Elon's Options
"We had a deal!"
This post has been edited since it was first published on June 11, mostly to clean up ambiguous comments and add links to some additional news articles.
This will be an historic week for Elon Musk and for Tesla. On Thursday, June 13th, Tesla shareholders will vote on whether to ratify Elon Musk’s 2018 options package, currently worth around $44 billion (intrinsic value). You may recall that the now fully-vested options grant was retroactively voided by a Delaware court this past January, after the trial court found fatal flaws in the board’s original grant approval process and in the related proxy materials sent to shareholders. Tesla intends to appeal the Delaware court decision once final judgement is entered, but it is hoping that a second shareholder vote, following a more diligent board review process and with enhanced proxy disclosure, will be sufficient legally to get the options package reinstated on appeal.
As I write, it is not at all clear that Tesla and Musk will get their way. Both major proxy advisory services, ISS and Glass Lewis, have recommended that shareholders vote AGAINST ratification of the options grant and many institutional shareholders are expected to follow this recommendation. In order for Tesla’s proposal to pass, it will have to receive FOR votes from shareholders holding a majority of the non-Musk shares voted in the meeting. In the original 2018 shareholder vote, the options grant passed with 73% of the votes cast in favor, but this time the vote is expected to be much closer.
The outcome of this week’s vote may depend on the turnout of retail shareholders, who are expected to be overwhelmingly in favor of the option proposal but who don’t always show up to cast their votes. Retail shareholders own somewhere between 30% and 40% of Tesla’s outstanding shares—I have seen various estimates, which don’t always split out ‘retail’ from ‘other’— and Elon Musk claims that he has 90% support among retail investors. Institutional investors own 40-45% of the shares, up from 30% or so at the time of the 2018 vote, a shift in ownership which in the absence of a large retail turnout may prove decisive to the outcome of the vote. Elon Musk owns about 13% of Tesla’s outstanding shares, which will not be counted for purposes of the options approval vote, and other company insiders hold another few percent. Tesla’s top three shareholders are Vanguard (7%), BlackRock (6%) and State Street (3%). In the 2018 vote, Vanguard voted against approval and BlackRock voted for approval. One of American’s largest pension funds, CalPERS, has announced that it will vote against the proposal as has Norway’s giant sovereign wealth fund, and other institutions may well follow the lead of these two firms.
Shareholder voting on the options proposal may be impacted by the recent performance of Tesla’s share price. Tesla shares currently trade at a price of $170, down 58% from their 2021 peak price ($400) and down 31% year to date ($248), but up 7.4x from the date of the 2018 options grant ($23, split adjusted). At the current TSLA share price, the intrinsic (in-the-money) value of the disputed Musk options (on 300mm shares) is around $44 billion, down from $54 billion or so (a capped amount) at the time of the Delaware court decision in January. And Tesla’s market cap at $500+ billion is now below the minimum vesting levels of several tranches of Musk’s option grants. (The twelve tranches of Musk’s options required Tesla’s market cap to grow in $50 billion increments, from $50 billion for the first tranche to $650 billion for the final tranche).
Elon Musk currently owns around 415 million Tesla shares, representing ca 13% of the total outstanding, At the time of the options grant in 2018, Musk owned about 22% of the total shares, but he subsequently sold several large blocks of shares raising $38 billion, a portion of which was used to fund his purchase of Twitter. In January of this year, shortly before the Delaware trial court issued its options decision, Musk made public statements that he was “uncomfortable growing Tesla to be a leader in AI & robotics without having ~25% voting control", a control threshold he was close to reaching even without the options grant prior to selling shares to fund his Twitter adventure. It is not clear how this thinly veiled threat by Musk—’increase my ownership stake or I will take my AI toys and play with them elsewhere’—will impact either the shareholder vote or any subsequent court decisions. But this may be another case where Elon Musk proves to be his own worst enemy and should simply have kept his mouth shut.
