Facebook IPO Doesn’t Impress Investors Much

Mark Zuckerberg
Facebook is tipped to be adding adverts to its mobile apps soon Reuters

A new crop of companies entering the U.S. public markets, including such high-profile offerings as Facebook, are turning the clock back on the way U.S. corporations are run.

Facebook, Groupon Inc (GRPN.O), LinkedIn Corp (LNKD.N), Zynga Inc (ZNGA.O) and others have put in place governance provisions that go against a long-term swing towards more shareholder-friendly rules.

One stark example of this reversal is in the number of companies that have classified or staggered boards, where only a handful of directors come up for election each year rather than all of them, making it hard for an activist investor or unwanted suitor to take control of the board through a proxy context.

Another is the creation of dual-class stock structures, which allow founders and early investors to gain greater voting control than their economic interest would otherwise suggest.

In the past 10 years, many of the biggest publicly traded companies in the U.S. have been getting rid of such provisions. Currently, for example, only about 24 percent of S&P 500 companies have classified boards, down from 61 percent in 2002, according to FactSet SharkRepellent.

But there hasn't been such a significant change among new arrivals. Of the 76 companies that went public last year, nearly 65 percent had classified boards. In 2002, 82 percent of IPOs had the feature.

Of the eight high-profile IPOs in the social networking and new media space last year, all either had classified boards or dual-class structures, with some having both.

Of these companies, Zillow Inc (Z.O) and LinkedIn had both, Angie's List Inc (ANGI.O), Jive Software Inc (JIVE.O) and Pandora Media Inc (P.N) had classified boards, while Groupon, FriendFinder Networks Inc (FFN.O) and Zynga had dual-class structures.

While new companies are generally more likely to seek protections against corporate raiders and activist hedge funds, the extent of the barriers and some of the actions taken to shore up defenses are being questioned, especially given the high-profile nature of some of the companies involved.

It has some major investors feeling disappointed.

These are companies who for one reason or another decided that they are going public, but they do not want to have to answer to the public market, said Janice Hester-Amey, a portfolio manager in the corporate governance unit at the California State Teachers' Retirement System.

The big issue is that you take money from the public market, and the reason that companies do this is so that they can acquire other companies, expand their business, Hester-Amey said. So the money is worth some respect.

Angie's List, Facebook, Groupon, Zillow and Zynga declined to comment. A spokesman for LinkedIn said that we believe our corporate governance structure allows us to execute on our strategic plans, enabling us to maximise long term value for our company and our shareholders.

The other companies did not respond to requests for comment.

CalSTRS, a $145 billion behemoth that invests the pension funds of California's more than 852,000 current and retired teachers, has already taken up some of its concerns with Facebook, sending a letter on Tuesday to Chief Executive Mark Zuckerberg that calls for increasing the size and diversity of its board.

Hester-Amey noted that Zuckerberg had a board that was all white, and all male, even though Chief Operating Officer Sheryl Sandberg and a large portion of its users are women.

It is particularly surprising that Sandberg doesn't get a board seat despite being widely seen as hugely influential not only within Facebook but with advertisers and women in the wider business community - including starring at events like the World Economic Forum in Davos. She has also served on Starbucks Corp (SBUX.O) and Walt Disney Co (DIS.N) boards.

As these newly public companies break from the trend of giving shareholders greater say, investors and corporate governance experts bemoan the lost lessons of past disasters --from Enron to Lehman Brothers - which they say at least partly resulted from boards and shareholders who wielded little power over management.

But they also say there is not much investors can do about it.

These guys running tech companies are probably hyper paranoid, said Eric Jackson, founder of activist hedge fund Ironfire Capital LLC. But they have the power to insist on these kind of structures and control, and the markets are so far willing to still buy into the company.

Until there is a real renouncement by investors of these structures through a lower share price they will continue to do this, Jackson said.

NOT MUCH TO 'LIKE'

At Facebook, corporate governance provisions effectively give the 27-year-old Zuckerberg complete control, so much so that the Harvard University drop-out even has the right to appoint his own successor before he dies.

Zuckerberg, who benefits from Class B shares entitled to 10 votes each, has also struck voting agreements with other shareholders. Altogether, he will control just under 57 percent of the vote.

If Class B shareholders lose control of the majority of the voting power, the board will become staggered to give it an extra defense.

Another potential point of irritation for investors eyeing Facebook is the lack of influence they will have over a so-called evergreen equity incentive plan, through which the number of shares reserved for employees' stock awards automatically rise by up to 2.5 percent every year through 2022.

Institutional investors don't want to see 2.5 percent of their equity value diluted every year, said Brandon Cherry, a principal at consulting firm Hay Group. They want to have control over when the plan increases.

AGAINST THE TREND

As many as 26 companies, or roughly one-third of those that went public last year, including Angie's List, Pandora, Jive, Zynga and Zillow, had evergreen equity incentive plans, according to Hay Group's IPO Pay Reporter data.

There are other blockages being set up too. Some 68 percent of the companies that went public last year do not allow shareholders to call special meetings, 82.9 percent do not allow them to act by written consent and all of them have advance notice requirements that make it harder to put up director nominees or other proposals on the agenda at annual meetings, according to the Factset SharkRepellent data.

It isn't much different from the situation 10 years ago before Enron and other frauds triggered a big push for change by activist shareholders - aided by the Sarbanes-Oxley corporate reform law, which came in that year.

That law, with its rigorous rules on corporate governance and accounting, is also sometimes blamed for a drop off in the number of IPOs in recent years as companies decide to remain private rather than having to face the cost in money and time of complying with the regulations.

It's a judgment that the bankers and companies make, as to how much these defensive provisions would cost them in terms of investors that would be less willing to participate in the IPO, said Richard Grossman, a partner at law firm Skadden Arps, without referring to any specific company.

A wish to protect themselves from unwanted advances at an early stage of their development is at play here as well. At Groupon, for example, the dual class stock structure will automatically end in five years.

DON'T LIKE IT? DON'T BUY

While Facebook's corporate governance goes against the trend, the company has also taken steps that are drawing praise from some experts.

Jeffrey Sonnenfeld, a Yale University professor and founder of the Yale Chief Executive Leadership Institute, said investors should focus on how enormously transparent Facebook is around its financial results.

Sonnenfeld said in structuring control, Zuckerberg likely drew lessons from Steve Jobs, the late Apple Inc (AAPL.O) CEO who was once driven out of the computer-maker he founded before returning to triumph some years later.

This is an argument that if you are buying Facebook, you are buying into the vision of Mark Zuckerberg, Sonnenfeld said. If this is a risk that's not right for you, don't buy it. 

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