The ill-conceived judgment against Elon Musk in the Delaware court make Delaware a poor jurisdiction for corporations

Judges who are jealous of corporate success don't help

The Court of Chancery in Delaware recently found that Elon Musk’s $55 billion compensation package was excessive and criticized both Musk and the Tesla board for approving the scheme. It is worth taking a moment to peel away the rhetoric in the 200 page judgment and explore the underlying facts.

In January 2018, Tesla shares traded at $23.33 a share and there were 2,490,000,000 shares issued and outstanding. The market capitalization of Tesla at that time was $58 billion dollars. Exercise of those options would cost Musk approximately $7 billion and that $7 billion would land in Tesla’s treasury, increasing the value of the company by amount Musk paid. The compensation package was voted on and approved by a majority of Tesla shares. No shareholder objected at the time and none were confused that Musk would do well if and only if Tesla did well.

The Tesla board approved a 10-year compensation plan for Elon Musk that comprises 100% at risk compensation - no salary, no bonus, no fee shares, no Resticted Share Units (RSUs), no Performance Share Units (PSUs) and no guaranteed compensation. Instead, Musk was awarded options on 304 million shares at the then market price of $23.33 a share vesting and excercisable solely on the achievement of set objectives for building the value of Tesla shares. The options shares if exercised (and only exercisable if the objective were met) amounted to about 10% of Tesla shares. It is not unusual for a founder and leader of a fast growing company to be awarded the opportunity to increase his ownership of the company by ten percentage points if that leader succeeded in building tremendous value for shareholders.

There is no doubt and no arguable case that Musk did not do a good job of leading Tesla. In just six years, under Musk’s leadership, Tesla market capitalization was equal to the market capitalization of all listed automobile manufacturers on Earth.

Many Tesla shareholders became rich owing to the success of Tesla’s management, including Musk.

Musk’s leadership was extraordinary. Tesla vehicles are well-designed, exhibit outstanding performance, and command premium prices in the most competitive market in the world - the auto industry.

General Motors is a good reference point for comparison. In January 2018, when Musk’s compensation was approved, GM stock traded at $40 a share. Today, GM’s stock trades at about $40 a share. Had Tesla under Musk’s leadership only matched that of the GM, Musk would have worked six year for zero compensation. Mary Barra, CEO of GM, received over $20 million each year since her appointment as CEO in 2014. Maybe GM shareholders would have preferred Musk’s package for Barra?

The Delaware decision will be appealed but it is not without some merit as a precedent even if it came to the wrong conclusion. Justice Kathaleen McCormick set out a set of principles for boards and courts to consider when setting CEO compensation, a subject of much controvery where little judicial guidance exists owing to the courts typical deference to the “business judgment rule” which gives boards wide latitude in setting exective compensation. McCormick correctly found that boards need to act independently of management, avoid conflicts of interest, and act soley in the best interests of the corporation they serve. But she erred in holding that Musk’s options were “deeply discounted” since they were awarded at the market price at the time of the award, without discount or premium, or that because he already owned shares in the firm he led he was already “motivated” by that ownership. Musk had other opportunities than Tesla and accepted the Tesla package on the basis that he would only benefit if he reached the goals. McCormick erred in finding the goals were easy to attain - to raise the market value of an automobile assembler about tenfold in an industry where the leaders of peers struggled to make any profits on electric vehicles or to build and value at all.

Justice McCormick seemed to persuade herself that $56 billion was “unfathomable” ignoring the reality that Bill Gates earned hundreds of billions from his leadership of Microsoft, as have many leaders of high technology growth companies whose corporations were extraordinarily successful. Apple, Google, NVidia, Netflix, Facebook (now called Meta), Amazon.com, Ali Baba, LVMH Moët Hennessy Louis Vuitton, among others, share the reality that real success brings real rewards to founders and leaders. There is a stench of leftist ideology in Justice McCormick’s decision although her willingness to try and put the brakes on excess compensation is laudable. Her talents would be better used to target the excess compensation for so many commodity based companies where the CEO’s are awarded millions and millions of dollars based on “performance” entirely in the hands of world commodity markets where they have no influence and can turn in high net income and receive millions in bonuses and options despite incompetent leadership, if the price of the commodity is high enough.