Corporate Governance

Review on Facebook Inc.

Project Brief
Much appreciated & acclaimed a company which has changed the landscape of human interaction on social media, and no exception to say, it is indeed Facebook; which has redefined the aspect of cloud business into a new height. Just before Facebook goes to public; it has been a much talked issue for shareholders-what would there be from Zuckerberg for the shareowners. This is a qualitative look out on Facebook Inc. whether the current formation of company structure pose threat to the governance perspectives. End of the day when company goes to public it has to have the strength to pass the hurdles of expectation versus the yard stick of business set by the rule of law. We tried to address issues of both strengths and weakness on which one can underpin the corporate governance facts of Facebook in a bit details.

Prepared by

Md Nazmus Shakib MSc. in Economics and business Administration Copenhagen Business School

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Table of Contents

Where the story Begins

3 3 4 4 5 5 5 6 6 7 7 7

Facebook and its strategy Looking at the governance Issues Ownership that defines the role in the business Boards to make things get going and effective Do we sense any Agency Problem? Top brass are in Uncle Sams heaven Performance dictates price in the market Competition is in fierce in the industry. Investing decisions with the spectacles of corporate governance Media watchdog Final call: sell or Buy Appendix A Appendix B References

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100 mln thoughts a day have been shared with utmost excitement and this virtual excitement
turns into hard cash. Believe it or not, this has been the powerhouse of all integrated marketing in this era where we, the Homo sapiens, believe in a single world with a single identity and thus connect with each other. Yes, we are talking about social media and especially, we are talking about the brainchild of Mr Zuckerberg, the Facebook. Throughout this written effort, we would thereby try to give a logical status update on Facebook Inc. in the perspectives of corporate governance. Where the story begins It was may be a bright shiny weather in Harvard back in 2004 when Mr Zuckerberg, came up with an idea to get connected with the fellow classmates. And ideally it has popped up into the arena of socially active world where it literally shook the whole world with the beauty of creating and knitting bonding between people to people irrespective to the boundaries that are still alive in the countries. It is indeed the awaited right child in this century. If we look at the business model of Facebook we wont find any complex set of patterns nor do we find any unrealistic modes of operandi. It is as simple as its vision keeping things open to the people so that people can connect and share their thoughts. Facebook and its strategy For the last 9 years journey of Facebook, what we have observed is, it has changed the shape of the world of media business especially in the marketing arena. To be precise it has created an industry and reaped huge profit out of it. DAU and MAU format has enabled Facebook to dig out more profit for the company itself. Social media business has always been driven by selling spaces in internet. It is not different in Facebook but the only USP that Facebook possess that it has the biggest ever user in the universe so far. And thats what turns out to be more public nature for Facebook than ever. Well a business model like Facebook is somewhat not static over the period of time- one may easily argue on that. And there is always a chance of convergence in this sort of industry. Mainly it is the innovators who are in other words trend setters who set the tone of the industry for future. Facebook creates a space for a real social networking business where different parties from different fields are playing along the line. Not just the marketing guys it has created a platform for all application developers who can price their talents. Looking at the governance Issues Facebook very recently launched a file in the SEC of USA for making it as a public listed company. And evidently it is now the most awaited IPO event in 2012. Simultaneously it has come up with tons of questions which didnt appear of late. If we put on the governance spectacle we may find something interesting to talk about apart from just how profitable

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Facebook is. Our aim would be to look into the pillar facts of corporate governance skeptically so that we can make out a decision logically and therefore constructive. Ownership that defines the role in the business Facebook by definition a founder ownership driven company since it was incorporated back in 2004. And it is very obvious that Facebook is nothing but a brain child of M Zuckerberg. Well in the history of USA we are watching it for once, it has had happened for many like Microsoft Owner Bill gates and late Steve jobs from Apple Inc. They are the first generation of the business they owned and thats where people get more enthusiastic about the future of the company. From a governance perspective, considering Facebook to be in the public property very soon we may look at the following issues: A. Dual Shares format: Facebook by its announcement has declared that there will be two types of common stocks. Both A and B class, holds the ownership of the business unit. Having said that when we see Class B stocks have more voting powers than Class A single out the rationale of equal ownership format. It depict that Class B gets 10 times bigger voting rights than of Class A, which in away demonstrate the non-eagerness from the owner to share his or her strengths over the company. The most controversial part would therefore be on the plate is, it will just become a one man show. This does not demean the geniuses of creating and crafting growth from M Zuckerberg for Facebook rather a basic question for the investors who are going to give their money to him and have kind of very little voice or no voice at some point of time. B. Decision is from owners: In all classic facts of highly owner concentrated company we find that decisions are somewhat pre decisive since the owner himself runs the show. In Facebook its very unlikely that it would turn out to be different. If you consider M Zuckerberg, he is actually wearing a double hat as both CEO and the chairman. Yes, in USA it might not sound unfamiliar, but the fact remains on the control of the owner in the company where we find that He owns 28% majority share of the company with more than half of the voting rights. C. Succession Rights: We by definition find in family oriented company where the owner always comes from the off spring of the first generation and it continues. In a highly owner concentrated firm Facebook we might not find any difference to that. There has been an extreme supremacy gifted upon M Zuckerberg that even after his death he can choose who would his successor. Compared to Microsoft owner Bill gates it can be stated here that it is quite a protective option played by Facebook owner. D. Takeover Defense Mechanism: Under the public listed companies Facebook enlisted itself into a controlled company where a majority portion of the shares are