I have no idea whether or not Musk’s options package will be ratified in the upcoming vote, but if shareholders do not approve the 2018 options grant, all hell may break loose in Musk world. Tesla is very concerned about this potential outcome and the company (with Musk in tow) is lobbying furiously to generate supportive shareholder turnout and to swing undecided voters into the “for" camp. According to press reports, the vote tally appears to be too close to call.
Tesla’s argument to shareholders is quite simple: “We made a deal with Elon in 2018, awarding him stock options with very ambitious performance vesting targets, in lieu of a salary, cash bonuses or other compensation. The options grant was approved at the time by directors and shareholders. The company under Elon’s leadership has achieved all of the performance vesting targets and he has earned the promised compensation. Tesla’s share price is up 7.5x from the date of the options grant (net of the dilution from Musk’s options), and long-term Tesla shareholders have benefited handsomely as a result. The Delaware court opinion was wrongly decided, and as a matter of simple justice Elon should receive the full package of options which were awarded to him six years ago. We ask you the shareholders to do the right thing and vote FOR the options proposal.” [These are my words in quotes, not Tesla’s, but I think the paraphrasing is accurate.]
On the surface, Tesla’s argument seems sound and worthy of support. But here’s the problem: The Delaware court voided the original grant in large part because Musk had stacked the board with individuals indebted to him personally—Tesla board members apparently earned several billion dollars investing with Elon— and the court concluded that as a result of this conflict of interest the directors who approved the grant were not acting in good faith and were not fully transparent with shareholders about the extent of their conflicts. And so the initial shareholder vote of approval was also legally defective.
In voiding the options grant, the court was also moved by the sheer size of the compensation award, which was completely unprecedented and which the judge called “an unfathomable sum”. At the time of the 2018 grant, the options awarded to Musk were valued by the company at $2.6 billion, something like 10x the size of the next largest executive equity grant in US public company history, which was Tesla’s previous options grant to Musk in 2012. And at the time of the Delaware trial, the intrinsic value of the options had risen to $54 billion (an amount capped by the terms of the options), meaning that Musk’s actual compensation received during the six years since the options grant amounted to $9 billion per year. I think it is fair to say that this windfall for Musk was simply too big a pill for the court to swallow, particularly when viewed under the ‘entire fairness’ standard of review with the burden of proof shifted to the defendant.
Because the 2018 options grant has been voided by the Delaware court (or will be when final judgement is entered), as things now stand Musk is not legally entitled to the previously granted compensation award and Tesla has no legal obligation, and some would argue no legal authority, to make him whole for his loss. What Tesla is now proposing looks to many like a retroactive payment of $44 billion to Musk for services rendered in the past, the benefits of which have already accrued to Tesla and its shareholders. And so the question for shareholders boils down to this: Should Tesla keep the 300 million shares underlying Musk’s options in reserve for potential future corporate issuance, for the benefit of all shareholders, or should these shares be transferred by the company to Musk as payment for his past services, with no concessions on the part of Musk and no guarantee even of his future commitment to the company?
From the Tesla and Musk perspective, this is a false narrative. They believe they had a deal (on compensation), properly authorized at the time of grant, and they want the original deal enforced by the courts with no changes to its terms. Their argument to shareholders is that ‘a deal is a deal’ and reinstating the options package is the only just, fair and honorable thing for the company and shareholders to do. In a similar vein, Musk has publicly criticized CalPERS for their decision to vote against the grant, saying "CalPERS broke the deal. Shame on them, they have no honor."
To see Elon Musk play the honor card strikes me as more than a little ironic, since breaking legal commitments seems to be a key component of the Musk playbook. We saw this back in 2009 when Musk took control of Tesla and attempted to stiff one of the original founders for a share of his equity, and again in 2021 when Musk tried to do the same thing to a departing Tesla senior executive who Musk thought had been overpaid for his years of service as a result of Tesla’s strong share price performance. We saw this in 2022, when Musk tried to weasel out of his legal commitment to pay Twitter’s shareholders the absurdly high (but contractually agreed) price of $44 billion, an amount about equal to the current value of the Tesla options which Musk wants back. And this is also what Musk seems to have done after taking control of Twitter, when the company under his direction refused to pay suppliers for millions of dollars of unpaid bills and fired a large number of executives and employees shortly before their equity compensation vested and without paying them their promised severance, which Musk justified publicly by saying that to do otherwise would have cost him $200 million dollars. In Musk world, it would seem that ‘honor’ means ‘a deal is a deal’, but apparently only when it is Elon who is on the good end of a bad bargain.
