September 25, 2017 / 7:27 PM / 23 days ago

Breakingviews - Cox: Facebook's about-face is only partial victory

Facebook CEO Mark Zuckerberg is seen on stage during a town hall at Facebook's headquarters in Menlo Park, California September 27, 2015. REUTERS/Stephen Lam/File Photo

NEW YORK (Reuters Breakingviews) - Mark Zuckerberg’s withdrawal of plans to excrete an inferior class of Facebook shares onto the investing hoi polloi should go down as an extraordinary moment in contemporary American capital markets. But the social network founder’s climbdown is not an unalloyed victory for democratic capitalism. Facebook is facing other, existential, challenges that almost certainly rendered Zuckerberg’s decision an expedient one. The battle to instill better corporate governance at Silicon Valley’s titans will continue to rage.

This is not to diminish the import of Zuckerberg’s Friday-night drop. The world’s sixth-richest man caved on a plan that would have allowed him to retain control of the $470 billion company even while selling his own shares, most of which carry 10 votes apiece, to fund his worthy philanthropic ambitions. Now, he says, thanks to Facebook’s recent stellar stock-market performance, he doesn’t need to adopt an even more feudalistic ownership structure for his dorm-room creation. That, he said, is why he asked his board to abandon the proposal.

However reached, it is the right decision. When the new stock plan was put to a vote, some 80 percent of minority shareholders – who actually lay claim to a majority of the company’s economics - rejected it. Although Zuckerberg was able to override them with his more than 400 million Class B shares, an incontrovertible message was delivered. It’s the same spirit that recently inspired the arbiters of the S&P 500, America’s most influential stock benchmark, to no longer admit companies that violate the one-share, one-vote principle.

Zuckerberg’s turn toward less shareholder-friendly behavior was naturally mitigated by the extraordinary performance of Facebook stock since he first surfaced the plan in April 2016. The shares gained some 50 percent over that period, creating $220 billion of additional market capitalization. That enriched Zuckerberg by around $30 billion. So he can indeed afford to sell fewer shares while still harvesting a charitable pile for the ages. At current prices, for instance, he’d need to sell 60 million or so shares to raise $10 billion. When he first hatched the plan, Zuckerberg and his wife Priscilla Chan would have needed to sell 90 million.

Nonetheless, it would be naïve to ascribe this act to a sudden bolt of altruism and a bull market. There are, in fact, two valid reasons - one tactical, the other strategic - for Zuckerberg and his chums on the board to reconsider. The first is the shareholder lawsuit against the plan, which was nearing its day in court. The second is a larger debate over Facebook’s lightly regulated business model in light of recent evidence that it may have abetted Russian agents seeking to influence last year’s U.S. presidential election though advertisements on its website.

The lawsuit was already damaging for Facebook. Discovery suggested that some of its directors were more concerned with safeguarding Zuckerberg’s interests than those of shareholders owning 85 percent of the company. Board member Marc Andreessen, who was on the special committee assessing the zero-stock proposal, allegedly passed along committee questions in advance and sent Zuckerberg text messages during the meetings to coach him. Andreessen also allegedly warned the CEO about committee concerns over his trying to find a way to keep a firm grip on Facebook after leaving the firm.

At a minimum, the revelations made a mockery of Facebook’s governance. They also could have undermined its legal case. Either way, a trial would have opened Facebook to greater scrutiny and tied up many of its executives and legal advisers at a moment when there are more pressing issues than Zuckerberg’s personal stock portfolio. Facebook could even have lost the case, which would have been doubly embarrassing to Zuckerberg and called into question the fitness of some Facebook directors.

The more strategic reason to abandon the plan is the one that most probably explains why, after giving the majority of shareholders what they wanted, Facebook’s stock slipped 5 percent on Monday. Facebook recently agreed to hand over documents related to advertisements that may have been taken out by Russian entities seeking to influence the election. As a result, legislators from both parties in the U.S. Congress are considering various ways to circumscribe its influence.

New rules might not dent Facebook's profitability in the near term, but they could have an effect similar to the one Microsoft endured 15 years ago when it became the focus of politicians and regulators globally. As my colleagues pointed out on Friday, Microsoft continued to expand its bottom line but its owners declined to rate its future income at the same 30 times multiple that had made it one of the most valuable companies in the world.

Avoiding that sort of outcome should be the bigger concern for Zuckerberg and his board. A falling stock price doesn’t just unnerve investors who might be willing to overlook substandard governance. It means Zuckerberg and his wife will have fewer billions to devote to making the world a better place, and that includes adopting a more inclusive form of capitalism.

Breakingviews

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