Yves here. This post is a useful antidote to the generally terrible reporting on why a Delaware court overturned a Tesla compensation package that would have resulted in Elon Musk receiving an unseemly $56 billion. It was pretty evident, if one read the coverage in the major financial outlets, that no reporter bothered running down the shareholder filing and the court’s ruling, or if they had, they could not be bothered to incorporate what they said in their stories.
It is hard to work up any sympathy for Musk, even before reading the explanation for the decision below. He is still the third richest person in the world. Importantly, Delaware is a favorite jurisdiction for big company incorporation precisely because it is so executive and board friendly. But you do have to observe some minimal forms, and Musk could not be bothered to do so. Or worse, he might have had to limit his wealth extraction.
Recall this is not the first time that Musk sloppiness has cost him bigly. Recall that Musk tried to back out of his agreement to purchase Twitter and failed. Even though Twitter shares are at higher levels than they were most of last year, the total market cap, and with it, Musk’s roughly 79% share, are below his $44 billion purchase price. Remarkably, Musk’s purchase agreement failed to include either due diligence rights or a breakup fee.
By Justin P. Klein, Director of the Weinberg Center for Corporate Governance, University of Delaware. Originally published at The Conversation
Delaware Chancery Court Judge Kathaleen St. Jude McCormick has blocked Elon Musk’s US$55.8 billion pay package, which Tesla’s board of directors approved in 2018 through a process she found to be “deeply flawed.”
No CEO of a publicly traded U.S. company has ever been paid this much for one year’s work, according to Equilar, which tracks corporate leadership data. Pay for the 10 highest-paid executives, including Google’s Sundar Pichai and Apple’s Tim Cook, reportedly maxed out at around $250 million in 2022.
The Conversation asked Justin P. Klein, the director of the Weinberg Center for Corporate Governance at the University of Delaware, to explain McCormick’s reasoning.
Why Did the Judge Block Musk’s Pay Package?
McCormick’s opinion began with a good question: “Was the richest person in the world overpaid?”
She concluded, in this reference to Musk – whose fortune was estimated to be worth $205 billion before the ruling and consists largely of his Tesla shares and stock options, along with his SpaceX stake – that he was.
This legal defeat may have knocked Musk out of his perch atop the Forbes list of the world’s richest people, making him the second-wealthiest, the media outlet calculated.
McCormick ruled against Musk in Tornetta v. Musk, a lawsuit filed on behalf of an investor who owned only nine Tesla shares – and by extension virtually all of the company’s stockholders. Ultimately, she determined that Musk’s compensation plan was considered and approved by a board of directors that was not sufficiently independent or objective.
The compensation plan was subject to a vote by the rest of Tesla’s shareholders. But the information they received left out key details and contained inaccurate statements.
This pay package deserved close scrutiny because of its enormity, McCormick observed. She called it the “largest potential opportunity ever observed in public markets by multiple orders of magnitude.”
What Was Wrong with Tesla’s Board?
McCormick concluded that many of Tesla’s board members, including his brother Kimbal Musk, had close financial and social relationships with Elon Musk and that they were beholden to him due to these ties.
The board approved this compensation plan without following commonly accepted norms, according to the ruling. Further, McCormick found that the directors allowed Musk to control the process for approving the compensation plan, dictating the terms, amount and timing.
Board members apparently made no efforts to benchmark the plan as compared to compensation paid to executives of comparable companies, a critical and typical step in any situation like this.
Musk was in control of Tesla, a publicly traded company, that should have standard protocols in place regarding its compensation practices.
There was no negotiation between Musk and the compensation committee or the board regarding the amount and terms of the plan, the chancellor found. This is both inconsistent with widely accepted compensation setting practices and striking due to the scale of the pay package.
“Musk launched a self-driving process, recalibrating the speed and direction along the way as he saw fit,” McCormick wrote. “The process arrived at an unfair price. And through this litigation, the plaintiff requests a recall.”
What Factors Are Boards Supposed To Consider in Setting CEO Pay?
In deciding what CEOs should earn, boards or compensation committees should consider the company’s performance under the leadership of the CEO and the executive’s own personal performance. They should also review what comparable companies take into consideration when making decisions about their own CEO’s compensation.
Other metrics or considerations may be taken into account, too. These may include whether the company has made progress in terms of diversity, equity and inclusion, employee retention, sustainability and environmental performance, worker safety practices, risk management and compliance with laws and regulations.
Around the time of this compensation decision, Musk was the subject of a Securities and Exchange Commission probeover alleged fraud stemming from what the SEC said were misleading statements regarding his plans to take Tesla private at $420 per share – a part of a tweet widely regarded as a cannabis joke.
The settlement Musk reached with the SEC forced him to pay a $20 million fine and step down as the company’s chairman for at least three years. It also required the appointment of two new independent Tesla board members and a requirement that he preclear certain public statements.
The company was not taken private.
