Highest Paid CEOs: #1 Mark Zuckerberg

This is the first in a series of five articles, covering the top five highest paid CEOs in the U.S. Sitting atop the list is Mark Zuckerberg, CEO of Facebook (NASDAQ: FB  ) , who made $2.3 billion (yes, that's not a spelling mistake, I did mean billion) in fiscal 2012, the latest year for which figures are available. Zuckerberg is one of five co-founders of Facebook, which was launched from a Harvard dorm room in 2004, and has been its CEO since the beginning. But the $2.3 billion is only part of the story ... and it's not the biggest problem with Facebook. The biggest problems are Zuckerberg's control over the company's shares and the board's complicity with him.

Breakdown of compensation

The proxy's compensation report indicates that compensation at Facebook is mostly equity. And you can say that again. Zuckerberg exercised 60 million stock options over shares of Class B common stock in May 2012. The value realized on the exercise was $2,276,677,500. 

The report continues: "Mr. Zuckerberg did not receive any additional equity grants in 2012 because our compensation committee believed that his existing equity ownership position sufficiently aligns his interests with those of our stockholders."

Can't really argue with -- he owns more than two-thirds of the company.

And he still has 60 million options, because the initial grant, made just a year after the company was launched and seven years before it went public, was for 120 million stock options. The remaining unexercised options have a current face value of $3.2 billion. So we can expect an even bigger payday to come, as long as the shares hold their value. But it's unlikely that Zuckerberg will receive any more equity awards.

Options aside, Zuckerberg is compensated at a low level compared to his peers. His salary is $500,000, and his cash bonus is typically even less. Oddly, the cash bonus is based on six-month performance periods with targets such as "grow user base" -- top execs generally are evaluated over longer performance periods. But again, cash bonuses are not high, comparatively, and typically represent a target of only 50% of salary for most executives.

Zuckerberg's perks cost the company more than his salary and bonus together, and include approximately $1,213,591 for costs related to personal use of aircraft chartered in connection with Zuckerberg's comprehensive security program and on which he flew with guests in 2012.

For other Facebook executives, pay also comes mostly in the form of equity, though for them the awards are in the form of restricted stock units (RSUs). For a company in these early stages, this is neither surprising nor inappropriate, though it would be more effective if these were based on some form of performance measurement rather than simply continued employment.

The compensation report notes that its cash compensation is well below market peers. Perhaps not surprisingly, Apple and Oracle are both included on that list. I mention this because guess which other CEOs are in the top five?

Zuckerberg's control - The shares

While the company had a shaky start, with shares falling from the IPO price of $38 to less than $18, it has since recovered and shares are now trading above $50. So while $2.3 billion does sound like an incredible amount of money, Zuckerberg is a co-founder and hasn't really profited from the company in any other way. He deserves some reward for creating a Russell 1000 company, and it's only right that this should come in the form of equity.

But the real problem with Facebook is the unequal voting rights and the lack of board oversight.

First, let's deal with the voting rights. These stock options and the vast majority of Zuckerberg's share ownership consist of Class B shares, convertible one to one into Class A shares. Zuckerberg owns 66.5% of this class and has voting control over an additional 18.2% and thus controls 83.2% of Class B shares and 67.2% of the total voting power because Class B shares have 10 votes to each Class A vote. The exercise of the stock options -- even though he sold some shares subsequently -- actually increased his voting control to this level. With this level of voting power, nothing is going to happen without his say-so. This situation, unfortunately, imperils the rights of public shareholders significantly.

Zuckerberg's control - The board

Next we come to the board, which is elected annually – by Zuckerberg, clearly, given his voting power – and is made up of eight directors. Two insiders are on the board: Zuckerberg and COO Sheryl Sandberg. Sandberg's election to the board in June 2012 was Facebook's initial response to criticism that its board lacked diversity.

There were a number of problems with this "solution." First, one woman on the board does not make it balanced. Second, since she is the COO, this appointment doesn't add expertise, it just duplicates it. Third, adding another insider to the board does nothing to increase the board's independence, which is already compromised. Clearly, someone recognized this problem and nominated another female director; and, on the face of it, an independent one.

The current board consists of Marc L. Andreessen, Erskine B. Bowles, Dr. Susan Desmond-Hellmann, Donald E. Graham, Reed Hastings, Peter A. Thiel, Sandberg, and of course, Zuckerberg.

Andreessen, Graham, and Hastings were elected as designees of Zuckerberg; in fact Andreessen and Bowles are Zuckerberg nominees.

Thiel was elected by "the holders of a majority of the shares of Series B preferred stock and Series A preferred stock". So, Zuckerberg again. Thiel is one of two original investor directors; the other, James Breyer, stepped down at the last annual meeting. Breyer and Thiel are the ones who ceded the voting power of their shares to Zuckerberg, so it was unlikely that they would have acted independently of him anyway.

The two remaining board members are, unfortunately, also conflicted. Graham and Hastings are CEOs of companies – The Washington Post and Netflix – that do significant business with Facebook and might not be considered completely independent. And Graham is designated the lead independent director?

This is not a board that can even remotely be expected to act independently of Zuckerberg and in the interests of public minority shareholders should their wishes clash. That would make me very chary of investing in Facebook.

Conclusion

Wider governance problems aside, and they are considerable, did Zuckerberg deserve what seems like an enormous windfall?

The key is that we shouldn't be thinking of this as pay at all. This grant was fundamentally an option on his ownership. It is likely that the options were awarded initially because there was very little cash to pay any kind of salary in 2005. They represent a bet on the future value of the company.

Given the circumstances, and the amount of wealth created here, it would seem to have been a good bet, though not one that is likely to be repeated.

The problem is, though, that they increased and will increase Zuckerberg's ownership and, therefore, voting control. But once the remaining stock options are exercised -- with another eye-popping amount of profit -- my guess is that Zuckerberg's compensation will follow the relatively modest path of two other Silicon Valley-type entrepreneurs: Bill Gates and Steve Ballmer, neither of whom ever received any kind of stock compensation and who earned comparatively low salaries and bonuses during their entire tenure at Microsoft.

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