February 2, 2012

Governance: In your Face… book!

Facebook flouts good governance

Yvan Allaire | Financial Post

The imminent initial public offering of Facebook Inc. shares has the hallmarks of a momentous event: the number of instant millionaires and billionaires, the implicit market value of a toddler company, the young age of its founder, and so on.

But what is also remarkable about the Facebook IPO is the way its founder intends to govern the company. He is essentially flouting all the principles and practices of orthodox, “good” governance.

The company will have a dual class of shares, one class with a single vote per share, the other with 10 votes for each share. Mr. Zuckerberg, directly and through voting agreements, will control some 57% of all votes (although owning only 28% of the shares). Dual class of shares, the bête noire of finance ideologues and the governance police, was also adopted by Google (and the co-founders of RIM must now regret dearly not having done the same).

If that were not enough to protect Facebook from unwanted suitors, the company has also adopted all measures designed to thwart any hostile bid:

  • A classified board with directors elected for a three-year term with staggered expiry dates so that only one third of directors are up for election each year — a very effective means of stalling any hostile attempt at obtaining control of the board.
  • Any transaction that would result in a change of control of the company will require the approval of a majority of outstanding Class B shares (those with 10 votes, controlled by Zuckerberg) voting as a separate class.
  • Several other protective provisions are triggered if and when the voting power of the Class B shares falls below 50%.
  • Then, since Facebook is a “controlled” company, therefore it is not required to have a majority of independent directors, a compensation committee or an independent nominating committee. As put in the Facebook prospectus: “So long as the outstanding shares of our Class B common stock represent a majority of the combined voting power of our common stock, Mr. Zuckerberg will be able to effectively control all matters submitted to our stockholders for a vote, as well as the overall management and direction of the company.”
  • Of course, Mr. Zuckerberg is chairman and chief executive of the company, a combination of roles that is anathema in most countries’ governance circles and increasingly so even in the U.S.

The lesson to be drawn from the Facebook IPO is straightforward. When your company is hot, you may do as you please and will hardly hear a peep of complaint from the governance gendarmerie. It is the time to set up protection devices to give your company the ability to think about, and implement, long-term strategy, impervious to the chicanery of quarterly earnings, the bullying of financial analysts and tourist investors, and the attacks of financial vultures.

In times past, entrepreneurs would bring their company public under a set of conditions pretty similar to those Zuckerberg is imposing on the buyers of Facebook shares. But nowadays, entrepreneurial companies, which are not so enticing as a Facebook or a Google, will either shun public markets or accept rules and conditions of corporate governance that may well be detrimental to their independence or even their survival.