In 2023, a jury found Musk not liable for related losses by Tesla investors who sued over the incident. Tesla shares closed at $187.91 on Feb. 2, 2024, far below that $420 price that unleashed litigation. The company’s share prices closed at $409.97 in November 2021 – the highest point to date.
The board could have considered this incident a negative factor when making its decisions about Musk’s compensation.
What Process Are Boards Supposed To Follow in Setting CEO Pay?
In setting CEO compensation, all members of boards or compensation committees should be truly independent and objective, with no interest in the outcome.
They should consider engaging compensation experts and benchmark or seek information on executive compensation at comparable companies.
These decisions require careful consideration of all components of the CEO’s compensation and how the pay package should be structured. That includes how much of the pay should be provided as cash, restricted stock, which may not be sold for a period of time, and stock options, which provide the right to purchase stock at a predetermined price before a particular time in the future.
When stock prices rise a great deal, stock options soar in value. That’s what happened with Musk’s colossal pay package.
What Happens Now?
Musk may decide to appeal to the Supreme Court of Delaware. On the other hand, Musk could ask Tesla’s board, its compensation committee – or both of them – to revisit and revise his compensation plan, taking into account the objections spelled out in the ruling.
That would include both the amount – $55.8 billion – and the process by which it was set.
Musk, however, appears to be seeking a third option. “Tesla will move immediately to hold a shareholder vote to transfer (the) state of incorporation to Texas,” he posted on X, his social media platform previously known as Twitter.
Even if Musk were to prevail and change Tesla’s jurisdiction of incorporation, it would not be likely to affect this decision.
The public vote is unequivocally in favor of Texas!
Tesla will move immediately to hold a shareholder vote to transfer state of incorporation to Texas. https://t.co/ParwqQvS3d
— Elon Musk (@elonmusk) February 1, 2024
Is Delaware Particularly Tough on Corporate Leaders?
Delaware is the corporate home of more than 60% of Fortune 500 companies even though it’s the country’s second-smallest state.
One reason for its popularity with businesses of all kinds is that Delaware’s courts are quite experienced, with a great deal of expertise in considering business matters and cases of this kind. Musk’s court case was heard in its Court of Chancery, a system that primarily decides corporate legal matters.
Although Musk suggested that standards in Delaware are overly strict in another message he posted on X after the ruling, this kind of case is very rare.
One of few similar lawsuits was filed against former Disney CEO Michael D. Eisner over his $140 million severance package. In 2005, Chancellor William B. Chandler III of the Delaware Chancery Court let it go, while acknowledging the apparent impropriety of paying an executive so much.
“Despite all the legitimate criticisms that may be leveled at Eisner, especially at having enthroned himself as the omnipotent and infallible monarch of his personal Magic Kingdom,” Chandler wrote, “I nonetheless conclude, after carefully considering and weighing all the evidence, that Eisner’s actions were taken in good faith.”
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While I’m not a true chartist or chart analyst, I do find longer term trends on such a volatile stock quite useful. Talk about pretty wide band of pricing discovery on this one. And according to CNBC, the beta of 2.43 is quite indicative of the volatile nature. I’ve seen long term holders of the company stock, such as a Ron Baron or Cathie Wood, basically slurp anything this man (Elon Musk) provides to the public.
All this malarkey about executive pay and CEO / founder pay could be quashed pretty quickly. Congratulations on your lavish compensation package. Now distribute 50%, upon receipt, to the IRS. You won the lottery, now pay your share of it ( many thanks, no doubt, to the citizens and government of Texas whom I would believe had provided a nice package of incentives for the gigafactory site in Austin ).
What was not considered here is that it’s not about money, but precedent. CEOs saw this and will move their companies out of Deleware. Further Deleware is in Biden’s home state – have you considered the connections there? I’ve read but not confirmed, Hunter was bragging about his connections to those judges.
Yours Truly grew up in Chester County, Pennsylvania. That’s just north of the Delaware line.
Let me tell you something: Delaware is all about connections. It’s even more tribal than Pennsylvania old money, and that is saying a lot.
No they won’t. This is just Musk bluster.
Delaware is very pro board and executive. It has a very deep, sophisticated judiciary and a long history of precedents. Having well-settled law is extremely important. Texas does not offer that. Going to Texas is a signal you have a wanna be rogue exec.
Why would be it bluster when he already reincorporated Twitter/X in Nevada from Delaware when he took it private?
And the risk to Delaware is Nevada not Texas. Musk has stated he would have picked Nevada if Tesla wasn’t already headquartered in Texas. A 2012 Virginia Law Review article observed that Nevada has deliberately modified its laws to becoming even more corporate friendly than Delaware. DraftKings, TripAdvisor, and TransPerfect all recently reincorporated from Delaware to Nevada. Obviously, a very small sample size. But, given how unusual it is for established companies to reincorporate elsewhere, this may lead to lawyers to question the wisdom of incorporating in Delaware by default. Musk’s loss won’t help.
Please read more carefully. Your comment reflects at best that or an attempt to straw man me.
