A Delaware judge's decision to throw out Elon Musk's $56 billion Tesla (TSLA) pay package poses a threat to the world's richest man's wealth. It could also change the way CEO pay is determined at companies across the country.
“This is a big deal,” said Brian Dunn, a visiting lecturer at Cornell University, noting that this is the first time a board decision on compensation has been overturned.
Delaware Chancellor Katherine McCormick's decision is “a wake-up call to all directors about the importance of independent negotiation of CEO compensation.”
Mr. McCormick found that Tesla directors breached their fiduciary duties when they gave Mr. Musk the largest compensation opportunity ever given to a public company executive.
why? That's because there are “extensive connections” between those negotiating the pay package, and the relationship between Mr. Musk and those who approved the deal has not been made public.
“Simply put, neither the compensation committee nor the board acted in the best interests of the company when negotiating Mr. Musk's compensation plan. In fact, there is no evidence of any negotiation at all,” McCormick wrote. Ta.
Analysts and experts say the ruling will resonate in the business world as other highly paid executives and board members watch the legal dispute unfold.
“This will make directors wary of offering too much compensation to satisfy the CEO,” added Dunn, the executive compensation expert. “Honestly, do you think overall CEO pay will go down? No, but I think we'll reign in an extreme situation that wasn't just Tesla.”
Greg Ballaro, an attorney for the shareholders, said that when Musk's compensation plan was agreed to in 2018, it was about 33 times the largest compensation plan ever agreed to by Musk in 2014.
“It was so large that it single-handedly skewed the compensation data,” Ballaro said. “The reason that $1 billion suddenly became a consideration is solely due to this package. If we cancel and erase this package…my guess is that the comparability data will start to atrophy. Masu.”
Musk's compensation plan is designed to pay Tesla stock options in 12 installments, which, along with four consecutive quarters of sales or adjusted EBITDA targets, will help the company reach a market capitalization of $50 billion. only if a series of increases in .
Performance-based compensation was limited by a five-year lock-up period and capped at $55.8 billion, but was tied to the value of Tesla's outstanding shares as of January 21, 2018.
For each benchmark met, Musk was entitled to 1% of Tesla's 2018 value.
For now, the revoked compensation agreement leaves Musk without access to $55.8 billion. However, at the time of the court's ruling, Tesla's CEO had not exercised those shares or sought distributions.
“The court's hard work will be reflected directly in the interests of Tesla investors, who will be less diluted by this large salary package,” Ballaro said. The first lawsuit alleging that board members breached their fiduciary duties was filed by shareholder Richard Tornetta.
Tesla's board could appeal McCormick's decision to the Delaware Supreme Court or create a new compensation plan that complies with McCormick's decision. Ballaro said he expects the defendants to appeal.
Wedbush analyst Dan Ives said Wall Street is watching to see how Tesla's board reacts.
Tesla shares fell 2.2% on Wednesday as the broader market fell. The stock is down 24% so far this year.
If the defendants appeal, the Delaware Supreme Court will likely consider whether McCormick correctly characterized Musk as the controlling shareholder in the compensation deal, said Michal Barzuza, a law professor at the University of Virginia.
At the time of the agreement, Musk owned 21.9% of the EV maker's stock.
“How exactly to define a controlling shareholder is more complicated, and there aren't as many cases about that,” Balzuza said.
He said the issue was an important factor in McCormick's decision because Delaware law applies strict scrutiny to transactions between a corporation and its controlling shareholder.
Musk used his Platform Those are two states where his companies Tesla, SpaceX and X Holdings already maintain a presence, and where fiduciary duties are more lenient.
“Never set up a company in Delaware,” he said in another post. He then asked users to vote on whether Tesla should change its state of incorporation to the Lone Star State.
If you want your shareholders to decide things, you may want to incorporate in Nevada or Texas
— Elon Musk (@elonmusk) January 31, 2024
Complicating matters, Mr. Musk recently sought to receive more Tesla shares in order to secure voting rights for 25% of Tesla stock. The move highlighted the significant influence Musk already has over Tesla.
Musk said his request for additional stock is not aimed at increasing his compensation, but rather to give him more influence over company decisions, especially as Tesla continues to develop advanced AI technology. Repeatedly stated.
William Klepper, academic director and adjunct professor at Columbia Business School, said: “Musk's recent request for 25% control of the company, following a Delaware court ruling, requires the board to give him should be given legal protection to reconsider their claims.”
The decision cites multiple board members as lacking true independence due to their connections to Musk, making it clear that these board members are concerned about Musk's future compensation and the need for truly independent directors. This could raise shareholder concerns about whether the company should approve the transaction.
“Tesla investors need to consider whether Tesla's board can meet its fiduciary duties if it owes the CEO more than the general interests of shareholders,” Klepper said.
More broadly, experts say the ruling will cause some compensation committees of other corporate boards to think carefully about the due diligence required when developing CEO pay packages. Stated. A central concern in the Tesla case was the influence management had over employees in charge of salary negotiations.
To avoid self-dealing and actual or perceived conflicts of interest, the majority of U.S. companies have completely independent compensation committees and consultants, said June Frank, managing director of ISS-Corporate. The company has established an objective process to set executive remuneration.
But Frank said the ruling may require companies to apply more thorough tests of independence, especially where executives can exercise significant control over their boards. said.
But for those sympathetic to Mr. Musk and Mr. Tesla, an adverse ruling against the $600 billion company could deter companies from forming in Delaware, where the lawsuit was filed, Wedbush's Ives said. he suggested.
Both Nevada and Delaware have immunity laws that protect directors and officers from liability for breaches of their duty of care.
However, Nevada law is much more permissive in protecting directors and officers from liability for breach of fiduciary duty unless the alleged wrongdoing was intentional.
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