Mark Zuckerberg Gets to Control Facebook a While Longer
Yesterday Facebook announced earnings, which were good. They were so good, in fact, that Facebook also announced a little present for Mark Zuckerberg, the co-founder and chief executive officer who got it to this happy place. Facebook said that it will create a new class of common stock, Facebook's third, to ensure that Zuckerberg can control Facebook as long as he wants to. Right now, Facebook has Class A stock, the normal publicly traded stock, with one vote per share, and Class B stock, mostly held by Zuckerberg, which has 10 votes per share. This structure, combined with a proxy agreement in which Zuckerberg gets to vote another shareholder's B shares, gives him voting control of the company even though he only owns about 15 percent of it economically 1 :
Under the new proposal, holders will get two new Class C shares for each A or B share they now hold. The Class C shares will have zero votes. The math will now look like this 2 :
Facebook will now have three times as many shares, each worth a third as much as a share is worth now. But all those new shares won't get any extra votes. Everyone's proportional ownership, by vote and value, will stay the same. 3
So why do it? Well, because Zuckerberg has said he will give away a lot of his shares during his lifetime. He elaborated on that plan yesterday, noting that he and his wife Priscilla Chan have big plans that include "helping to cure all diseases by the end of this century, upgrading our education system so it's personalized for each student, and protecting our environment from climate change." Curing all the diseases will cost money. The vast majority of Zuckerberg's wealth is in Class B shares, and if he gives away too many of those, he'll lose voting control of his company. The cut-off is now about $6.1 billion worth (ignoring the proxy agreements) 4 :
If he sells more than about $6.1 billion, he'll fall below a majority of the votes. But in the new regime, he won't: Instead of selling his voting shares, Zuckerberg could just sell $6.1 billion worth of zero-vote C shares, so he wouldn't lose any voting power at all. 5 The real magic, though, is that he can sell up to about $32.7 billion worth and stay above 50.1 percent 6 :
As Zuckerberg says:
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. Right now, there are amazing scientists, educators and doctors around the world doing incredible work. We want to help them make a bigger difference today, not 30 or 40 years down the road.
So Facebook gave him the right to sell $32.7 billion worth of stock and keep control of Facebook. What did it get in return? Viewed in a certain light, this is a very nice gift to Zuckerberg, and it is awkward for a public company to give gifts -- especially the gift of voting control over its stock -- to its CEO. Facebook is of course aware of this awkwardness, and appointed a special committee of independent directors to negotiate and sign off on the deal, and to make sure that Facebook was getting value back for what it is giving Zuckerberg.
And the main thing it got in return was: Mark Zuckerberg can sell $32.7 billion worth of stock and keep control of Facebook. It is clear that the board thinks this is a good thing. From Facebook's proxy statement:
The Special Committee and our board of directors believe the Reclassification is an appropriate way to make it more likely that Mr. Zuckerberg will remain in a position to influence our direction for many years, and we believe that this influence has been and will be beneficial to our growth, strategy, and stability.
That is a perfectly reasonable thing to think. When Zuckerberg first announced his plan to give away his wealth, the shares briefly fell as investors thought he meant he was giving up voting control immediately. Investors seem to want Zuckerberg in charge. The board seems to want Zuckerberg in charge. The world is a scary place. There are Carl Icahns out there. Even wildly successful tech companies can come under pressure to become boring and cost-conscious and share-buyback-y. The market isn't always fond of imperial CEOs who sink shareholder money into weird projects like Instagram and Oculus; capital return is a constant temptation. A Zuckerberg with majority voting control of Facebook, even after spending tens of billions of dollars to cure all the diseases, will be insulated -- and will insulate Facebook's business -- from any shareholder pressure to rein in his ambitions. So far those ambitions have made a lot of money for shareholders.
But the board got some actual concessions out of Zuckerberg too. Most notably, the existing high-vote share arrangement gives Zuckerberg his majority control of Facebook as a founder; in the new arrangement, he gets it only as the CEO. As the proxy explains:
If Mr. Zuckerberg were to leave us or if his employment with us were to be terminated for "cause," under the Current Certificate, he would not be required to relinquish majority voting control. Moreover, under the Current Certificate, Mr. Zuckerberg would be able to pass along his shares of Class B common stock (and potentially his majority voting control depending on sales or transfers by Mr. Zuckerberg, as well as changes in our share count) to his descendants after his death, thus leading to potential multi-generational majority voting control of the company.
The Special Committee and the board of directors believe that attracting a qualified chief executive officer to succeed Mr. Zuckerberg would be significantly more difficult if Mr. Zuckerberg, our founder and (in that event) former chief executive officer, continued to retain majority voting control of us in such a circumstance. The Special Committee and the board of directors also believe that the quality of a chief executive officer who would step into the role under these circumstances is likely to be significantly lower than it would be if we were no longer controlled by Mr. Zuckerberg, which could result in the potential loss of significant value for us and our shares of Class A common stock.
The new arrangement will convert Zuckerberg's high-vote B shares into A shares if he dies, is fired for cause, or resigns. 7 That probably doesn't have too many immediate practical implications: As Zuckerberg sort of adorably says in his note to shareholders, "helping to connect the world will always be the most important thing I do," and he seems to have no plans to step down soon. But there is a symbolic shift, from Zuckerberg having dynastic control of Facebook to having managerial control. In the old arrangement, Zuckerberg and his heirs got to control Facebook forever, even if he stops showing up to work, as long as he (or they) held enough of the high-vote stock. That isn't a particularly unusual arrangement: He's the main founder, he built it, he should get to pass it on to his heirs and generally control it forever. Plenty of public companies have been handed down over generations just like that.
