Managing Musk

Are Tesla's directors up to the task?

I recently published a short post on the latest developments with respect to Elon Musk’s $55 billion options package, voided a few months ago by a Delaware court. In that post, I referred to an older post of mine which explored the legal and financial details underlying that court decision. As it turns out, however, I never actually published that earlier post, which some of you spotted and helpfully pointed out to me. Rather than revise and republish that old post, I decided to incorporate some of my earlier commentary into this new post on the broader subject of corporate governance at Tesla, using the options grant controversy as a sort of case study of the challenges associated with managing a CEO like Musk.

I have been thinking a lot recently about Elon Musk, which if nothing else helps take my mind off Donald Trump. And I have been thinking particularly about the challenges facing the Tesla board of directors in governing a public company run by Musk, a talented but also notoriously difficult individual. And the question I keep coming back to is this: Are Tesla’s directors up to the task?

Elon Musk’s business empire has for many years been fertile ground for corporate governance controversy, most notably at Tesla. Think for example of Tesla’s acquisition of Solar City (a financially-challenged company run by Musk’s cousins), Tesla’s decision to invest corporate funds in a crypto currency being publicly promoted by Musk, Elon’s ill considered going private tweet (“price $420, funding secured”), his alleged drug use, his threat to develop AI outside of Tesla unless he gets more control over the company, and the many distractions and conflicts created by his extensive involvement with other companies in which he has a large financial stake and to which he devotes a significant amount of his time and energy.

And then there is Musk’s ubiquitous personal presence on social media. Against my better judgment, I have remained a lurker on Twitter (now X) and there are days when I and 170 million others receive not one or two but four or five tweets from Musk. (At times this past year, it seemed like there was an ongoing contest for who could tweet the most frequently, Musk, Trump or Bill Ackman.) And Musk’s tweets seem to have become increasingly erratic and provocative, not at all the sort of communication one would expect to receive from a major public company CEO. According to press reports, Musk’s tweets have put off a significant number of Tesla customers, demonstrably reducing demand for the company’s vehicles in certain key markets (eg New York and California). I don’t know if the impact of his tweets on Tesla sales has (or has not) caused Musk to rethink his approach to social media, but at least he has not come out publicly and told the offended Tesla customers to go f—k themselves, as he did to Twitter advertisers concerned about Musk’s approach to content moderation and ad placement on the site.

Suffice it to say that Musk’s personal behavior often seems to be well outside the bounds of what most of us would consider normal, and would not likely be tolerated for long by most corporate boards. But then most companies don’t have a rock star like Elon at the helm, or directors who have personally made so much money doing business with their CEO.

Elon Musk has been described as the Thomas Edison of our time, a once in a generation entrepreneurial talent. By force of his own vision, creativity and will, Musk has made things happen that few others would have attempted let alone achieved. Like Edison, however, Musk is far from infallible and his erratic behavior sometimes crosses the line and creates problems for the companies with which he is involved. But Musk is such a talented and successful individual in so many respects that one might be tempted to conclude, as Elon apparently has, that the normal rules of executive behavior simply do not apply to him.

Which of course can make things quite tricky for the directors of Musk-run companies. It has been a long time since I practiced corporate law, but to my knowledge there is still no legally recognized “Elon exception” to the laws governing director duties and corporate governance. Under Delaware law, and I suspect even in Texas, the directors of business corporations are fiduciaries, charged legally with acting in good faith to advance the interests of the companies they serve, and are not meant simply to rubber stamp whatever the CEO wants to do or to turn a blind eye when the CEO’s behavior violates company policy or threatens to harm the company’s business.

Which brings us to the matter at hand, Tesla’s decision six years ago to grant Elon Musk the largest executive compensation award in US public company history, a package of performance stock options valued on the grant date at $2.6 billion and which five years later had an intrinsic (in-the-money) value of ca $55 billion. The options grant was approved by Tesla’s board of directors and ratified by shareholders in 2018, but was subsequently voided by a Delaware judge in a decision which came down six years after the options were awarded and after all of the options’ performance vesting metrics had been achieved. Musk and the Tesla directors were outraged by the court decision, as were many Tesla shareholders, and the company is now seeking to have the 2018 option package reinstated.

As is often the case, the matter of Musk’s 2018 options grant is more complicated than it might seem from a quick read of the press coverage. It also raises a number of interesting questions about the state of corporate governance at Tesla, where Musk appointees and close confidents continue to dominate the board.

Let’s explore.

