Facebook's dual-class problem is coming to other tech companies

Facebook shareholders expressed frustration with Mark Zuckerberg's running of the company at its annual shareholder meeting Thursday.

They could do little about the situation, though, because Zuckerberg's shares give him the ability to determine the outcome of any shareholder vote and to control Facebook's board.

The problem faced by Facebook shareholders is likely to be repeated at other companies in the future, because a growing number are similarly giving a disproportionate amount of control to insiders.

That control insulates managers from accountability and poses dangers to shareholders, employees, and the public at large.

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As upset as many may have been, there was absolutely zero chance Facebook investors were going to oust Mark Zuckerberg on Thursday or even curtail his power in any way.

The outcome of the company's annual shareholder meeting was determined years before it even began.

That plain fact shouldn't just gall Facebook's shareholders. It should worry investors and policy makers as a whole. That's because the number of would-be Facebooks is growing, and their shareholders and the public will have similar trouble gaining control of them should they ever go off the rails like Zuckerberg's company has.

It was clear at the meeting that many of Facebook's investors are furious with the way Zuckerberg has been running the company. Shareholders got two proposals on the ballot this year that would have limited his power. And at the meeting, several investors spoke out against him.

Read this: Facebook's former security chief says Mark Zuckerberg has too much power and needs to step down as CEO

One shareholder directly asked Zuckerberg whether he would resign as the Facebook's chairman. Zuckerberg didn't answer the question, instead reiterating his own call for government regulation. Another shareholder asked Susan Desmond-Hellmann, Facebook's lead independent director, if she would hold a meeting of the company's board with the express purpose of ousting Zuckerberg as chairman; she said no.

Facebook investors have good cause to be furious

Facebook's shareholders have good reason to be unhappy with Zuckerberg and the company's leadership. The social-networking giant has seen a seemingly non-stop string of scandals since the 2016 election, from Russian interference in that campaign to repeated and massive leaks of user data to the spread of genocide-promoting propaganda.

The fiascos have harmed the company's reputation, prompted users to start avoiding its service, spurred growing calls for regulating or breaking up the company, forced it to significantly increase its spending on things such as human moderators, and likely will lead to a multi-billion dollar fine from federal regulators.

Despite all of that, Zuckerberg and Sheryl Sandberg, his top lieutenant, have resisted all calls for any kind of personal accountability. Zuckerberg has refused to step aside or to force Sandberg out.

Unfortunately for shareholders, they are powerless to do much more than rant. Solely by himself, Zuckerberg can determine the outcome of any shareholder vote. He can install or replace board members as he chooses. And he can determine the company's direction and policy without any input from anyone else, if that's what he wants.

What gives Zuckerberg this power is Facebook's governance structure. The company has two classes of stock. Its Class A stock, which is held by everyday investors, get one vote per share. Its Class B stock, which is primarily held by Zuckerberg, gets 10 votes per share. Thanks to those extra votes, Zuckerberg controls nearly 58% of the voting power at Facebook, even though he only owns or has power over about 14% of its total shares.

Investors are beggars, thanks to choices made years ago

That system leaves shareholders — nominally the owners of the company — in the position of beggars. Because they can't control Facebook's board or direction, they're reduced to sounding off — or pathetically pleading with Zuckerberg for change.

Investors actually called on Facebook to ditch its dual-class system on Thursday. One of the shareholder proposals they voted on would have urged the company to phase out its dual-class stock structure “at the earliest practicable time.” You don't have to be a mental genius to know how that went down.

Facebook's shareholders are suffering the consequences of decisions made seven years ago. The bankers who took the company public and the institutional investors who bought shares in its initial offering essentially signed off on giving Zuckerberg his disproportionate power. But what's galling is that those early investors made that agreement not just for themselves but for every Facebook investor that would follow them. If you buy a share of Facebook today, you have to live by the agreement they struck.

That's what's called an agency problem. It may well have been in the bankers and institutional investors interest to give Zuckerberg's outsized power their stamp of approval; they were getting in on what was expected to be a hot IPO, after all. But their choice — which will live on in perpetuity, because Facebook's dual-class structure has no set end date — wasn't necessarily in the interests of later investors in the company.

Backers of dual-class structures often argue they allow visionary founders to focus on building long term value for their companies rather than on the often short-term concerns of the public markets. That was the case Facebook's board made in opposing the shareholder proposal to do away with the structure.

“Our board of directors believes that our capital structure contributes to our stability and insulates our board of directors and management from short-term pressures, which allows them to focus on our mission and long-term success,” they said on the company's regulatory document it filed in relation to the vote. They continued: “Zuckerberg is invested in our long-term success, and under his guidance we have established a track record of creating value for our stockholders and navigating important opportunities and challenges.”

Dual-class structures are bad for investors and society

But, as Facebook has shown, such structures also insulate corporate managers and directors from the legitimate concerns of investors and the public. They permit them to operate with impunity with little fear of being held accountable for their missteps, no matter how egregious.

Even looked at through the narrow lens of shareholder returns, such structures are often bad deals for investors. Research from the US Security and Exchange Commission indicates that companies that have dual-class structures that exist into perpetuity tend to underperform those that have sunset provisions.

If Facebook were the only company or one of only a handful with such structures, it would be bad enough. But the dual-stock problem has been metastasizing.

Many of the tech companies that have gone public over the last two years — including Lyft, Pinterest, Zoom, Snap, Dropbox, Spotify, and Roku — have structures that give insiders extra votes and disproportionate power. And more are on the way, including such well-known startups as WeWork, Slack, and, likely, Airbnb.

While many of those companies wouldn't appear to pose the same level of danger to society as Facebook has shown itself to be, some could. As one example, driving — the activity at the heart of Lyft's service — literally puts lives at stake.

Even if they don't pose such societal-level risks, the companies' dual-class structures pose other risks. The lack of accountability they enable can encourage fraud, self-dealing by management, reckless spending, and more, any of which could negatively affect not just the companies' shareholders, but their employees, and the communities in which they operate.

At this point, curtailing dual-class structures is likely going to take an act of Congress. And given that public policy makers don't seem to have focused on this problem and that Congress itself is hopelessly divided right now, such structures aren't going away anytime soon.

So be prepared to hear about more investors ranting at corporate managers but unable to do anything about it. Mark Zuckerberg is only the most visible member of the growing class of protected CEOs.

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Read more:

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Facebook's Mark Zuckerberg isn't accountable to anyone, so it's time Congress took away the source of his power

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