Is Facebook's Stock Split Idea Good for Investors?

Source: Facebook.

Facebook did it again. Coming off back-to-back earnings blowouts, it's hard to imagine that the sprawling social-media powerhouse could have the wind more squarely to its back.

And if you're CEO Mark Zuckerberg, this ebullient environment is also the perfect time to make a bold request from the fawning investing masses, like last week, when the company said the board is seeking approval to issue a new class of non-voting stock in a move that would ensure Zuckerberg's control of the company while allowing him to pursue philanthropic activities.

Zuck's feeling charitableAs part of the company's Q2 earnings announcement, Facebook unveiled a proposal to create a new three-tiered stock structure.The company currently operates under a two-tiered structure, with Class A and Class B shares. Class B shares are each allowed 10 votes in all corporate governance matters, while Class A stock casts only a single vote per share.

Under the proposed structure, Facebook would pay all Class A and Class B shareholders a one-time dividend of two newly created Class C shares. These newly minted Class C shares would carry all the economic benefits due to Facebook investors but, crucially, carry no voting power.

So why is Facebook doing this, you ask?

In two letters accompanying the earnings release, Zuckerberg and Facebook General Counsel Colin Stretch argue that the new share structure will allow Facebook to maintain its laudable long-term vision while allowing Zuckerberg and his wife, Priscilla Chan, to accelerate their philanthropic pursuits. As they note, Facebook's long-term vision has enabled the company to make some of its most successful decisions, such as acquiring Instagram for a then-preposterous $1 billion. As such, separating Zuckerberg's financial stake from his voting control will allow him and his wife to accelerate their plans to give away 99% of his Facebook shares over his lifetime, while maintaining his ability to control and manage Facebook. Though I believe Zuckerberg is the right man to lead Facebook, it's worth noting that the stock split plan could create a few long-term risks at Facebook.

Source: Facebook.

For better or worse ... The value Zuckerberg has brought to Facebook is beyond dispute. But when the time comes for Zuckerberg to step down, that's when his disproportionate control over Facebook could grow fractious.

The share structure at Facebook -- whether the current one or the proposed one -- is only a good deal for retail investors for as long as Zuckerberg continues his winning streak. However, should any normal scenario arise in which a company might ordinarily remove its CEO, Zuckerberg will be effectively institutionalized and unremovable under the new share structure. What's more, this could hypothetically lead to Zuckerberg running the company while also having little to no vested interest in its financial health or performance as he could give away C shares to meet his philanthropic promises and keep B shares.

What if he makes a cataclysmic product decision? What if, as so often happens as technology executives age, he fails to properly prepare Facebook to deal with a generational shift in technology?

Or what if Zuckerberg becomes fatally ill?

History tells us that one of these scenarios will arise, maybe more. In every one of these adverse circumstances, it will be up to Zuckerberg, and Zuckerberg alone, to be the bigger man.

Note, too, that according to research, such non-egalitarian voting structures on average tend to underperform by a host of relevant metrics. A recent study from corporate-governance watchdog Institutional Shareholder Services found: "Controlled companies generally underperformed non-controlled firms over all periods reviewed in terms of total shareholder returns, revenue growth, and return on equity, according to a new study. The study also finds that average chief executive (CEO) pay is significantly higher at controlled companies with multi-class stock structures."

Facebook is the exception to these criticisms in every regard today, but the long-term risks still remain.

But in the end, sounding any alarms is probably irrelevant. According to Facebook's annual report, Zuckerberg currently owns over 418 million of Facebook's Class B shares, which gives him alone nearly 54% of the company's total voting power. So Zuckerberg can basically do as he pleases, including force this proposal on outside shareholders, whether they like it or not.

So, like it or not, "In Zuck We Trust" may well become Facebook investors' favorite motto.

The article Is Facebook's Stock Split Idea Good for Investors? originally appeared on

Andrew Tonner has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Facebook. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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