In Silicon Valley, Chieftains Rule With Few Checks and Balances

Harry Campbell

Silicon Valley is different, they say. One of the most economically creative and dynamic pockets of the United States, it is where entrepreneurs rule. Perhaps it is no surprise then that the men who hold sway in the Valley are now looking to transform not only the global economy but the way that public companies are run, locking out both public shareholders and directors.

That the call for shareholder rights is a refrain seldom heard in the Internet sector is not new. Since Google went public in 2004 in a way that maintained control for its founders, the leaders of Silicon Valley have been chary about shareholder voting rights.

In the latest wave of Internet initial public offerings, shareholder voting rights have become even more diminished. Facebook, Zynga, LinkedIn and Groupon all gave control of the company to the founding shareholders over public shareholders. Mark Zuckerberg of Facebook appears to have even negotiated arrangements that give him — or really, his heirs — control over some shares after his death. Google is planning to issue a class of nonvoting shares that will further disenfranchise shareholders, partly justifying its actions in its annual founders’ letter as maintaining a governance structure that “is now somewhat standard among newer technology companies.”

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To be fair to these companies, shareholders who invest in them do so with full knowledge that such a lack of control was disclosed.

But shareholders may accept these arrangements because they assume that a board will act independently. Directors are meant to act as a check on executives or at least add their expertise and advice to big decisions.

In the Valley, however, the idea of the visionary chief executive dominates, and there may be little room for input from directors.

This sentiment was voiced recently by Reed Hastings, the chief of Netflix and a director for Facebook and Microsoft. Speaking at the Stanford Directors’ College, a yearly retreat where public company directors learn the art of being a director, he reportedly cast skepticism on the traditional board model.

According to Kevin M. LaCroix of the D&O Diary, “Hastings said several times that for the board of a large publicly traded company ‘the fundamental job is to replace and compensate the C.E.O.’ Where the company has the resources to hire outside consultants as needed, it is not the board’s role to offer counsel or advice.”

After resistance from the audience during questioning, Mr. LaCroix reported, Mr. Hastings backpedaled, stating that his remarks applied only to “the largest public companies” or “special situations” where a board was required to act. (Mr. Hastings did not respond to requests made through Netflix for a comment.)

Such a sentiment is at odds with what corporate governance advocates and others suggest for boards. Today, boards are expected to be actively involved in supervising executives and participating in major decisions affecting the company. This represents a revolution from the 1970s, when the chief executive ruled, directors were often cronies of the chief and boards were extremely deferential.

Mr. Hastings’s attitude can be found elsewhere among Silicon Valley’s new elite. When Mr. Zuckerberg negotiated to acquire Instagram for $1 billion, he reportedly told his board only about 24 hours before the deal was approved, appearing to present it as a fait accompli.

Even if these boards did feel free to challenge these founders, they are tight and interlocking. Two of the directors of Netflix sit on the board of LinkedIn. Reid Hoffman, the chairman and co-founder of LinkedIn, sits on the board of Zynga, which has a director who is a partner of Kleiner Perkins Caufield & Byers and sits on the boards of Klout and Amazon.com. Mr. Hastings is joined on the board of Facebook by Marc Andreessen, one of the biggest deal makers in Silicon Valley who sits on the board of eBay. And so on.

These directors all work in the same environment, often invest in one another’s companies and have little incentive to challenge the chief executive because it will affect their own ability to serve as directors or participate in the next big thing in Silicon Valley.

Take Mr. Andreessen, who recently stated on the “Charlie Rose” show that the 28-year old Mr. Zuckerberg is one of the “best C.E.O.’s in the world.” Between Mr. Andreessen and Mr. Hastings, one has to wonder how active the Facebook board is.

Another example of the incestuous Silicon Valley board comes from Mr. Hastings’s own board at Netflix. Its members include the co-founder of Zillow, a professional director who sits on the Google board, two directors for LinkedIn and partners of Technology Crossover Ventures and Redpoint Ventures, two big venture capital players. It is a rather clubby Silicon Valley board.

But this does not necessarily mean that these entrepreneurs are wrong. Maybe boards are overrated in Silicon Valley, where technology moves quickly, innovation is a must and decision-making must be fast and creative for a company to survive. Presumably, these companies give control to their founders and chief executives because they have to act decisively. And these founders built these companies into successes. Why should they be subject to collective decision-making and oversight by a board? After all, boards of financial institutions didn’t acquit themselves well during the financial crisis, and they were supposedly active, involved boards.

The counterargument is that a board willing to engage in vigorous debate prevents hubris and dumb decisions by chief executives. Mr. Hastings, for example, was heavily criticized for trying to split Netflix’s Internet and DVD movie businesses, a decision he reversed after the public outcry. And the number of so-called visionary chieftains who made incredibly bad decisions is legion.

A board can serve as a check on executives and prevent abuse. The conceit is that an actively involved board leads to better decision-making and outcomes, an idea heatedly debated in the world of corporate governance. An active board may be particularly important in these tightly controlled companies where ego may get the better of decision-making. Not everyone can be Steve Jobs.

These companies may lack shareholders or directors to check executive behavior, but they are also free from becoming takeover bait, another important check. An active merger market in the 1980s worked as a disciplining force — pushing managers to shape up if their companies were performing poorly, under threat of a takeover attempt. The days are gone when a company like RJR Nabisco could spend lavishly on executive perks without consequence from a passive board. But these technology companies are controlled by small groups of shareholders and are unlikely to become takeover targets.

So the new thing in Silicon Valley appears to be for public companies to be run as private ones without significant input from boards and shareholders. This leaves the wunderkinder of the Internet free to run their companies without interference. The question is whether this is merely a bubble in corporate governance or a trend that will spread to the rest of corporate America.