for the coming year.

This could have led to management ignoring the company's best interests and a long-term optimal action plan. They could have "milked" the company by cutting back on forward-looking activities and eliminating every possible cost in sight. Sawing off the branch they (and we!) are sitting on would have been the way to receive an allocation and get the chance to acquire options. Now, we can be sure that Palmer will not follow this path. He is financially independent after a previous entrepreneurial journey and is motivated by other drives in his role at Cint. However, he can articulate how these skewed incentives affect the rest of the management, all those who, unlike Palmer himself, cannot buy shares for millions in the company. Everyone can see the attractiveness of the company's valuation and their own role in generating value. But they miss out on participating in the upside, due to performance requirements.

Be careful what you wish for. You just might get it.

We do not have all the answers for every given situation. If someone can convincingly argue that a given situation requires additional performance requirements, we are not locked into any principle but will embrace the approach that suits the specific company in the specific case. All situations of this kind carry a negotiation element – it's a give and take. We are also, of course, aware that the people on the other side are often skilled businessmen and women. Everyone investing in our funds should know that we enter these negotiations with open eyes and high ambitions on their behalf.