Elon Musk Discovers the Price of Running a Public Company

In 2018, Tesla’s CEO, Elon Musk, got what was potentially the most lucrative compensation package in history, an incentive-based deal that would earn him stock options worth nearly $56 billion if he hit the contract’s targets. He did exactly that, and ahead of schedule. Over the next few years, Tesla’s market capitalization rose by many multiples: Despite having fallen from its November 2021 peak, it is still worth 10 times more than its value in early 2018. That performance put Musk in line for the biggest payday ever—until Tuesday, when a Delaware judge presiding over a shareholder lawsuit threw out the entire pay package.

This was not business as usual. Historically, judges do not interfere with compensation decisions made by a board of directors. And Musk’s deal was not only approved by Tesla’s board, but also overwhelmingly ratified by a vote of the company’s shareholders. Given that the entrepreneur then lived up to his end of the bargain, making shareholders rich in the process, taking away the $56 billion after the fact seems a dramatic, even harsh, decision. But the ruling is also, in certain respects, a predictable result of Musk’s apparent indifference to rules and process, especially those related to running a public company. The ruling also points to a problem that afflicts many companies—CEOs having their pay determined by boards that they effectively dominate.

That, in essence, is what the judge found happened in Musk’s case: She held that Musk had effectively dictated the terms of his own pay, because Tesla’s directors were not truly independent of him and had not engaged in an arm’s-length negotiation with him when making the deal. She also ruled that the shareholder vote was flawed because Tesla had failed to disclose the personal and business relationships between Musk and several board members, and had presented the board as independent when it was not.

The judge’s factual determinations, at least, are hard to argue with. Ira Ehrenpreis, who was the chair of Tesla’s compensation committee when the pay deal was set up, is a longtime associate of Musk’s and a friend of Musk’s brother, Kimbal (who also sits on the board). Antonio Gracias, who was also on the compensation committee at the time, testified during the trial that he and Musk were “close friends,” and that he and his family had vacationed with Elon and Kimbal on many occasions. (Gracias also sat on the board of directors of SpaceX, another Musk company.) James Murdoch, similarly, was friends with Musk and vacationed with him.

These directors, in other words, had close ties to Musk, which might plausibly have made it difficult for them to say no to him on the compensation package. On top of that, Tesla board members were exceedingly well paid for their service, with some of them earning millions of dollars in compensation annually. That gave them a strong incentive not to put their job at risk by challenging Musk. The combination of all these factors helps explain why the shareholder advisory groups Institutional Shareholder Services and Glass Lewis flagged the board’s lack of independence as a problem in 2018.

In theory, of course, even a board that had connections to Musk could still have conducted an arm’s-length negotiation with him. But the judge found that Tesla’s board did not do so. In fact, the board seems not to have done much negotiating with Musk at all. He devised the original compensation plan, which resembled a similar, if less extravagant, package he’d gotten in 2012; later revised it; and then revised it once more (actually making the deal less valuable to him)—changes that the judge found he initiated, and that Musk himself described as “me negotiating against myself.” The board members never even commissioned a study to benchmark the deal against other compensation plans. If they had, they’d have found that no comparable pay package existed (although they possibly knew this already).

In figuring out how much Musk should be paid, then, the board didn’t try to bargain with him to get the best deal possible. Instead, the judge wrote, it saw its job as being “to cooperate with Musk, not negotiate against him.” Obviously, a board of directors wants to maintain good relations with its CEO, particularly one as important to the company as Musk was (and is). But $56 billion is a colossal sum of money, a remuneration package without precedent, in fact. So it’s a bit perplexing that no director appears to have suggested that maybe the board could set Musk’s potential payout at, say, $20 billion instead. Consider that he already owned nearly 22 percent of Tesla stock at the time of the deal, a share that an independent board member might reasonably have regarded as sufficient additional incentive for the chief executive to do his best work.

Even allowing for all this, there is admittedly something strange about a judge voiding a deal that Tesla shareholders voted for—if they thought the arrangement was fair, why should a judge decide otherwise? But here again that pesky independent-director problem rears its head. When Tesla described the pay package to shareholders in a proxy statement, the company did not disclose anything about the personal relationships, and potential conflicts of interest, between Musk and the members of the compensation committee. Nor, the judge found, did it adequately describe the process by which the pay package was devised. Those failures to disclose, the judge ruled, meant that the shareholders were unable to make a fully informed choice about the deal.

The court’s decision will presumably be appealed. Although Delaware gives judges a lot of discretion in interpreting the law, aspects of the ruling—including, most notably, the finding that Musk was Tesla’s “controlling stockholder” despite having a minority stake in the company—could make it vulnerable to reversal. The possibility also exists that Tesla’s board will try to come up with a replacement pay package for Musk for shareholders to vote on. But however this litigation turns out, Musk has seemed almost sure to encounter such a decision at some point in his career.

That’s because running a public company means that you have to follow certain rules and regulations—things that Musk has never much cared for and has typically treated as annoyances. (In 2018, after he got in trouble with regulators over some tweets, he famously told 60 Minutes that “I do not respect” the Securities and Exchange Commission.) In his ideal world, in fact, Tesla would probably be a private company, as both SpaceX and X (formerly Twitter) are. But being a public company made it easier for Tesla to raise capital, so he went that route instead. The problem is that he never fully accommodated himself to the obligations that come with being public. Musk doesn’t own a majority of the shares in Tesla, nor does he have a controlling vote over the company. But his behavior suggests that he thinks of Tesla as his.

To be fair, almost everyone else thinks of it as his, too. And one real irony of this story is that, if Musk had done a better job of following the rules, he could almost certainly have received a huge pay package without any of the legal trouble. Maybe not $56 billion huge, but still some historic amount. Erratic and volatile though Musk may be, he is, after all, one of the great entrepreneurs and wealth builders of our time. Even genuinely independent board members and fully informed shareholders would very likely have been happy to sign off on an incentive-laden deal that would richly reward the CEO if Tesla’s stock price soared the way it did. But it turns out that sometimes there’s a price for sidestepping best practices regarding corporate governance and executive-pay negotiations—and Musk may end up paying it.

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