As Petra indicated, Musk is treating his plan to move Tesla’s state of incorporation to Texas as not just his effort to “punish” Delaware, but claimed lots of other companies would follow. That is bogus. Delaware is extremely big corp friendly. There is no reason for any even minimally compliant company, as in the sort that listens to their expensive corporate counsel. to be unhappy in Delaware.
The issue with the TSLA compensation package is that he had stock options that vested with each $50 billion dollars in market cap that the stock achieved at the market price of the stock in 2018. In Dec. 2018, TSLA had about a $57 billion dollar market cap and shares were at around $22, so he would have to double the market capitalization to gain any compensation. By Dec. 2023, TSLA had a $791 billion dollar market cap, about 1,380% higher for the shareholders, and while his equity stake was comparable to the market cap at the time of the executive compensation scheme, its a little over 7% dilution. Its basically a contingency fee for an executive. Certainly, in hindsight, most people would have preferred to be a shareholder in TSLA in the comparable period relative to GM or Toyota, despite the CEO compensation. Were the shareholders harmed?
My feelings about this are mixed. Yes, Musk was sloppy, yes the compensation is excessive, even if Musk’s compensation was arguably justified based on the performance, you rip the ceiling off executive compensation, and the rest of them will be clamoring for more. However, if you are going to now legally institutionalize a cottage industry around CEO compensation and you are not going to incentivize CEO’s to set the world on fire for their shareholders, we are just going to get more management consultants and more mediocrities and stupid shareholder buy-backs and stupid mergers to game executive compensation. These executive compensation studies are a problem, because they get average CEO pay and everyone believes they are above average so it constantly ratchets up. Its doubtful that most CEO’s would even consider Musk’s compensation scheme not because it was excessive, but because they knew they were incapable of doubling their market cap, let alone making their company’s stock a 10 bagger.
Musk was already Tesla’s largest shareholder. Even without his $55 billion compensation package, he was properly incentivized to, as you say, “set the world on fire for [] shareholders.” Moreover, because Musk is also the CEO of Space X and CTO of X, his Tesla job is part time. Even if $55 billion, the largest CEO compensation package in history, was warranted to a full time employee, it’s still a bit much for a part timer.
The point though, which you seem to miss, is that the largest shareholder, CEO, and then Chairman of the Board, gave the board of the company he controlled a compensation plan which they rubber stamped. A board of directors is NOT supposed to act as the corporation’s control person’s rubber stamp.
The Court ruled that because there were false statements made about the plan prior to the shareholder vote, Tesla had the burden it prove it was fair to the shareholders. Tesla failed to meet this burden of proof.
The parade of horribles you mention isn’t going to be affected by this ruling. There is nothing in it that doesn’t follow long-standing Delaware law.
I think it is clear from my remark that I do not disagree with the outcome of the ruling, or the court’s concern with Musk packing the Board with his buddies.
I am saying, if I had been a shareholder of TSLA from 2018-2023, I would not feel the slightest bit cheated by Elon getting that executive compensation. But the problem is that making an exception for Elon would blow the whole executive pay ceiling out for everyone else, and it is already crazy. so I agree with the outcome.
Excess executive compensation is a real problem, the issue is that the solution of committees looking for average wages in Lake Woebegone’s executive suite, or coming up with a bunch of subjective matrices like ESG commitment over say shareholder value is just going to continue the problem which is not that individuals are gaming compensation, but that executives are paid way too much in general. Realistically, you don’t need all this nonsense, you just cap CEO comp at 10x, 100x, 1000x, whatever ratio people agree on, of the lowest paid employee at the company, and let the CEO’s game it as much as they want (e.g. give all the people working for them a raise).
Tesla’s highest market cap was $261.44 billion in December 2023 (12/26/2023). This is a far cry from the $791 billion you state. It’s highest ever market cap was just over $400 billion.
The judge ruled against Musk because the board members were not independent of Musk and did not properly disclose their lack of independence to shareholders.
This is quickly refuted by the following link. Sorry but the above market cap figures are not accurate. CNBC equity update shows a +/- $580 billion market capitalization for TSLA as of recent activity.
Most boards are clubby memberships as it is, unfortunately, just my broad observations.
https://www.cnbc.com/quotes/TSLA
The 791 billion market cap was from a commercial website which is not always infallible, so checked it.
If you go on Yahoo, you will see that TSLA have a $582 billion dollar market cap today with shares at $183, and shares were at $241 at the end of December (241/183 = 1.3169) so approximately 766 billion:
https://finance.yahoo.com/quote/TSLA?p=TSLA&.tsrc=fin-srch
so not sure where you are getting your numbers from?
I apologize. I misread the chart. I stand corrected.
I do not think that Musk getting his move to Texas is a slam dunk.
There are a lot of shareholders who might want to short the stock if the vote fails, and Musk throws a tantrum and leaves. (FWIW, I think that Musk leaving could be a good thing for the company, though not the share price, he does not understand manufacturing (self-evident) or car design. (If he understood cars, the base single motor Model 3 would have been front wheel drive)
Musk will be in prison by the time this awful decade ends