25

Recently a judge in Delaware voided Elon Musk's contracted pay package with Tesla. Here's a sample story about it:

CNBC - Elon Musk’s $56 billion Tesla compensation voided by judge, shares slide

And the court's post-trial opinion (January 30, 2024) Thanks Jeremiah Willcock

It seems like this is something that shareholders voted on, and that the size of the pay package is based on the performance of the shares. So what's the legal basis for this judge's ruling?

1
  • Comments have been moved to chat; please do not continue the discussion here. Before posting a comment below this one, please review the purposes of comments. Comments that do not request clarification or suggest improvements usually belong as an answer, on Law Meta, or in Law Chat. Comments continuing discussion may be removed.
    – Dale M
    Feb 4 at 7:34

2 Answers 2

51

A company's board of directors has a fiduciary duty to the shareholders, which means they are legally obligated to do what is in the shareholders' best interest. Board members cannot make decisions that will benefit themselves personally, but not the shareholder. The lawsuit alleged that Musk effectively controlled the board of Tesla through personal ties. The judge found that the board acted in Musk's best interest rather than the shareholders', and that they did not adequately disclose relevant information to shareholders before the vote on the pay package. Tesla board members are paid millions of dollars by the company (i.e. the shareholders) to represent the company to the best of their ability, and they did not.

These lines from the article sum it up well:

Tesla, Inc.’s directors breached their fiduciary duties by awarding Elon Musk a performance-based equity-compensation plan.

Put simply, neither the Compensation Committee nor the Board acted in the best interests of the Company when negotiating Musk’s compensation plan.

Tesla and Musk’s attorneys, the court decided, were unable to prove that the stockholder vote was fully informed because the proxy statement inaccurately described key directors as independent and misleadingly omitted details about the process."

As an analogy, suppose you are selling your house and hire a realtor to negotiate with potential buyers. You ultimately sell the house for $500k, but you later find out the realtor never actually listed the house and just took one lowball offer from their best friend. Even though you yourself approved the sale at $500k, the realtor has breached their fiduciary duty by failing to represent your best interest. The hidden relationship between the realtor and buyer is clearly relevant, as you would not have approved the sale had you known there was no real attempt to get a better deal. In such cases, it is possible for the contract formed under false pretenses to be rescinded.

1
  • Comments have been moved to chat; please do not continue the discussion here. Before posting a comment below this one, please review the purposes of comments. Comments that do not request clarification or suggest improvements usually belong as an answer, on Law Meta, or in Law Chat. Comments continuing discussion may be removed.
    – Dale M
    Feb 4 at 7:34
20

It's right there in the article:

Rather than negotiate against Musk with the mindset of a third party, the Compensation Committee worked alongside him, almost as an advisory body.

In a public company, the board has to negotiate with the CEO as if they are competitively hiring a salaried employee to manage the business. The expected pay could be estimated as follows:

CEO compensation usually depends on revenue and income metrics. It ranges between 0.01% of total revenue and 1% of net income. For instance, Apple's CEO Tim Cook earns ~$100 million, while the company brought $100 billion in net profit in 2022 and 2023. That is 0.1%, high-end pay for a high-performing CEO.
Tesla's revenue in 2018 was $21 billion; in 2023, it reached a revenue of $96 billion and net income of $15 billion. On the open market, this would typically result in CEO pay between $10 million (0.01% of revenue) and $200 million (1.3% of net income).
Stock growth is already accounted for in CEO pay by making it mostly stock options.

The agreement reached in 2018 provided an unusually large stock grant, tied to share price increases. This ended in a total compensation package of $56 billion - 300% of the company's net income. It's stock, not cash, but it effectively reclaims 10% of the company for Elon.

Nominally, the board is supposed to negotiate for the lowest reasonable pay package for their choice of CEO to take the position. The judge didn't believe it was the best possible price in Tesla's case.

“Swept up by the rhetoric of ‘all upside,’ or perhaps starry-eyed by Musk’s superstar appeal, the board never asked the $55.8 billion question: Was the plan even necessary for Tesla to retain Musk and achieve its goals?”

The court found that the board was essentially negotiating the best deal for Elon, which the shareholders weren't aware of. It also didn't find such compensation consistent with what an independent board of directors would reasonably negotiate with an independent CEO-for-hire. Effectively, both sides took a gamble, and hit a jackpot. Musk has the right to gamble in this manner, but a public corporation's board, according to this particular court ruling, is not.


This is the legal reasoning. The underlying reason could be that CEOs are a frequent target of criticism for wage disparity. The aim could have been to avoid a new upward spiral in wage ratios. This package would've been the first time it crossed 1,000,000:1.

Elon Musk may be an exceptional talent, but it always starts with the exceptions. In 10 years, it could be Calhoun (man who sacrificed Boeing's reputation for quality to drive up stock) negotiating a similar package. Short-term, the shareholders gain, but it's not necessarily in the nation's long-term interest. Delaware is a very pro-business state, chosen by most US corporations, but also a blue one, which tend to prefer less income disparity.

Regardless, that's speculation, and the official reason is that the board didn't negotiate in good faith to reduce it to a reasonable minimum at which Elon Musk would have accepted the job.

1
  • Comments have been moved to chat; please do not continue the discussion here. Before posting a comment below this one, please review the purposes of comments. Comments that do not request clarification or suggest improvements usually belong as an answer, on Law Meta, or in Law Chat. Comments continuing discussion may be removed.
    – Dale M
    Feb 4 at 7:34

You must log in to answer this question.

Not the answer you're looking for? Browse other questions tagged .