On September 21, 2017 Facebook’s board of directors voted to abandon the pending reclassification of the company’s common stock.
A class action lawsuit by Facebook shareholders seeking to enjoin the reclassification was scheduled to begin trial on September 26, 2017. The reclassification would have issued two shares of non-voting (Class C) stock to every share of regular (Class A) stock and high-voting (Class B) stock. Shareholders contended that the reclassification would have allowed Facebook founder and CEO Mark Zuckerberg to reduce his equity interest in the firm from approximately 15% to 5% while retaining his full voting control of over 50%. The lawsuit contended that this increased disparity between Zuckerberg’s voting control and equity interest would have harmed Class A shareholders.
Brattle expert Benjamin Sacks opined in reports and testified at deposition that academic studies found that the value of firms are lower when the disparity between their controlling shareholders voting power and equity interest (the “wedge”) is larger. He concluded that by increasing Zuckerberg’s wedge, the reclassification would have reduced the value of the Class A shares.
The loss in value occurs because of what financial economists call the “private benefits of control” (or PBCs). These are benefits that controlling shareholders enjoy but which are not shared with minority shareholders. PBCs may include “tunneling” (actual monetary extraction) or “psychic” benefits which nonetheless reduce firm value, such as furthering causes important to a controlling shareholder, but which may alienate customers or otherwise not be value maximizing for the firm. The controlling shareholder receives the full value of the PBCs but bears only part of the “cost” of the loss in value through their equity stake. As their equity share decreases their “cost” of extracting PBCs decreases but the value of the PBCs remains the same, so there is likely to be more PBC extraction and firm value will fall.
The Brattle team was led by Principal Benjamin Sacks, Senior Associate Fabricio Nunez, and Associate Yingzhen Li.