Monday, 14 May 2018

Financial Times/Aeisha Mastagni: Facebook’s dual-class share structure is akin to a ‘dictatorship’

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Facebook’s dual-class share structure is akin to a ‘dictatorship’

The company has grown at an unbelievable pace, it is time for its governance to catch up
Aeisha Mastagni
Mark Zuckerberg, right, and Facebook co-founder Dustin Moskovitz at Harvard

Aeisha Mastagni May 10, 2018
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A business that started in a university dormitory and then explodes far beyond its narrow walls — is not that the American dream? Facebook founder Mark Zuckerberg forfeited finishing his Ivy League education so he could connect friends, archive their photos and let them share life events with the world.

The business of Facebook is thriving. Bring on the initial public offering. Oh yes, dual-class structure shares; everyone is equal but some are more equal than others.

Wait, that is not the American dream. Does not everyone in the US have rights, with checks and balances to hold people to account? Who is it that holds Mr Zuckerberg to account?


As an investor, the California State Teachers’ Retirement System provides capital. In exchange we have privileges, such as the right to elect directors that represent our interests, and this includes holding management to account.

Calstrs, with a portfolio of more than $220bn, 54 per cent of which is passively indexed, expects that when a company turns from being a private enterprise to one that is publicly traded, its governance should evolve in line with its status.

Calstrs endorses the principle of “one share, one vote” — that every share of a public company’s common stock should have equal voting rights.

We own a small part of most companies in the market. We focus, therefore, on governance issues that affect the capital invested on behalf of our 933,000 members.

It has been six years since Facebook went public. For Calstrs, it has grown from a small private equity investment to a top 10 portfolio company. The dream that began in a dorm room is now one the largest companies by market capitalisation and one of America’s most influential entities.

Facebook has grown at an unbelievable pace. The capital structure has changed and it is time for its governance to catch up.

Cornell University research shows that as companies move further from their IPO date, there is a decline in the value added by a dual-class structure. The authors suggest that best practice in corporate governance, such as moving from dual-class to single-class, should mature too.

The study reveals that as groups with dual-class structures age, they experience a 7-9 per cent larger decline in Tobin’s q (the ratio of the market value of a company’s assets divided by their replacement cost) against a 6-7 per cent higher valuation when they are new to the public market.

The Securities and Exchange Commission has shown that three to six years after an IPO, perpetual dual-class stock trades at a substantial discount to dual-class stock with a sunset provision.

That’s right, Facebook: it is time to get serious; it is time to act like an adult.

In February 2012, just three months before Facebook went public, Calstrs wrote to Mr Zuckerberg to ask him to diversify the all-male board to reflect its 60 per cent female user base. We also asked him to equalise the voting power of shares to represent investors’ economic interests.

The response was tepid. Sheryl Sandberg joined the board — a woman but an insider. To date only one other woman, Susan Desmond-Hellmann, has been added. The company maintains its dual-class shares.

Why?

Research by the European Corporate Governance Institute backs up Cornell’s view. It says: “Over time, this valuation premium tends to dissipate, whereas the difference between voting and equity stakes of the controlling shareholders of dual class firms (the ‘wedge’) tends to increase”.

Shareholders such as Mr Zuckerberg (at last count, he owned 29.3 per cent of the shares) have enough control to repel activists, to isolate the board from problems and prevent shareholders’ proxy proposals from being passed — especially those about executive compensation.

Why does Mr Zuckerberg need the entrenchment factor of a dual-class structure? Is it because he does not want governance to evolve with the rest of his company? If so, this American dream is now akin to a dictatorship.

It is time to end the dual-class. The Council of Institutional Investors, using an analysis of SEC filings, has listed 22 dual-class companies with time-based sunset provisions incorporated into their charters.

Calstrs believes Facebook should be there, too.

Aeisha Mastagni is portfolio manager, corporate governance, at Calstrs
Copyright The Financial Times Limited 2018. All rights reserved.
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