The Elon Musk pay dilemma

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Delaware chancery court judge Kathaleen McCormick made little effort to disguise her incredulity at Elon Musk’s jaw-dropping 2018 pay package when she ruled this week that it should be rescinded.

Tesla’s board was “perhaps starry eyed by Musk’s superstar appeal”, she said, when it completely failed to ask “the $55.8bn question: was the plan even necessary for Tesla to retain Musk and achieve its goals?” Her resounding answer, as she rescinded it, was no.

If that judgment holds up under any appeal, then what should Tesla have paid for Musk’s services? How big a stake does he deserve to have in a company whose value briefly topped $1tn in 2021? And how much personal control should he have over the company in the long term?

Those are questions that Tesla’s board now has to grapple with as a matter of urgency if it wants to keep its notoriously mercurial chief executive on-side. They are also questions that every successful tech company that still has an influential founder at the helm comes up against at some point. That “how much” question has been answered in very different ways. There is no simple conclusion: it just depends what company boards — and shareholders — will stomach.

Steve Jobs famously worked for $1 a year as chief executive of Apple. His ownership stake was only in the single digits, but that was still seen as incentive enough to keep him focused. At the other extreme have been founder-CEOs such as Larry Ellison at Oracle, whose annual pay reached nearly $100mn a decade ago. His compensation was eventually slashed after years of complaints from shareholders.

But Musk’s 10-year, $55.8bn stock compensation deal blew away all comparisons. Tesla claimed that it was “all upside” for its shareholders, since Musk would only get the shares if Tesla’s market value rose by $600bn. How could that not be a great deal?

Judge McCormick chose to look at it from a different angle: what did the company actually need to pay Musk to make sure he kept turning up to work? Musk had made clear he was staying at Tesla anyway. Her ruling was based on a fairness assessment. The process the board went through was not independent enough, she said, while the absolute size of the award — 250 times larger than the median compensation of comparable CEOs — couldn’t be justified.

That doesn’t necessarily mean Tesla can’t come up with a massive new stock compensation plan to replace the one that has just been rejected. If they go about things the right way, all Tesla and Musk need do, like any company, is make sure shareholders get a fully informed opportunity to pass judgment on the plan — something that didn’t happen last time around, according to the judge.

Meanwhile, the decision — should it withstand any appeal — would seriously cut into Musk’s personal stake in Tesla. The 2018 plan has left him with 304mn shares under option, representing nearly 10 per cent of the company’s current share count. Without the chance to exercise his options on that stock, Musk will be left with only the 13 per cent he currently owns.

That is well below the 25 per cent that he said earlier this year he needed if he is to stay fully committed to the company. Otherwise, he suggested, he would shift his AI and robotics efforts to his other corporate ventures instead. Like many of Musk’s tweets, the suggestion that he might refocus his AI efforts elsewhere looks like a future lawsuit waiting to happen. He has frequently claimed that most of Tesla’s future value depends on it operating a large fleet of robotaxis, rather than just being a carmaker, and has touted its plans to make humanoid robots. Shareholders may argue they have already paid up for that potential.

Tesla’s shares slipped on the news as Wall Street waited to see what the company would do next. Lifting Musk’s ownership from 13 to 25 per cent would cost shareholders about $70bn. Musk himself has suggested that the company might consider creating a separate class of stock with extra voting rights, something that would increase his control without necessarily adding to his economic interest. But while many tech companies have a dual-class share structure at the time of their IPOs, creating one after the fact would be a radical departure from normal practice.

Musk’s 2018 pay deal broke all historic records as the “largest potential compensation opportunity ever observed in public markets by multiple orders of magnitude”, according to McCormick. The next one could be equally extraordinary.

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