But the new arrangement flips that: Zuckerberg gets to control Facebook as long as he keeps coming to work, even if he sells most of his stock. His control as majority shareholder is now tied not so much to his symbolic role as a founder, or to his economic role as an owner, but to his managerial role as CEO. 8 It all feels a bit more Silicon Valley, a bit more meritocratic: Zuckerberg can't just rest on his laurels; he has to work to keep control. But it also reflects a desire by Facebook's board to protect its visionary CEO from the pressures of outside shareholders -- and, if it hires a new visionary CEO, to protect that CEO from the pressures of an outside Zuckerberg. The entrepreneur is in charge, free of outside pressure, but only as long as he's an entrepreneur.
Not everyone loves this. Even in the proxy statement that Facebook filed yesterday, in addition to the board's proposal to create a third class of non-voting stock, there's also a shareholder proposal to get rid of the high-vote Class B stock and give each share one vote. "Our company takes our public shareholder money but does not let us have an equal voice in our company’s management," complains the proposal. But of course the low-vote shareholders can't vote themselves more votes; that would defeat the whole point of the dual-class structure. The shareholder proposal is hopeless.
On the other hand, the high-vote shareholders can vote themselves more votes. As the company says, "Mr. Zuckerberg will have the power to approve the adoption of the New Certificate," providing for the new Class C shares, "without the affirmative vote of any other stockholder." And he plans to. The shareholder vote is purely symbolic.
Still, there will be a shareholder vote. Facebook here is following in the footsteps of Google, which also went public as a two-class company controlled by its founders, and also added a third class of non-voting stock to prolong that control. Of course Zuckerberg can approve Facebook's new zero-vote stock, just as Google's founders could approve their zero-vote stock, without the consent of any other shareholders: They had voting control since their initial public offierings, so they can do what they want. It is tempting to see these precedents as a warning to future IPO investors: If you buy low-vote stock today, you could end up with no-vote stock tomorrow. And not a lot of companies go public with a no-vote class of stock.
But in practice controlling shareholders can't just vote themselves more control. Courts tend not to like that. So Google and Facebook had real special committees of independent shareholders to vet their new no-vote stocks, and those committees seem to have taken their jobs seriously. And those committees approved the new no-vote stocks after the founders spent years performing well and accruing shareholder goodwill:
“Investors are remarkably willing to overlook sub-optimal governance decisions when things are going well. The opposite is true when things are not,” said Brian Wieser, a senior research analyst at Pivotal Research Group LLC in New York. “If you’re the controlling shareholder and you believe you need this, then the best time to do it is when things are going well.”
What does this decision say about the supposed short-termism of public markets? On the one hand, clearly Facebook's directors are worried about it: The main purpose of giving Zuckerberg voting control of the company even as he sells down his shares is to insulate his decisions as CEO from the short-term focus of the public markets. On the other hand, the market's willingness to give Zuckerberg that control suggests that its short-termism is overstated, or at least selective. Public shareholders are willing to trust visionary CEOs to allocate capital for the long term. The CEOs just have to earn it first.
The numbers come from pages 37 and 38 of Facebook's proxy statement, also released yesterday. The value is based on yesterday's closing price of $108.89; the stock is up today. I assume that Class B shares are worth as much as Class A shares, which is a little dubious -- they have control rights -- but close enough, given that they turn into Class A shares on transfer. Zuckerberg's proxy is from Dustin Moskovitz, a Facebook co-founder.
This assumes that:
- Class C shares will have the same value as Class A and B shares; and
- Each share in the post-dividend world will be worth one-third as much as a share was worth yesterday, i.e. $36.30.
That second assumption is of course questionable -- presumably Facebook thinks this structure will create value, and the market seems to agree -- but it's good enough for our purposes.
Note that the value of the shares subject to proxies will go down, at least in my calculation, just because two-thirds of that value will be transferred into non-voting C shares, and it is silly to have a proxy on non-voting shares. This is just an artifact of the calculation, though; the total value of Moskovitz's shares won't go down.
I just do a waterfall here where he sells A shares until he runs out, and then sells B shares. Note that when Zuckerberg sells B shares they turn into A shares, so the total vote count goes down.
That is, he'd sell 168 million of his Class C shares ($6.1 billion worth), leaving him with 678 million Cs and all of his As and Bs.
Again, the waterfall here is he sells C shares until he runs out, then As, then Bs. With the proxy votes, he can get to about $35.9 billion and stay above 50.1 percent.
If he sold $32.7 billion worth of stock in the current structure, without the C shares, he would have to sell all of his A shares and 296 million of his Bs, leaving him with only about 24 percent of the vote (not counting the proxy votes).
See section 3.8(b) of the amended certificate of incorporation. The shares convert three years after Zuckerberg dies or becomes disabled, or one year after he is fired or resigns.
This is not strictly right, by the way; the new certificate of incorporation lets him keep control if he steps down as CEO but takes a job as, say, "Executive Chairman of the Board of Directors." But, you know, he's got to keep a CEO or CEO-ish job.
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