How did Musk become Tesla’s largest shareholder? There appears to be some controversy over whether Elon Musk should or should not be considered a ‘founder’ of Tesla, but by 2018 there was no doubt as to who controlled Tesla. Musk was at the time not only Tesla’s CEO and chairman of its board of directors, he was also the company’s largest shareholder with a 20% stake. A large portion of Musk’s ownership stake consisted of shares purchased in Tesla’s early days, when he invested $70 million of his own funds, representing over 35% of the total equity capital raised by Tesla from 2004-09. But Musk also received increasingly large stock option awards (in lieu of annual bonuses) in 2009, 2012 and again in 2018. During 2022, Musk exercised some of his older vested options and subsequently sold $23 billion worth of stock to fund his acquisition of Twitter. By January of 2024, Musk owned outright 400+ million Tesla shares, an ownership stake of ca 13%, at the time worth about $60 billion.

The 2012 options grant. In the spring of 2012, three years after the company’s first award, the Tesla board agreed to grant its CEO a second package of performance stock options exercisable into 5% of the total number of shares then outstanding. The options were structured in ten separate tranches, each of which would vest only upon the achievement of two objectives: incremental $4 billion increases in the company’s market capitalization and the achievement of defined operational milestones. At the time of grant in 2012, Tesla’s market cap was only $4 billion and so the option package would fully vest only if Tesla’s market cap grew by a factor of 10x over the life of the options. The 2012 share grant was not put to a vote of shareholders at that time, but it was retroactively ratified in subsequent triennial ‘say on pay’ votes held in 2014 and 2017.

During the five years following the 2012 options grant, Tesla achieved all but one of the operational performance milestones set forth in the options and increased its market capitalization by a factor of 17x, roughly 70% of which was attributable to Tesla’s increased share price. (The remainder was attributable to the issuance of additional shares, which diluted shareholders but raised much needed capital to fund the company’s continued growth.) As was the case following the 2009 grant, Musk’s compensation from 2012-18 consisted almost entirely of the options grant, with only negligible salary and no cash bonuses paid during this period.

The 2018 options grant. By early 2017, with Tesla close to achieving the final operational milestones embedded in the 2012 options, the board began to consider how it might incentivize Mr. Musk to lead Tesla through the next phase of its development. What came out of these board deliberations was the 2018 CEO Performance Award, patterned after the 2012 plan. The 2018 grant consisted of twelve tranches of performance stock options, each exercisable into 1% of the company’s shares outstanding at the time of grant, which would vest sequentially upon the achievement of defined operational (or financial) and market cap milestones. At the time of the 2018 grant, Tesla’s market cap was around $50 billion, and each of the market cap milestones required incremental market cap increases of $50 billion. In order for all twelve tranches to vest, Tesla would not only need to hit all of its operational milestones but also to grow its market cap from $50 billion to $650 billion, no mean feat. Vesting of the options was also conditioned on Mr. Musk’s continued employment at Tesla, serving either as CEO or as Executive Chairman and Chief Product Officer, in each case with all of the company’s leadership team ultimately reporting to him. The options had a 10-year life from the date of grant, an exercise price of $23.33 (the split-adjusted market price on the date of grant), and required that Musk continue to hold any shares received upon exercise for a period of five years.

The board approval process. This is where the story gets interesting, for lawyers at least. In its 2018 proxy statement soliciting shareholder approval of the CEO Performance Award, Tesla described a prolonged, vigorous and informed board deliberation process, led by the compensation committee of the board consisting entirely of ‘independent’ directors. During the deliberation process, the comp committee solicited and received professional advice from compensation consultants and external legal counsel. The chairman of the comp committee and the company’s general counsel also held confidential discussions with fifteen of Tesla’s largest institutional shareholders, soliciting their views on how best to compensate Musk going forward. According to the proxy statement, the committee discussed extensively over many months various considerations of importance to this decision, including the reasons for such an award, how best to incentivize and motivate Musk, how to align the interests of Musk and Tesla’s other stockholders, whether to model any new award on the 2012 Performance Award, what specific performance metrics to include in the new award, the size of the award and how best to balance the risks and rewards of any new award.

Based on this reading of the proxy statement, I think one would be hard pressed to argue that the Tesla board did not engage in the sort of informed and independent decision making which under Delaware law normally elicits judicial deference to the good faith business decisions of the company’s directors. Which no doubt is what Tesla and its directors expected would be the outcome of the lawsuit filed by a small Tesla shareholder (derivatively on behalf of all shareholders) seeking recision of the 2018 options grant (and a big contingent fee for the plaintiff’s attorneys).

But this is not in fact how the Delaware court saw matters. Not even close.

