Facebook shareholders are wedded to the whims of Mark Zuckerberg
So, against all odds, you managed to get your hands on a few shares of Facebook stock via one of the most hyped initial public offerings of all time and managed to survive its messy first day of trading.
Congratulations. You’re now married to Mark Zuckerberg.
The 28-year-old company founder is today one of the most deeply-entrenched chief executives in American business. Thanks to a two-class stock structure, Zuckerberg will own about 28% of Facebook but control 57% of all shareholder votes. To put it simply, he can do whatever he wants with Facebook, and you, the shareholder, don’t have a say — not even if you team up with every other outside shareholder in the company. You can’t veto a decision or vote down his choice of board members.
Your purchase of Facebook shares was an expression of supreme confidence in Zuckerberg. You better hope he does everything right, because if he doesn’t, he’ll be harder to get rid of than tuberculosis.
Zuckerberg’s impregnable ownership stake, which even allows him to name his posthumous successor, may have had something to do with the company’s uninspiring reception by stock investors last week. But it isn’t unique in American business, especially in Silicon Valley. Only a few weeks ago, Google announced plans for a new class of shares with no voting rights at all, the better to enhance the control positions of co-founders Larry Page and Sergey Brin and Executive Chairman Eric Schmidt, who already shared roughly two-thirds of all shareholder votes. At Zynga, a game company whose fortunes are inextricably linked to Facebook, founder Mark Pincus holds all the company’s Class C shares, which carry 70 votes each. After a recent stock offering he and his insider pals controlled 98.2% of the company’s voting power.
At heart, these arrangements are expressions of contempt for the very principle of taking a company public. Facebook didn’t have to go public to raise money, of which it had plenty in the bank. It was pushed into doing so by federal law, which mandates public financial disclosures once shares in a company become distributed to a large enough insider group. Zuckerberg was indisputable king of Facebook the private company; so why should anything change for Facebook the public corporation?
“The idea is that the rest of us should be happy to go along,” says Charles M. Elson, an expert in corporate governance at the University of Delaware. “You’re assuming he’s infallible, but if something goes wrong, you’re powerless.”
It won’t do to argue that Zuckerberg’s actions still affect only Facebook. As head of a public company, his actions will be scrutinized at a granular level as never before. The reverberations will be seen not only in their direct effect on the company itself, but in how they are regarded by investors in the stock market, whose take will in turn affect how the stock is priced and therefore the value of portfolios, small and large, in which they are held. That’s a lot of responsibility for someone who must be considered — even if you accept his fawning treatment by the press — a novice.
It’s not as though Facebook has clear sailing ahead. Its user growth rate has already slowed, its weak spot is advertising on the mobile devices through which more than half of its users log in, and major advertisers such as General Motors question whether Facebook ads work at all. These issues would be challenges even for a veteran chief executive with an experienced board looking over his or her shoulder; what about for one who doesn’t think he needs to answer to anybody? Facebook’s ownership structure “destroys accountability,” Elson says, “and accountability makes you a better manager.”
It may turn out that Zuckerberg is exactly the visionary genius he’s billed as. Some young CEOs are, but how many? All we can say is that whatever the number is, it’s a lot smaller than the number of wunderkinds anointed thusly by their public relations flacks and shills in the press.
Indeed, if you’re wondering whether Zuckerberg will wield his imperial power with the maturity and circumspection one expects from the CEO of a corporation valued at more than $100 billion, the hints are emerging. In early April, after the IPO was already in train, Zuckerberg privately worked out a deal to acquire a photo-sharing service named Instagram for $1 billion. It was Facebook’s largest acquisition ever, it is widely regarded as an overpayment, and the Facebook board learned about it after it was a fait accompli.
Leaving aside why any self-respecting business person would agree to sit on a board that gets treated that way by a CEO, does this bode well for Zuckerberg-style management?
