Musk’s $83B realisable pay sunk due to the absence of director independence.

Words can barely describe the tremendous impact Elon Musk has had and promises to have on everyday lives. He has driven major disruptions to financial services, space travel, energy networks, and automobile industries, and promises to disrupt all things associated with tunnelling, train travel, artificial intelligence, social media and brain function, providing the world does not stand in his way.

While you can never say “never” to Mr Musk, at least for now, the law has said “no” to him realising most of an $83 billion pay day. The reward was disallowed for achieving the barely credible with Tesla primarily (but not entirely) because the board that put forward the deal which shareholders approved was not deemed “independent”.

The Tesla Trial

A compensation grant by Tesla in 2018 provided its CEO with the opportunity to receive 12% of Tesla’s total outstanding shares at the time, which had a fair value at grant date of $2.283 Billion USD. Various milestones relating to these measures were reached over the years for option grant’s 12 tranches to vest.

The value was 250 times larger than the contemporaneous median peer compensation plan.

And, for the record, there was no compensation consultant anywhere to be seen in this story.

The plaintiffs failed to show that this was fair.

The rationale presented by Tesla is that they would receive massive share growth and retain “deeply qualified and committed executive officers”.

A single shareholder (Mr Tornetta) filed a lawsuit against the company in 2018, stating that it was excessive and that the directors breached their fiduciary duty to shareholders by allowing it to be approved. Among the many interesting findings from the judge overseeing the case was that compensation committee members were not independent.

The compensation committee’s directors’ relationships with its CEO included a mix of close personal relationships, financial and investment connections, and for the chair in particular, a dependence on wealth received from Tesla for the position of director. These relationships disqualified directors from meeting tests of independence.

One aspect of the pay deal would have pleased ACSI

The grant was tied to a market cap maximum goal of $650 billion USD, revenues of $175 billion, and underlying earnings of $14 billion. At the time of grant Tesla’s market value was $59 billion. Vesting would not start to occur until market value achieved $100 billion. At the time Tesla had $12 billion in sales and $400 million in profits.

Arguably, achieving higher revenues than GM and a market value greater than Microsoft may have met ACSI’s idea of “stretch targets” (see HERE). So, in very basic terms and round numbers, Mr Musk would receive $65 billion if he delivered shareholders a value of $650 billion. At current prices investors received a 10 fold return.

Actually, when you looked at the grants in more detail, some targets appeared quite achievable.

As Mr Musk received no salary, and all was performance based pay, it also ticked a key ISS box, although the total amount seemed to faze ISS.  (ISS and Glass Lewis opposed the deal).

It is notable that 73% of investor shares voted for the pay package. However the judgement (see HERE) contends they were not fully informed of conflicts and process.

Importance of Independence

A prior article by Guerdon Associates looked at a 2014 Supreme Court case that defined the way in which NEDs should act in Australia, citing the importance of directors who are “independent of corporate management”. It is generally preferred that a majority of the board is considered independent. This minimises agency risks.

One of the issues in the Tesla case is that the directors are dependent on Tesla for income which may affect their ability to make a fair decision regarding executive compensation. If a director is dependent on a company for their wealth it is much harder for them to step down when they can no longer fulfil their position. This can impede their ability to challenge management on important topics. It can also make them more likely to agree with decisions that may not be in the best interest of the company and shareholders, negating their fiduciary duty. This is an important consideration for the board in assessing new board candidates. That is, do they have enough accumulated wealth and/or diversified income to be independent, and walk away if they disagree with aspects of governance.

Did they do what is in the best interests of the company?

It is interesting that the judge did not venture into business judgement and associated territory, other than indicate that given the absence of independence a director could not be relied on to apply business judgement. Some would say that only Musk could have got Tesla out of the hole it was in at the time, with its massive supply problems and manufacturing facilities relying on assembly of cars in tents, among other things. While precedent is hard to come by, some have referred to Steve Jobs return to Apple in 1996, as it was teetering on the brink of failure. His return provided focus and innovation, and a legacy that has resulted in a company with a market cap of $3 trillion. But others may also point to Mr Jobs’ successor, Tim Cook, who has guided the company from 2011 to achieve this market value. A similar appointment at Tesla may have met all the same goals for a fraction of the cost. Like Apple under Mr Cook, it may have achieved the value while no longer a leader in innovation, but still delivered great products that consumers love.

So many learnings from this case

A selective list, in no particular order;

  • At least consider a comparative analysis
  • Seek independent advice
  • Arriving at a mutually agreeable pay deal is not one of cooperation, but an adversarial negotiation
  • An individual can control a company with 20% effective ownership
  • Time spent on deciding a pay deal is no indication of quality. So it is not the number of meetings that count
  • Extraordinary reward is not justifiable when the recipient already has a material ownership stake. The uplift delivered in value also delivered for the recipient. And, with such an ownership stake the recipient was not going anywhere
  • If a justification was what private equity is paying, you need to show why this is a valid comparison
  • The proxy failed to disclose actual or potential director conflicts in respect to Musk

The post-trial opinion probably should be read by all directors. It is a good read, if only to read a judgement on a serious conflicts matter whereby the judge quotes from Star Trek. You can read the post-trial opinion HERE.

© Guerdon Associates 2024
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