Archive for the ‘Significant Shareholders’ Category

Facebook gets an “F” for governance and an “F” for diversity

“It’s [insert significant shareholder’s name]’s way or the highway” is a common refrain I hear from directors on control block boards.

Facebook’s governance has been described by Businessweek as resembling a “dictatorship” and by a Wall Street Journal blog as “Governance = Zuckerberg.”

Under the public offering, 27-year-old Mark Zuckerberg owns almost 60% of supervoting shares, is Chair and CEO, can name a successor CEO, and has complete control over the nomination process for directors.

The governance debate over control block companies is not new. News Corp, Research in Motion, Hollinger, Magna and others are noteworthy for running into governance problems as a result of a high degree of control in one person or group of persons.

When I observe control block boards in action, the dynamic is very different from a widely held board. Directors tell me that they really owe their position to the control person. And they act in this fashion. The shortest meeting I observed was 10 minutes long. The founder said, “Gentlemen [and there were no women in the boardroom, similar to Facebook], this is what I propose to do. Any questions? [There were none, from very high profile directors sitting at the table.] Good, then. Let’s go for lunch.”

Governance is all about checks and balances. From the controlling shareholder point of view, this is his company, his board and his directors. This is fine, but dangerous for minority shareholders and in the long term if or when things start to go wrong.

The answer is not “if investors don’t like it, then they don’t have to invest.” If or when founders go to public capital markets for money, their accountability changes. If founders don’t like this, then they don’t have to go to the capital markets is the counterpoint.

I have argued (see “Richard Leblanc’s paper”) for example that minority shareholders (the other 40% of Facebook for example) should have seats at the board table and be there to oversee related party transactions and protect all shareholders including minority ones. They should also be independent from the founder.

Nevertheless, people do things simply because they can. Legal counsel has drafted the S-1 filing giving Zuckerberg as much control as possible. This is entirely legal.

What is also legal is the diversity of Facebook’s board. California State Teachers’ Retirement System sent Zuckerberg a letter earlier this week urging him to appoint women to the Facebook board and enlarge it in line with its market capitalization. There is ample evidence that diverse groups mitigate groupthink and strengthen decision-making. Facebook COO Sheryl Sandberg has been a proponent of greater board diversity, arguing the figures for women on boards are currently stuck at 15% and have been this way for the last 10 years. See a compelling video here.

But why would Zuckerberg do this? The Securities and Exchange Commission does not even define diversity. As a result, companies can define diversity downward to include diversity of “perspective,” “experience” or other factors, when they are an all male board.

It is particularly surprising that this board is not diverse, when its customer base contains people from just about all regions of the world.

The reason it is not diverse is presumably it reflects Zuckerberg’s intent.

When it comes to governance and diversity, the business reason for addressing the shortcomings above is quite simple. A good board earns its keep when it prevents the CEO from making that one big mistake. It takes enormous confidence to put people on the board with whom you disagree but whose opinion you respect, if only to keep you from making that mistake.

Zuckerberg is a genius in the world of programming and social media, but people make mistakes, are not infallible, nor irreplaceable nor live forever. It is these things that governance addresses, or is supposed to.

The Magna Situation and Overdue Corporate Governance Reform

This week, it was revealed that Messrs. Michael Harris, Louis Lataif and Donald Resnick, former members of a Special Committee whose role was to assess a related-party transaction involving control person Frank Stronach, all received overwhelming “withhold” votes compared to “for” votes cast by shareholders (62% “withhold” votes vs. 38% “for” for each).

This is a clear message by Magna shareholders that these individuals lack support and a mandate.

More importantly, this is a teachable moment for reforming Canadian corporate governance practices, particularly in respect of controlling shareholders and related party transactions. Many Canadian companies have “dual share” structures whereby a person(s) can control appointments to a board of directors –even with a minority of the total equity– and engage in transactions between themselves and the corporation (otherwise known as a “related-party” transaction, or transactions with insiders). These transactions, and the directors who oversee them, should be subject to greater scrutiny in my view.

Here are some proposals for reform:

Majority Voting: To begin with, each director of each board each year should receive a majority of votes cast by shareholders, plain and simple. If they do not, they should be required to resign, with shareholders nominating a replacement director who has majority support. “Withhold” votes should be changed to “Against” votes and the system simplified. All director votes should be disclosed and the system transparent.

Director Independence: Director independence should be changed from what the board believes to be the case (as it is now), to a more objective standard. In Magna’s case, Mr. Harris received $749,710 in total compensation in 2010. This is anomalous for a non-executive director position in my view. Irrespective of Mr. Harris, it is reasonable for a quantum this large for part-time work to receive scrutiny in terms of potential impact (or not) on the independence of that director. Mr. Resnick, a second person on the special committee, has been on the Magna board since 1982. This length of service is also anomalous. It is equally reasonable for this length of director service to be subject to objective scrutiny. A “9 year” independence limit is now law in the UK, whereby directors exceeding nine years service are presumed to no longer be independent. These are just two examples of how implementing a reasonable person standard for director independence could call into question the independence of incumbent or prospective directors. Other examples include director interlocks, personal associations and affiliations with firms who supply services to the company.

Minority vs. Controlling Shareholders: Next, directors representing minority shareholders who are independent of both management and the controlling shareholder should be placed on boards with a controlling shareholder. This brings greater objectivity and independence and oversight of potential conflicts of interest such as related party transactions. These directors should be elected directly by minority shareholders. The controlling shareholder should have no undue influence on this election.

Special Committees: The rules for special committees also need to change, particularly in overseeing insider transactions. Above a certain monetary threshold, for example, boards should be required to appoint an independent expert to provide an impartial opinion on the terms and conditions of the transaction and its impact on minority shareholders. Special committees should be composed only of directors who affirmatively declare they are independent (objective standard), directly or indirectly, of all parties and matters being discussed and considered. Interested parties should have no influence whatsoever. Terms of reference for the special committee should be disclosed and records maintained. Previous advisors to the company should be prohibited from advising the special committee. These reforms would go a long way to tightening up the role of special committees in overseeing potential conflicts of interest with company insiders.

Voting on the Transaction: Significant insider transactions above should require approval at a general meeting. Minority shareholders should be given a chance to oppose the resolution approving the transaction. Controlling shareholders should be precluded from voting on the transaction as they are self-interested in it.

Will the above reforms be implemented? They should. Unlike the US, Canada has been struggling with enormous powers of controlling shareholders since the inception of corporate governance guidelines some 20 years ago. Given our ownership patterns of companies –and ability of persons, families or even foreign corporations to exert control over companies, and potentially extract benefits– it is high time these above issues are resolved.

Back to top

text cloud