“Facebook is gearing up for an IPO, and Zuckerberg is acting like he is running a sole proprietorship,” observed Gordon Smith, a law professor at Brigham Young University, on the corporate governance blog theconglomerate.org. “If Zuckerberg is this cavalier about corporate governance on the cusp of the Facebook IPO, imagine how he will run his company after he has the money.”
Even before Instagram, Zuckerberg took steps that a responsible board might have nipped in the bud. The company has consistently trampled on users’ privacy, which may explain why there’s a sizable cadre of sophisticated Internet users who don’t trust it and won’t use it. A powerless board isn’t just the shareholders’ problem, Elson warns: “If something goes wrong, monitoring gets exported from the board to an outside entity like the government, and we all end up paying for it. We’re all harmed.”
It’s true that CEOs don’t have to own a majority of votes to exercise dictatorial power. Rupert Murdoch does so at News Corp. with a tad under 40%, Jeff Bezos at Amazon with 20%. They’ve maintained their authority partially by building on a record of success, but that doesn’t make it any easier to approach them with what might be considered constructive criticism when the chips are down — witness the quandary of a News Corp. board pondering its chairman’s responsibility for the disastrous legal mess in which the company is mired in Britain.
Nor is the eruption of insider power plays a new phenomenon. The 1920s saw a similar trend toward the dilution of shareholder votes, and we know how that turned out. Criticism against entrenched insiders mounted in the wake of the 1929 crash, and in 1940 the New York Stock Exchange announced a blanket rule against listing nonvoting stock.
The exchange, however, proved to be a paper tiger on the issue. When Ford Motor Co. announced its IPO in 1956 with a structure designed to retain voting control for the Ford family, the Big Board objected, up to a point. But the Ford listing was such a big deal — think of it as the Facebook IPO of the ‘50s — that the exchange soon gave in. In the 1980s, shareholder voting rights began to get watered down by managements trying to fend off hostile takeovers. The Securities and Exchange Commission tried to outlaw the practice, only to be stymied by the courts.
You also see it in media companies such as the Washington Post, where the pretext has been the desire to protect the company’s journalistic properties against political or economic pressure. From his unassailable perch, Washington Post Chairman Donald Graham has transformed his company into a marketer of for-profit education services, and perhaps not coincidentally one that has lost nearly two-thirds of its value since 2004. Graham, as it happens, holds a seat on the Facebook board, which presumably allows him to share his management insights directly with Zuckerberg.
This leaves us with the question of what are the buyers of Facebook’s IPO thinking? Most of them are big institutional investors such as mutual funds and pension funds, which have fiduciary responsibilities to their investors and members. But many may have no choice but to put money in Facebook. “No fiduciary should put money into a non-voting share,” says Robert A.G. Monks, perhaps the nation’s leading activist and advisor for shareholder rights. He calls dual-class arrangements like Facebook’s “grotesque” and observes, from long experience, that “if there isn’t any accountability, it always ends in disaster.”
That’s the quandary facing the California State Teachers’ Retirement System, or CalSTRS, which has long taken a strong stand against dual-class stocks and other entrenching mechanisms, and has formally complained to Facebook about the lack of diversity on its board.
Facebook is certain to become part of market indexes to which some CalSTRS investment funds are keyed, according to Janice Hester-Amey, portfolio manager in CalSTRS’ corporate governance unit. “We don’t have any way of avoiding the stock,” she told me. “You’d have all sorts of risk if your strategy was to replicate the market and you left it out.”
Because CalSTRS can’t vote with its feet, its policy is “engagement,” Hester-Amey says, meaning that it tries to jawbone corporate boards and management into avoiding policies inimical to shareholder rights.
But she acknowledges it’s difficult to get them to give up voting primacy. CEOs will entrench themselves if they think they can get away with it. Indeed, says Monks, the Facebook case is just the tip of the iceberg. More than a few Titanics have been sunk by less.
Michael Hiltzik’s column appears Sundays and Wednesdays. Reach him at email@example.com, read past columns at latimes.com/hiltzik, check out facebook.com/hiltzik and follow @latimeshiltzik on Twitter.
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