The California State Teachers Retirement System, which carries a huge amount of stock market clout as the state's second largest public pension fund, recently had some very harsh words for Facebook, one of its largest investments.
In an op-ed published Wednesday in the Financial Times, Aeisha Mastagni, a CalSTRS portfolio manager, called Facebook "akin to a dictatorship." Her complaint was the dual-class stock structure gives Facebook's founder Mark Zuckerberg unassailable voting power over the company even though he owns only about 16% of all its outstanding shares.
Facebook has grown far beyond the dorm-room enterprise that Zuckerberg founded, Mastagni wrote, and consequently it has outgrown the supercontrol exercised by Zuckerberg.
"That's right, Facebook," she wrote. "It is time to get serious; it is time to act like an adult."
Unfortunately, at this point, on the gonna-happen scale this is a "won't." Zuckerberg would have to voluntarily cede his control, and there's no evidence he's inclined to do so. That's true even though the drawbacks of his control can be measured in increasing public distaste for the company's privacy policies and the proliferating government investigations of its behavior.
(The company's shares lost nearly 20% from the stock's recent high in February after disclosures started flowing of the company's tolerant treatment of the data mining firm Cambridge Analytica, but the stock price has since made up most of the decline.)
Yet buried in Mastagni's broadside is a dirty little secret: CalSTRS, like its fellow institutional investors, deserve a large share of blame for this situation—not only Facebook's abuse of its powerless majority shareholders, but the proliferation of companies with entrenched founders with supermajority votes.
The institutions failed to put their feet down when the New York Stock Exchange dropped its rule against dual-class voting shares way back in the 1950s (to attract the listing by Ford Motor Co., whose owning family wanted the benefits of a public offering but not the downsides of public ownership).
More importantly, they failed to put their money where their mouths are when Facebook first came to the public market in 2012. CalSTRS, as it happens, was an investor in Facebook even before the company's initial public offering. Mastagni says the fund wrote Zuckerberg prior to the IPO to ask him to put some women on the company's all-male board and to "equalize the voting power of shares to represent investors' economic interests."
She says, "the response was tepid." That's an understatement. It would be more accurate to say it was arrogant and dismissive. Zuckerberg added Sheryl Sandberg to the board, but she already was an insider. And the dual-class structure stayed; Zuckerberg controls nearly 79% of class B shares, which have 10 votes each, and a negligible amount of class A shares, which have one vote but are the shares held by the public. The combination gives him 53.3% of total voting power.
The ability of even huge institutions like CalSTRS to force changes on entrenched management is, sadly, limited. Facebook is so big now that CalSTRS has to own its shares, in part because Facebook is part of market indices that are components of the fund's passive investment, or indexed, portfolio. Because that portfolio is 54% of CalSTRS' $220 billion in holdings, Facebook has evolved into a "top 10 portfolio company" at the fund, Mastagni wrote.
That means that Zuckerberg can safely ignore CalSTRS' complaint, because he knows the fund can't vote against him with its feet — it has to own his shares.
It's true that CalSTRS has other options. "There's more it can do than divest, and divestment isn't its best course," says David Webber, a shareholder rights expert at Boston University Law School and author of the recent book "The Rise of the Working Class Shareholder," an examination of the ability of public pension funds to force corporate change.
The big pension funds can lobby the Securities and Exchange Commission and major stock exchanges to tighten their rules on dual-class stocks. They can express their discontent via shareholder resolutions and say-on-pay votes at annual meetings. "They may have no oversight," Webber told me, "but they do have mechanisms to exert pressure."
CalSTRS and other big institutions could have turned thumbs down on the Facebook IPO. But plainly they thought that the potential for earning the long green outweighed their complicity in what was certain to be a longer-term problem and a lousy corporate governance principle.
The drawbacks of supermajority control were widely understood even before 2012, even if they're more obvious today. Mastagni cites two academic papers finding that whatever benefits are enjoyed by firms with supermajority control at the time of their listing dissipate fairly rapidly over time — even as the control of the entrenched majority shareholders increases. Those papers both were published this year, but they rely on data going back to the 1980s.
Big stock exchanges and index firms are currently pondering bans on dual-class stocks. The FTSE indices will bar companies whose public shareholders have less than 5% of the vote. Standard & Poor's will bar companies with multiple share classes from its indices, including the all-important S&P 500 — but it is grandfathering existing companies, such as Facebook.
The problem with investing in companies with entrenched owners is that there's no turning back, at least until things get so bad at a company that the crisis is inescapable; by then, it's too late. CalSTRS knew this going in, which is why its complaints now ring just a little bit hollow.