The Delaware court decision. In January 2024, a Delaware trial court—the same court (and judge) that had previously ordered Musk to complete his agreed acquisition of Twitter, costing him personally some $20+ billion—unexpectedly voided Tesla’s 2018 stock options grant to Musk. In doing so, the trial court opinion presented a summary of the facts underlying the Tesla board’s deliberation and decision making process which was markedly different from that described by the company in its 2018 proxy statement. In essence, the court found that most members of the Tesla board and compensation committee were not in fact ‘independent’ of Musk and that the committee review process was not as thorough and deliberative as portrayed in the proxy statement. According to the court, the comp committee did not in fact dig very deeply if at all into the various ‘considerations’ set forth in the proxy statement. Evidence produced at trial suggested that it was Elon Musk himself who designed the options package and presented it to the board for approval on his own terms and timeline, not the other way around, and that the ‘negotiations which took place between the committee and Musk were limited in scope and addressed only peripheral terms of the option package. In the court’s opinion, the weight of credible evidence produced at trial supported its finding the Tesla board’s decision granting Musk the 2018 CEO Performance Award was not made by truly independent directors exercising in good faith their fiduciary duties to the company and its shareholders.

As a consequence of this finding, the court determined (consistent with established Delaware law) that the defendants (Tesla, the directors and Musk) would not be entitled to the wide scope of judicial deference normally given to board decisions under Delaware’s ‘business judgement’ rule, but would now have the burden of proof to justify the transaction under the tougher ‘entire fairness’ standard. Which as a practical matter was pretty much game over for the Tesla team, given the unprecedented size of the grant.

And because of various material misstatements of fact made by the company in the 2018 proxy statement, the subsequent ratification of the plan by 75% of the non-Musk Tesla shareholders would not save the award from judicial nullification.

So what comes next? Here we don’t have to speculate, because Tesla has now made public exactly how it plans to resurrect the 2018 options grant. A week or so ago, Tesla filed a new proxy statement seeking shareholder approval for two actions: (1) retroactive shareholder ratification of the 2018 options grant to Musk, and (2) the reincorporation of Tesla in Texas, something Musk had previously threatened to do and which the company’s board has now independently decided is in the best interest of the company and its shareholders.

This time around, however, Tesla has gone to great lengths to document the various ways in which its latest board decision making process addresses (and it hopes remedies) the various flaws cited by the Delaware court in its January decision. In contrast to the 2018 process, Tesla this year set up a ‘special committee’ to review the voided options grant and to recommend appropriate action to the full board, rather than relying again on the fatally conflicted compensation committee. The special committee consists of just one director, Kathleen Wilson-Thompson, who joined the Tesla board in December 2018, shortly after its approval of the Musk options, and who is apparently the only Tesla director not tainted by Musk conflicts.

And in an attempt to remedy any legacy proxy statement disclosure issues which might once again infect the shareholder ratification process, the company has incorporated into the proxy statement the full decision of the Delaware court, putting Tesla shareholders on notice of the many alleged defects in the original grant award process and of the reasons the court failed to find the 2018 grant ‘entirely fair’ to Tesla and its shareholders.

Moving from process to substance, Tesla is asking shareholders once again to ratify the 2018 award as a matter of “fundamental fairness and respect to our CEO”. As I read it, the company’s argument is essentially this (my words, not the company’s): “Elon Musk has been treated badly by the Delaware court and as a matter of simple fairness he deserves to have his 2018 options grant reinstated on the original terms. The company agreed in 2018 to grant him the options; shareholders at the time ratified that decision; Elon worked hard for six years without pay in reliance on the option grant; and the company under his leadership hit all of the performance metrics set forth in the options. In summary, we gave him the options; he earned them; and he deserves to keep them.”

Which will no doubt sound right to the vast majority of Tesla shareholders, as it does to many others who do not own TSLA shares and may not be big fans of Elon.

As for the outcome of the upcoming vote, I suspect that Tesla shareholders will once again vote overwhelmingly to ratify the 2018 options grant. But there may be some who object and vote ‘no’, taking the harsh but not unreasonable position that while Elon may in fact been treated unfairly, whatever benefit the company stood to derive from Elon’s leadership when it issued the performance options in 2018 has already been received, at a cost savings to the company of $55 billion complements of the Delaware court. And in this view, the Tesla board cannot as a matter of fiduciary duty simply reimburse Musk for his judicially voided benefits, at great cost to the shareholders, simply because the Musk-appointed and conflicted board screwed up in the first place.

And while I do not think this argument will carry the day, in court or at the shareholder voting booth, one can only hope that the Tesla board—and Ms. Wilson-Thompson in particular—is prepared to defend their decision retroactively to reinstate the 2018 options grant, giving Elon an additional 300 million shares of Tesla stock for work already completed, when in six months time Elon comes back to the board with his hand out looking for an even larger equity stake in order to make him ‘comfortable’ and to keep him ‘motivated’ as Tesla’s CEO for another few years of part-time work.

And, of course, to fund his mission to Mars.