On 21 January 2018, the Tesla board of directors voted to grant Musk a tranche of stock options which have a value of approximately US$50bn. It is important to note that the exact value depends on Tesla’s share price on a given day. This executive compensation is not in the form of outright cash, but gives Musk the exclusive option to purchase Tesla shares at well below their market value.
Musk’s extravagant lifestyle is funded by borrowing and offering his Tesla shares as collateral. Instead of drawing a conventional salary from Tesla, he is effectively paid in stock options. Since he doesn’t have a salary, he doesn’t pay any income tax.
Excessive executive compensation – Tornetta v Musk
The award in question is not the first stock option Musk has received from Tesla. He received awards in 2009 both to encourage him to stay involved with Tesla, and for achieving development targets in relation to the Model S. These awards comprised 4% each of the company’s stock. From 2012, he received a further 10 tranches each of 0.5% of Tesla stock. Each of these awards was tied to achieving market capitalisation and operational targets. By the end of 2017 Musk owned 21.9% of Tesla shares, and thanks to Tesla’s increasing share price, his stake was now worth some $13bn.
Tesla shareholder Richard J Tornetta objected to the 2018 award. This was partly on the grounds that this large new issuance of Tesla shares would substantially dilute the value of existing shareholders’ portfolios, including his own. Tornetta believed that Tesla’s directors had breached their fiduciary duties (duties of care and loyalty) to Tesla’s shareholders. Therefore, he sued Tesla on 5 June 2018 in the Delaware Court of Chancery. The case came before Chancellor Kathaleen St Jude McCormick, who issued her ruling on 30 January 2024.
The chancellor’s opinion
Chancellor McCormick’s 200-page opinion raised a number of awkward questions for Tesla and its board. Her findings were that Tesla (the company), was effectively controlled by Musk.
Several members of the Tesla board of directors had been presented to shareholders (including Tornetta), as being independent at the time the board was seeking shareholder approval of the 2018 award to Musk. In reality however, they were anything but. They had close personal and/or financial ties to Musk and indeed Musk observed in 2018 that the new chair of the board Robyn Denholm would “not rein him in”.
McCormick also found that Tesla’s proxy statement (a statement required by a publicly traded company when soliciting a shareholder vote such as the one on Musk’s 2018 options award), had materially omitted numerous important facts.
Even more important than these findings of fact, are the questions raised by McCormick, reminiscent of Sherlock Holmes’ famous “dog that didn’t bark in the night”. Why was the compensation plan needed to incentivise Musk? As seen above, in 2018 Musk owned nearly 22% of Tesla shares. This means he stood to gain financially by 20% or more, every time Tesla’s market capitalisation (the number of shares issued multiplied by the price of each share) increased. What efforts had the board taken to negotiate with Musk over the award?
Accordingly, McCormick ruled that Tesla’s board of directors had indeed breached its fiduciary duty to the shareholders, despite her opinion that “a board of director’s decision on how much to pay a company’s chief executive officer is the quintessential business determination subject to great judicial deference”. Her decision was to rescind Musk’s compensation award, not least because Musk “dominated the process that led to board approval [of the award]”.
McCormick concluded her opinion by directing Tesla and Tornetta “to confer on a form of final order implementing this decision and submit a joint letter identifying all issues, including [attorneys’] fees, that need to be addressed to bring this matter to a conclusion at the trial level”. One might have expected this to draw the matter to a conclusion, but this was not to be the case.
Tesla’s response
Less than an hour after publication of the chancellor’s opinion, Musk posted on Twitter: “Never incorporate your company in the state of Delaware.” He also put up a poll asking his followers if Tesla should reincorporate in the state of Texas and then less than 12 hours later claimed that the poll had received 1.1 million votes with 80% being in favour. That Twitter polls are highly vulnerable to manipulation or that those voting may not be experts in company law or financials was curiously not mentioned.
Some internal machinations then took place at Tesla which were not made public until 17 April 2024. Tesla’s board released a further proxy statement which sought shareholder approval on a number of matters, including reincorporating the company in Texas and crucially, ratification of the 2018 grant to Musk that had just been struck down by the chancellor.
