After Facebook (FB) announced stupendous results Wednesday – revenue up 52%, profits tripled, both measures leaping from already high bases – who would deny that CEO Mark Zuckerberg at age 31 is one of the great business leaders now working? Not me. He has shepherded the company from non-existence just 12 years ago to a market value of $332 billion, fifth greatest in America, ahead of Johnson & Johnson (JNJ) and General Electric (GE). It’s an astounding achievement. And yet – there was a nearly inaudible sour note in Facebook’s news on Wednesday, and I regret to say that it does not bode well.
It was the announcement of a new class of non-voting shares that will be distributed to all Facebook shareholders. Why? Facebook already has two classes of stock, Class A and Class B, created when the company went public to ensure Zuckerberg would retain total control of the company. The Class A shares have one vote each, and Zuckerberg owns a tiny percentage of them; the Class B shares have 10 votes each, and he owns 85% of them. Overall, he owns 16% of the company but wields 60% of the votes. The new Class C shares are being created for one purpose only: to allow Zuckerberg to maintain control while he and his wife fulfill their pledge to give away 99% of their Facebook wealth. He will be issued a ton of the non-voting Class C shares, and those are the ones he’ll donate.
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He and the company were refreshingly candid about their motives. “I’ll be able to keep founder control of Facebook so we can continue to build for the long term, and Priscilla and I will be able to give our money to fund important work sooner,” he said in a statement. It all sounds great – giving billions to worthy causes, building Facebook for the long term. But multi-class ownership structures have a long history, and they always sound great when things are going well. When things stop going well, which is guaranteed to happen eventually, the trouble starts.
The reason is obvious. The board’s most important job is to make sure the company always has the right CEO, and if it doesn’t, to change the CEO. But in a multiple-class company like Facebook, the board can’t fire the CEO. Just the opposite: The CEO can fire the board, which means he can do almost anything he wants. If he wants more income, he can make the company pay out bigger dividends even if that’s bad for the business; it happened at Readers Digest Association when it had a multiple-class structure. Or he can push through any other plan he likes. For example, Facebook’s new class of stock must be approved by a shareholder vote. Care to guess how the vote will turn out?
Multiple-class structures ensuring founder control are common in the media industry – Comcast, New York Times, and News Corp. use them – and in Silicon Valley, where Alphabet, Zynga, Groupon, LinkedIn, and others use them. Investors must remember that they’re betting not on an institution but on a person and maybe that person’s progeny; all three of the media companies cited above have second- or later-generation leaders, for example.
As for Facebook – all hail Zuckerberg! Truly. He is a phenomenon. But the argument in favor of Facebook’s governance set-up is the same argument made in favor of benevolent dictators.