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held by owner. And for this and allocation of capital stock of Class B, owner will have the power to effectively control matters to be submitted to vote from general shareholders, and discretion given to owners to take measures in the way of Business matters where applicable. It actually held off the sign of takeovers or M&A until or unless owner does consent on it. As a result a mini dynasty amy prevail in Facebook even if it is going to be a public company. Boards to make things get going and effective Again if we look at the board structure at the Facebook we might sense of family oriented board member. Indeed it is not the only example from Facebook rather we have seen Zynga coming out with these thoughts and more precisely, companies from Silicon Valley very often came up with this kind of Board structure. We see no Independent directors yet and probably we are not going to see that in near future. It is the reason of Controlled Company form of listing under the corporate governance which allows Facebook goes with a board structure without any independent directors. And since Board members decide the form of compensation for the executives and due to double hatted responsibilities it becomes a classic case of conflict of interest in the end. Do we sense any Agency Problem? In present situation we do not find any since its an owner concentrated company and shares are somewhat distributed to the family or family like members and they are the insiders as well. Once Facebook is on the public table things might change a bit. As a matter of fact, a large number of shares are expected to be in IPO for capitalization which means a larger number of shares may be at the hands of outsiders. But the twist part here is both owners and the people before 2005 stock plan in Facebook has got better rights since they all hold Class B shares, which are mightier. So Type II agency problem may arise where minority shareholders may feel themselves in the back seat. Again it may arise if Facebook finds biggest financial players investing on them, and in the case of USA they are the mighty stakeholders who can influence the legal matters as well. This may sense classic agency relationship for breaking ice on both majority vs minority and vs stakeholders. A recent example of CLTS may be an awakener. Top brass are in Uncle Sams heaven It is always a pivotal take out in the field of corporate governance whether a top position in the company are having extreme pay package. History says that in USA there has been a tradition of high compensation to the top brasses and the directors. The question would not be totally unfair as owners of Facebook are enjoying both monthly salary and the huge bonus. They are pulling out a lot of money from the firm; which might be big consideration from the shareholders point of view when it goes public. It is when the board is cultivating incentives even if conflict of interest exists.

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Performance dictates price in the market It is true and fundamental for any companies who are trading publicly needs to have solid performance in the financial matters. Looking at the financial parameters of Facebook we might conclude that it is in a very handy position now to exploit market expectation for attracting more capital and in return give high ROA. Capitalization: Facebook has got some brilliant strength that nobody possesses right now as a public company. Every day Facebook can severely detect its performance through monitoring their DAU format. And investors can take that as an indicator of response from users. In a current situation Facebook may have a 100Bln capitalization, which would be by far ahead than any competitors like Google. Though they are expecting such a huge response still we can say that its a bit overvalued considering the fact physical entities and scope of economies of the business. Revenue Strengths: If we look at the revenue we may find it really interesting for both Facebook marketers and investors. 87% YOY growth has been registered which is a good sign for any company. And the best part is 85% revenue is coming from the objective point of doing the business. Net Income Factors: Again we see a good score for Facebook investors since there has been an average 214% growth in net income. But still we need to look at the ratio of Revenue vs NI, which will entail the 52% of cost, in a vivid sense. Debt ratio: Looking at the figures of assets and liabilities investors may find a good indication. An overall 6% decline in Assets to liabilities ratio unfolds that Facebook has made more cash in last fiscal year and able to pay out the debts. Competition is in fierce in the industry. Once we all gets into the bus of Facebook we got to know the emergence of people to be connected. And thanks to Facebook that it made a way for others in the industry as well. Big players like Google see it a chance to capitalize their user strengths and so does the others. Now the big question would arrive what next will determine the essence of the people. Facebook as a company is already enjoying 1/8th population of the world in their web with mammoth information in the backyard. As a result, Facebook has been trying to outplay competitors with acquiring more app providers, the recent one is Instagram cost them $1bln. Needless to say, there are other social networking companies around the corner like Tweeter, Myspace etc. But amongst them the only company who backend and forward linked edge, and it Google. They has recently launched Google+. It might be a real blow for Facebook if they really do not come up with innovative products and platforms. To win here all that a company needs a constant drive for innovation and a happy shock for the users.