On 3 May 2024, Tesla chair Robyn Denholm posted a video to Tesla’s investor relations page, imploring shareholders to vote in favour of both the redomestication issue and Musk’s pay award. It seems ethically dubious at the least, to have the chair of a publicly traded company try to influence a shareholder vote in this way after the proxy statement has been released.
Purported ratification by Tesla shareholders
The purported ratification of the 2018 grant, occurred at Tesla’s AGM on 13 June 2024. Tesla announced that shareholders had duly voted both in favour of moving the company to Texas, and to restore Musk’s 2018 grant. Yet this is far from the end of the matter: Tesla’s second proxy statement was also highly misleading by omission.
It did not address several important questions. First, why did Tesla so desperately need to retain Musk? Second, how independent were the directors who (re)negotiated Musk’s package? Ultimately, it ended up being just one ‘independent’ director, who owed her wealth to Musk for appointing her to Tesla’s board. Additionally, what steps did the board take to negotiate with Musk over his award? The answer is none. Finally, why did Musk require such an “unfathomable” (to use Chancellor McCormick’s words) award, over 250 times the average compensation for comparable CEOs?
The further implication is that a shareholder vote, even one based on full and accurate disclosure of all relevant materials, can override the ruling of a judge applying settled Delaware law. This is without even considering the implication that the desire to redomesticate Tesla in Texas, is Musk’s angry response to being held accountable to his shareholders by the Delaware court. Texas does not currently have business courts analogous to the Court of Chancery in Delaware. Therefore, the question of how moving to Texas benefits shareholders (as opposed to Musk personally), is again unanswered. A Tesla shareholder has already filed suit challenging the Texas move.
The conflicts of interest on Tesla’s board
As chair of the board, Denholm has a fiduciary duty to act in the best (neutral) interests of the company. Yet she appears to be disregarding this requirement. Her video mirrors the same omissions of material fact found in Tesla’s 2018 proxy statement. She characterises the court as overriding the wishes of Tesla shareholders, when arguably it upheld shareholder rights to full disclosure.
Denholm consistently refers throughout the video to “incentivising Elon”, suggesting that Musk’s 2018 package was for his personal benefit, not Tesla’s. She claims that because Musk’s 2018 pay award was struck down, Musk hasn’t derived any compensation from the growth of Tesla. Yet, if this was true, how did Musk fund the purchase of Twitter through selling Tesla stock?
Denholm was criticised by the chancellor as being effectively in Musk’s pocket. This criticism stems from her ‘hand-picked’ appointment to Tesla’s board, which allegedly earned her $280mn through sale of Tesla stock options. In comparison, she earned only $17mn in the years immediately before her appointment to Tesla. It’s also worth noting that Denholm became chair after Musk was forced to resign from the post. This resignation occurred as part of a settlement with US regulators, following Musk’s tweet that he was on the verge of taking Tesla private at $420 per share (a substantial premium over the trading price at the time). He also claimed that “funding [for the deal was] secured”.
These conflicts of interest for Denholm and the other Tesla directors only serve to underline the chancellor’s finding: that Tesla’s board is made up of ‘yes men’ who do not stand up to Musk, and fail to act in the best interests of Tesla’s shareholders.
The current state of play
At a hearing on 2 August 2024, the chancellor asked Tesla many of these questions. Musk is a ‘controlling shareholder’ who stands on both sides of the 2018 award. Under Delaware law, such transactions must be approved by a special committee of the company’s board and a majority of minority shareholders (i.e. those who are not insiders such as the board). This committee must be independent, and able to freely select its own members and advisors. Furthermore, the committee has a duty of care to negotiate a fair price, and the shareholder vote must be fully informed and free of coercion.
Denholm’s video clearly fails to meet the last of these criteria and arguably, Tesla’s board has failed the others as well. It seems likely that Musk’s Texas move will not allow him to escape the jurisdiction of the Delaware courts and as a result, he isn’t getting $56bn any time soon.