It may well be that a majority of Tesla’s shareholders will vote on Thursday to ratify the 2018 options grant. But if this happens, will it necessarily mean that the Delaware court will vacate or revise its order voiding the grants? I have no idea, and legal experts seem divided on the question. In proceeding with the shareholder vote, Tesla is relying on a rather obscure feature of Delaware law intended to deal with technical defects in prior corporate action, which the company concedes is a ‘novel’ application of the law. Because final judgment has not yet been rendered by the trial court (pending approval of attorney’s fees), Tesla has not yet appealed the January decision. Tesla hopes that a positive shareholder vote ratifying the 2018 options grant, supported by an enhanced board review process—conducted by a newly appointed committee of one, consisting of the sole Tesla director deemed not to be conflicted in this matter— will strengthen its case with the trial court or on appeal. Which may or may not turn out to be the case.
If this doesn’t work, however, Tesla may have another trick up its sleeve. In this week’s proxy vote, Tesla is not only asking shareholders to approve the options grant, it is also asking them to approve a change in Tesla’s state of incorporation from Delaware to Texas, which the company believes will be a more ‘shareholder friendly’ environment. Tesla’s attorneys have assured the Delaware court that they will not re-litigate the options grant in Texas, but if the company wins on the shareholder vote they may well reconsider this commitment and try again in Texas.
I really have no idea how any of this will play out. At the end of the day, however, it may turn out that the most enduring aspect of the Musk options fiasco is the impact it will have on future CEO pay decisions, at least in the public company context. At some point we as a country are going to have to rethink the distinctly American practice of awarding CEOs annual compensation in the tens of millions and sometimes in the hundreds of millions of dollars (or more). I have been waiting years now for large institutional shareholders to band together and rebel against outrageous CEO compensation awards, saying in effect “We are mad as hell and we’re not going to take it anymore”. So far this has not happened, other than in one-off instances. But a rejection of the Musk options package by Tesla’s institutional shareholders may help turn the tide. And in voting ‘no’, Tesla’s institutional shareholders will be the ones doing the truly honorable thing, not only reversing Musk’s compensation award but also perhaps opening the door to much needed reforms in American executive pay practices.
And if this happens, we may well have Elon Musk to thank for reducing CEO pay in this country. Which would be truly ironic indeed.
Links
Legal Hurdles Loom Over Tesla’s Bid to Revive Musk’s Record Pay, Reuters, May 30, 2024
Top Proxy Firm Recommends Against Musk’s Pay Package, WSJ, May 31, 2024
Tesla Pay Package Gives Elon Musk a Taste of Karma, WSJ June 8, 2024
The $25 billion Footnote in the Tesla Pay Vote, WSJ, June 8, 2024
Tesla Shareholders Vote on Elon Musk’s Big Payday. What Happens Then? NY Times, June 8, 2024
A New Measure Shows CEO Pay at Even More Astronomical Levels, NY Times, June 7, 2024.
The Vote on Elon Musk’s Pay Package is Coming Down to the Wire, WSJ, June 11, 2024
To Understand Elon Musk’s Descent, Look at His $46 Billion Pay Package, NY Times, June 11, 2024
Tesla Investors to Decide if Elon Musk Deserves $45 billion Payday, NY Times, June 12, 2024
Tesla Share Price Is Its own Referendum on Musk, NY Times, June 13, 2024
Tesla Proxy Statement, April 2024
Delaware Court Decision Voiding Musk Options, January 2024