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Investing decisions with the spectacles of corporate governance Investing in Facebook will take a critical analysis on different issues. In a normal view it would be the biggest and therefore people would love to invest here. Governance Relevance: We can use this as a governance alarm which would lead way for the shareholders who may think of investing in Facebook. This alarm system consists of 4 items governance conformance and each item has been denoted a numeric figure from 0-3; where 0 means non-conformance and 3 means best fit. We have devised it from the report that Facebook provided; it needs to remember that its not the final and decisive but can be a light in the tunnel. Overall performance Metrics: By now we have the overall governance points. Now if we consider Facebook on 4 different angles, we may find it easy whether it would be hand to invest on Facebook or not. The four parameters are: A. Governance Aggregate B. Net profit C. Debt to asset ratio 4. Competitive edge. We value each sector equally and this will make a total of 100% for making a decision in investing in Facebook. Media watchdog There is a big speculation in the market that Facebook is going have the biggest IPO monetization in the industry. Evidently Google when they came in the market they had the same kind of hype. One thing is very common in these days and thats media penetration. Media is now playing like an alternate government in case where big shots are involved. So having a question on deep in share price or any anomalies whatsoever Facebook will always be under the watch dog of media. Therefore, from the shareholders point of view, media would play a safeguard for their legitimate demand. Final call: sell or Buy It is estimated that Facebook will nearly cover up to $100 bln capitalization through IPO offer. And they may be allotting diluted 2.35 billion shares for the outsiders, which turn a share price of Facebook to $42.5. Well, compared to Apple and Google it seems really good having all prior condition is met during the course of time. And within the passage of time like all other big shots in SiliconValley we must hope from Facebook that it will continue its success journey like it did in past. And $42.5 will really seem a tiny in terms of returns. Finally, Yes, I will go for buying a share of Facebook ranging from $38-$42 provided it maintains a sound strategic move within and beyond. Till then we will be looking forward to M Zuckerberg to bring up more blast with the same and unbeaten Share and Connect formula.

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Appendix A: Governance Relevance Matrix

Overall this has been adopted from the annual report and all other materials currently available. We have defined each category with a relevance points from o-3; thus we found the overall Governance relevance. Here O means the best fit in corporate governance whereas 3 meant for the worst match.

The given numbers here are just as logical as taken out from annual report from Facebook Inc submitted to SEC, Nasdaq, USA. For quantifying the quality factors of Corporate Governance, we a have devised such a matrix which might be proven handy in the future. Never the less the number here cant be taken as the final one rather it can be taken as indicative.

Market expectations of Facebook share on IPO

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Appendix B: Overall performance metrics (Qualitative approach)

Here is an assessment on the investment decision for Facebook Inc. We have covered 5 different parameters with some sub divided groups and then tried to form a numeric % out of 20% for each category.

Each category has different aspects and we assess Facebook in different aspects of different parameters. It is solely based on logical assumptions and complete business sense.

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References: 1. Steen thomsen & Martin Conyan, international Corporate Governance Reading 2012, Cand merc.(IBS) , CBS. 2. 3. 4. 5. 6. 7. 8. http://www.about-facebook.com/ http://sec.gov/Archives/edgar/data/1326801/000119312512034517/d287954ds1.htm http://dealbook.nytimes.com/2012/02/02/understanding-the-facebook-prospectus/ http://www.zerohedge.com/news/facebook-files-ipo-prospectus http://topics.bloomberg.com/facebook-inc/ http://www.google.com/finance?cid=12500558 http://investing.businessweek.com/research/stocks/private/snapshot.asp?privcapId=20765 463

9. http://www.insideipo.com/2012/02/the-facebook-corporate-governance-minefield/ 10. http://www.insideipo.com/2012/01/facebook-top-five-corporate-governance-challenges/ 11. http://business.time.com/2012/02/07/facebook-governance-already-a-concern-for-giantca-pension-fund/ 12. http://www.businessweek.com/technology/zuckerberg-controlling-57-of-facebook-seenas-risk-to-investors-02022012.html 13. http://www.wired.com/epicenter/2012/02/facebook-ipo-2/2/ 14. http://blog.sfgate.com/techchron/2012/01/27/the-facebook-ipo-is-almost-finally-nearlyupon-us-maybe/