Zuckerblogging, Part I
Facebook this week informed its shareholders that it is planning to issue a stock dividend. Existing shareholders, including Zuckerberg, will receive two shares of a new class of non-voting common stock for each of their existing shares. Readers may recall that Facebook already has 2 classes of common stock, one providing each share with one vote, and a second (mostly held by Zuckerberg) providing much more voting power. The dividend raises both some interesting philanthropy issues as well as some interesting technical questions about Tax Code section 305 (if the idea of “interesting…section 305” is not an oxymoron).
Vox has a pretty good explainer on why FB is pursuing this structure: it’s to make sure Zuck keeps control of the firm even as he fulfills his pledge to give away 99% of his Facebook stock. But in some ways it is odd that this move is so novel. Many, many entrepreneurs in the past have created foundations, and many of them have wanted to keep control over their firm in the family (see, e.g., the Fords, or Milton Hershey). Traditionally, what you did was form a private foundation, then give it the stock of your firm. You appoint your family to sit on the board, and they vote the foundation-owned shares of the firm’s stock, presumably to appoint one of their own as CEO (again, see the Fords). Federal tax reforms in 1969 limited, but did not by any means eliminate (see, e.g., the Hershey Trust), this technique.
The problem is that if the foundation keeps all the stock, it can’t give away any money. The solution, historically, was dividends. State nonprofit law strongly encouraged the use of dividends over stock redemption or sale, anyway, and so the use of dividends nicely aligned legal compliance with continuing family control.
What is different about Zuckerberg, then, is that he apparently does not want to bother issuing dividends. (See here: “Facebook does not pay a dividend.”) This is in line with trends of the last 2 decades, which have been sharply toward stock redemptions and away from dividends. (Does that trend have anything to do with changes in state law deemphasizing the use of dividends in foundations and retirement funds? Watch this space.) And, since the main use of dividends in the literature is to remove free cash flow from the hands of imperfectly controlled managerial agents, it makes perfect sense that a Zuck-controlled Facebook sees no needs to take free cash flow from the hands of Zuck.
But this brings us to section 305, the tax code provision governing stock dividends. We’ll get there next time. For now, your homework: consider whether a stock distribution whose purpose is to substitute for the purposes a cash dividend would historically have served can gain the favorable tax treatment usually accorded to non-cash dividends.
